13th December 2022
13th December 2022
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5 - 2 votes
Every organisation faces the need for staffing and having workers carry out the functions needed to make that organisation meet its targets, fulfil its objectives and ultimately make enough money to be profitable. Today's business world has made it so that there are different ways to engage people to carry out these organisational tasks. These range from directly employing people, hiring freelancers, contracting service providers or hiring external consultants. While these different engagements have similar effects in that the individual provides services/tasks, they are fundamentally different in how they operate and in the true nature of the relationship between the persons and the organisation. These are all expressed in the different types of contracts used namely:
An organisation needs to be aware of the differences between these three types of worker contracts so that it knows which works best for its particular business model or which is easier for it to manage. For example, in practice, a small business (e.g. a startup). This is because in reality, the staffing requirements of a larger organisation are different from that of a smaller organisation, especially in relation to its needs and what it can afford.
An employment contract is a document that sets out the terms and conditions and the details of the relationship between the employer and the employee. Under UK law, an employment contract is regarded as a contract of services which is mainly identified through the existence of the element of control. Under an employment contract, the employer is regarded as exercising an element of control over the employee.
The three recognised characteristics of an employment relationship are the presence of an element of control, payment in the form of remuneration for the services provided and the existence of a contract that classifies the relation as a contract of service.
The element of control means that the employer can dictate how the employee is required to carry out their duties in the performance of the contract of services. An example in practice is that the employer can demand that the employee resume at a certain time to start work, and close at a certain time on a work day. If the employee fails to adhere to these rules, the employer can reprimand the employee through disciplinary measures which may even include terminating the employee's employment contract. Under an employment contract (i.e. a contract of service, the employee's freedom to carry out the service however they choose is significantly curtailed.
Additionally, under an employment contract, the employee is paid a set amount for the services they provide, i.e. the salary which should conform with the statutory requirements on minimum wage and income tax. The employment contract also provides the employee with certain protections under the law such as protection from unfair dismissal, payment of salary during sick leave, and access to maternity or paternity leave. Hence, if an employer or an organisation is looking to have sufficient control over how the worker performs their duties, and is okay with providing the statutory protections afforded by law to the worker, then an employment contract may be the preferred type of contract. Furthermore, an employment contract requires the employee to perform the duties/services personally (i.e. they cannot choose a substitute or an intermediary to perform the duties/services). This option may provide the employer with more quality control and certainty as it can closely monitor the works of the employee and ensure they meet the employer's desired standard.
A service contract (or a contract for services) is an agreement between two parties, the client/customer and the contractor/service provider, where the contractor agrees to provide specific services to the client in exchange for payment.
The first fundamental difference between the service contract and the employment contract is that. In contrast, the remuneration of the employee is by reason of the employment under an employment contract, the payment of the contractor under the service contract is dependent on the performance or provision of the contracted services.
Additionally, the contractor under a service contract usually works or operates independently of the client. This means that the client does not have control over the way the contractor performs the service. Rather, the contractor will have the power and right to choose how it will fulfil the services for which it has been contracted. The client will be limited to only choosing the deliverables and milestones that are to be performed.
Furthermore, a service contract does not have the same level of statutory protections afforded to an employment contract. For example, an employee is protected from unfair dismissal, redundancy or TUPE rules by reason of their status as an employee. Conversely, a contractor's recourse is limited to general contract law regulations such as in the Supply of Goods and Services At 1982 and other like statutes.
Although employment-related regulations do not apply to service contracts, the Equality Act 2010 is still applicable in protecting the contractor from harmful situations such as racial discrimination, age discrimination and so on.
In addition, except the service contract expressly prohibits it, the independent contractor may elect to use a substitute to perform the services on their behalf. In practice then, the situations where an organisation may choose to use a service contract are quite specific. Between two private individuals (i.e. where the client is not operating in a business capacity), the service contract is the obvious choice. But where the client is operating as a business (as a company, a sole trader or a partnership), it is not so clear cut.
The service contract is primarily beneficial where the client business entity wishes to avoid an employer-employee relationship that can trigger statutory employee protections. A practical example of such a scenario is with a startup business (company, sole trader or partnership) that cannot afford to take on employees but is in need of persons who can provide services for the startup to help it grow. Similarly, some well-established organisations and businesses may choose to hire a contractor under a service contract where the service needed is a specialist one that their current workforce cannot provide, or where the service needed is temporary and there will be no need to have an employee performing these tasks.
A consulting agreement, in many ways, is like a service contract with the major difference being that the consulting agreement is used specifically where the contractor will be providing the client with consulting services. Consulting services require specific skillsets and expertise such as management consulting, financial advisory consulting, IT consulting, Human Resources consulting etc. Because of the specific nature of the consulting agreement, it is always used in commercial relationships.
Under a consulting agreement, the contractor (also known as the consultant) has the option to work through an intermediary (i.e. a corporate entity/company or a partnership). That intermediary will serve as the vehicle through which the contractor will perform the consulting services. This proves beneficial to the consultant for different purposes, particularly the avenue to avoid income tax which is charged on an employee's salary. Similarly, the employer (the client under the consulting agreement) gets to benefit from the consulting agreement as it does not need to give the consultant employee rights or incur the costs associated with hiring an employee (e.g. employee national insurance payments). Because of the existence of these benefits to both parties, there are IR35 rules which apply to a consulting agreement. The IR35 rules examine the true nature of the relationship between the consultant and the client in order to determine whether it is in reality an employer and employee relationship. The major element that will be sought, as discussed earlier, is whether the client has sufficient control over the consultant and how they perform the consultancy services. If there is sufficient control rising to such a degree, then the consultancy agreement will be treated as an employment contract and the statutory rules on employment will apply. This indicates then that an organisation should be diligent when choosing to hire a consultant using a consultancy agreement and make sure that the true nature of the relationship is not that of an employee.
It is immaterial that the parties title the agreement as a "consulting agreement". If the true nature of the relationship is of an employer and employee, the IR35 rules function to treat the agreement as an employment contract. For more information on the IR35 rules, please see the gov.uk website.
In practice, a consulting agreement is attractive to organisations that are looking for very specific expertise or technical know-how and they wish to hire an external person or entity to provide them with this expertise. This is very similar to a service contract, with the only difference being that the consulting agreement provides for off-payroll working and is therefore subject to scrutiny under the IR35 rules.
The choice of which of these agreements to use comes down to the specific needs of the employer or organisation looking to hire a service provider. While all these agreements relate to the provision of those services, they differ in how the status of the person hired will be categorised. Hence, in addition to understanding these differences and the legal ramifications of each, the overarching consideration is a practical one and the impact of the chosen contract on the organisation's business. The key points to remember are: