IT Contractor FAQs - Frequently Asked Questions

The most popular way to start up in business in the UK is as a sole trader.

So why do IT contractors avoid this route, and work via their own limited companies or via an umbrella company scheme?

What is a sole trader?

Setting up as a sole trader is an easy process. After informing HMRC of your intention to become self-employed, you can get going right away. Unlike the limited company route, you are personally liable for the finances of the sole tradership, and your liability for any debts incurred is potentially limitless.

For taxation purposes, your personal and business affairs are treated as one, and you account for your business income via the self assessment process each year.

You can read Bytestart's guide to becoming a sole trader.

Why won't agencies deal with sole traders?

Even if you wanted to set up as a sole trader, you would be unlikely to find a recruitment agency who would be prepared to do business with you.

You can either become a PAYE employee of the agency, or form a relationship via your own limited company, or an umbrella company.

Although you are legally entitled to work as a sole trader, you would probably only be able to work directly for clients who were happy to engage you on that basis.

There are several reasons why this is the case:

1) Fundamentally, the Income Tax (Earnings and Pensions) Act 2003 - and previous Acts - prevent 'self employment' when an agency is involved, as the obligations of the Act would mean the recruitment agency would have to treat the contractor as an 'employee' and deduct PAYE and national insurance at source.

Chapter 7, s44 states:

"all remuneration receivable under or in consequence of the agency contract (including remuneration which the client pays or provides in relation to the services) is to be treated for income tax purposes as earnings from that employment."

2) Additionally, the agency (or client) could potentially be liable to pay any tax liabilities of any contractors who defaulted on their payments to HMRC.

3) From a contractors' point of view, your personal finances are protected if you work via a limited company and something goes wrong (assuming you run it in an above board manner), whereas as a sole trader your business and personal assets are treated in the same way.

In the absence of the tax legislation mentioned above, this reason alone would probably be enough to dissuade contractors from becoming sole traders.