When you start hiring people to help with different areas of your business, you have a choice whether to pay them through the payroll versus pay them as a freelancer.

Sometimes, this choice is easy. For example if you hire an outsourced accountant like us, we will always be paid as a “contractor” or “expense” to your business, rather than on payroll.

Other times, it’s more challenging to decide. Usually, you have two choices:

  1. Pay them through your payroll using the PAYE system.
  2. Pay them as a freelancer.

When making this decision, you should look at the following areas:

  • What is the set up time/cost for this option?
  • What are the tax implications for this option?
  • How does it work for the employee or contractor?
  • What do you need from the employee or contractor?
  • What do you need to do every month with this option?

* Please note that the IR35 rules essentially states that if a person is using an intermediary (such as a limited company) but working full time for one company, then they should be treated, and taxed, like an employee). This article will assume that the person in question is a genuinely self-employed, or working for multiple people.*

What is the set up time/cost for this option?

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Payroll

To set up payroll for the first time, you must apply to be an employer within your Government Gateway login.

Once this is done, you must set the employee up in your payroll system. This is usually part of your accountancy software, but you can also use external payroll systems.

Free payroll systems can be found here.

Paid for payroll systems can be found here.

We usually use Xero Payroll for our clients, included with any of our bundles.

Contractor

To set up a contractor, there is nothing you have to do from an administrative point of view other than make sure you have a solid contract and the terms are clearly specified.

Summary

As you can see, it is a lot easier to set up a contractor relationship than a payroll relationship. Contractors usually provide the contract themselves, but you may want to include a NDA depending on the nature of the work they’ll be doing.

What are the tax implications for this option?

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Payroll

If you pay an employee through the payroll, you will incur the following costs:

– Gross salary of the employee as agreed at the start of their work

– Employers National Insurance contributions (roughly 13.8% of anything they make over £737 monthly)

– Employers Pension Contributions (usually around 3% of the gross salary- depending on your pension scheme)

What you’ll see on your profit and loss is:

  1. The NET pay of the employee
  2. The ER NI contributions
  3. The ER Pension contributions

These costs will all be “taken away” from your revenue, meaning you’re net profit will reduce, therefore your corporation tax reduces as well.

** Keep in mind, you’ll also be paying PAYE income tax and the employee national insurance and pension contributions, but this will be part of their gross salary, so will not be an “extra” cost to the company **

man completing tax return

Contractor

If you pay a contractor, the entire expense will be put through the profit and loss as an expense, reducing your final corporation tax bill.

Summary

Whilst the payroll system is slightly more complicated, it can usually work out as slightly more tax beneficial when it comes to the corporation tax side of things. However, that is because it is usually the more expensive option!

How does it work for the employee or contractor?

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Payroll

If you hire someone via the payroll system, it means that everything is taken care of for them. They will not have to file anything with the government separately, unless they have other income from outside your agreement.

It also means the tax comes out of their salary on a monthly basis, so is usually easier to manage and the preferred option for many people.

Contractor

If you hire someone as a contractor, this usually means that they are set up as a sole trader or limited company. Either of these cases means they must report their income on their own accord, and file their taxes separately to your company.

This means their taxes come out at the end of the year, rather than monthly, so it takes a bit more planning and accountancy skills to do it this way.

Summary

Depending on the nature of work, and the individual, they may or may not prefer to be on the payroll. As the payroll solution is the more simple route for the individual, most people prefer this way.

What do you need from the employee or contractor?

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Payroll

To set an employee up you will need the following information:

Personal Details

Name:

Date of Birth:

Resident Address:

Phone Number:

Email:

NI Number:

Current Employment

Start Date:
Pay Frequency:

Contract Amount:
Pension Opt-In:

You should double check that this will be their only source of PAYE income here as well.

Previous Employment

You’ll need a P32 or P45, or written confirmation that they have not made any income in the current financial year.

Bank Details

Sort Code:

Account number:

.. so you can pay them!

Contractor

To hire a contractor, you only need the following:

  • A contract stating terms of work, rate of pay, and frequency of pay
  • Their bank details

Summary

Paying employees through payroll means you have to know a lot more about them than if they were a contractor, however, this also gives a sense of trust and security between the two parties.

What do you need to do every month with this option?

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Payroll

Once the employee is set up on your system, you’ll need to file every month with HMRC regardless of whether they got paid or not (in the case of a zero-hour contract).

To do this you must insure that all figures are accurate, and that what the payslip says is what the employee actually gets.

PAYE is usually made payable on the 22nd of the following month.

Contractor

What you have to do every month when paying a contractor really depends on the agreement you have with that particular person.

If they are on an hourly contract, it may be the case of submitting their hours at the end of the week/month/quarter, getting it reviewed by their manager, and then raising an invoice to be paid.

In the case of a monthly set fee, it may simply be put on a direct debit that you can then forget about!

Summary

The payroll system is slightly more manual and time consuming than the contractor option, however, your accountant can usually take care of the submission to ensure correct data.

Overall;

Hiring a contractor is a lot ‘easier’ than hiring someone through the payroll. Having said that, that is completely from a financial and administrative point of view. Many individuals prefer being hired through the payroll system, it’s a higher sense of job security, it usually means they are entitled to more benefits, they don’t have to file their own taxes, and a whole host of other reasons.

If you’re still unsure, or would like some professional advice, contact us! We’re happy to jump on a quick, free, 30 minute call to discuss your business and help you come to a good decision.