One of the most important decisions you can make at the start of a new working relationship is whether you're going to be an employee or a consultant. It sounds straightforward, but the difference is huge — legally, financially, and practically. Here's what you actually need to know.
Employment contracts
An employment contract creates an employment relationship. You work for the employer, under their control, following their instructions. In exchange, you get statutory rights. Minimum wage or a negotiated salary. Holiday pay. Statutory sick pay. Maternity or paternity leave. The right not to be unfairly dismissed. You're also subject to their duties — you have to follow their instructions, comply with their policies, and use reasonable care in your work.
As an employee, tax and National Insurance are deducted at source by your employer. They're responsible for paying employer's National Insurance. You get the security of being an employee, but less flexibility — they're your employer and they have broad control over how you work.
Consultancy agreements
A consultancy agreement is a contract for services. You're not an employee — you're a contractor providing services to a client. The key difference is the level of control. A client can tell you what outcomes they want, but they can't usually tell you how to achieve them. You have more autonomy — you might work your own hours, use your own equipment, set your own methods.
As a consultant, you're responsible for your own tax and National Insurance. You invoice the client, claim business expenses, and pay your own taxes. You don't get statutory employee rights — no holiday pay, no sick pay, no protection against unfair dismissal. But you also have more flexibility. You can take on multiple clients, set your own rates, and work to your own schedule.
The legal test: employee vs contractor
In UK law, whether you're an employee or a contractor depends on the reality of the relationship, not just what the contract says. A contract can be called a "consultancy agreement," but if the reality is that you're working under the client's control like an employee, the law might treat you as an employee anyway.
The tests that courts and tribunals use include:
Control. Does the employer/client tell you how, when, and where to work? If yes, that suggests employment. If you have complete autonomy over your methods, that suggests consultancy.
Integration. Are you integrated into the business? Do you have an email address, attend team meetings, work at their office, use their equipment? Integration suggests employment. Working remotely with your own equipment suggests consultancy.
Substitution. Can you send a substitute to do the work? If yes, that suggests consultancy. If the contract requires you personally to do the work, that suggests employment.
Mutuality of obligation. Is there an ongoing obligation on both sides? If the employer must provide work and you must accept it, that suggests employment. If it's project-based and either party can walk away, that suggests consultancy.
Exclusivity. Are you working exclusively for one client or multiple clients? Multiple clients suggests consultancy. Exclusivity suggests employment.
The practical difference in protections
If you're an employee, you have significant statutory protections. You can't be dismissed without fair process and a fair reason. You're entitled to minimum wage, paid holiday, statutory sick pay, and protection from discrimination. If the relationship breaks down, you can bring a claim for unfair dismissal.
If you're a consultant, you have fewer protections. You can be dropped by a client with contractual notice. Your only protection is the contract itself. If the contract says either party can terminate with one week's notice, then yes, they can do that with one week's notice. You have no statutory rights to redundancy, notice, or fair process. Your protection is whatever you've negotiated in the contract.
Tax and National Insurance
From a tax perspective, the difference is significant. As an employee, your employer deducts income tax and National Insurance, and pays employer's National Insurance. You get a payslip and the tax is handled automatically. As a consultant, you're self-employed. You invoice your client, pay tax on your profits, and pay Class 2 and Class 4 National Insurance. You also need to register for VAT if your turnover is over the threshold.
The upside is that you can claim business expenses — office, equipment, accountancy, insurance — which reduce your taxable profit. Many consultants end up paying less tax than employees because of deductible expenses. But you're responsible for tax compliance, quarterly payments, and managing your own cash flow.
IR35 and inside IR35
If you're contracting to the UK public sector (or sometimes the private sector), you need to know about IR35. This is a tax rule that says: if you're working as a contractor but the relationship is really like employment, you should pay tax as if you're an employee. If you're "inside IR35," the client is responsible for deducting tax and National Insurance. If you're "outside IR35," you pay tax as self-employed.
The test for IR35 is similar to the employment vs contractor test — the reality of the relationship matters more than the contract name. If you're a contractor who attends the office daily, follows the client's instructions, and works exclusively for them, you might be inside IR35 even if the contract says you're a consultant. If you're genuinely working autonomously for multiple clients, you're probably outside IR35.
Public sector organizations have to determine whether engagements are inside or outside IR35, and contractors have to declare their position to HMRC. Getting this wrong is expensive — HMRC can reassess your tax bills for up to six years back.
What to negotiate
If you're being offered a consultancy agreement, you have more to negotiate than an employee would. Some key things:
Notice and termination. How much notice do you need to give, and how much do they need to give? If it's one week either way but you might need months to find another client, push for longer notice.
Payment terms. As a consultant, you should invoice and be paid within 30 days. Don't agree to net-60 or longer without additional payment (interest) for late payment.
Exclusive engagement. If you're working full-time for them, are you exclusive? If not, can you take other clients? Make sure you can.
Rate and hours. As a consultant, you should be clear about your daily or hourly rate and expected hours. Is it 30 hours a week? 40 hours? Are you paid extra for overtime?
Expenses. Who pays for equipment, software, travel? Make sure you're not subsidising the engagement with your own money.
Insurance. Do you need professional liability insurance? Who pays for it?
The decision
Choose employment if you want security, predictable income, statutory rights, and a clear separation between work and personal time. Choose consultancy if you want autonomy, flexibility, the ability to work for multiple clients, and the potential for higher earnings (though with more tax complexity and less security).
If you're being offered a consultancy agreement but you suspect the reality is employment, get it reviewed. Misclassification can cost the client money in backdated taxes, and it can cost you security you thought you had. Our contract review service covers consultancy agreements and flags whether the relationship looks genuinely like consultancy or if there are red flags suggesting you might actually be an employee.