Using Subcontractors: Employment Status Tests, IR35 Risk, CIS Obligations & Contracts

Quick Answer: A subcontractor is self-employed only if they have genuine business independence — they use their own equipment, work for multiple clients, can send a substitute, and bear financial risk. HMRC's CEST tool tests employment status. If a subcontractor is actually employed in all but name (personal service, no substitution right, under your control), HMRC will reclassify them as employees and pursue you for PAYE, NI, and penalties. Always register as a CIS contractor before the first payment.

Summary

Using subcontractors is a routine part of most trades businesses — you hire a plasterer for a week, bring in an electrician for the first fix, or pass overflow work to another sole trader. Done correctly, this is perfectly legal and commercially efficient. Done incorrectly, it creates a significant tax and employment law liability.

The key distinction is employment status. HMRC distinguishes between genuine self-employment (the subcontractor runs their own business, takes risk, and has multiple clients) and disguised employment (the subcontractor works exclusively for one contractor, follows their direction, and has no real independence). Where the latter is found, the contractor who hired them becomes responsible for all PAYE income tax, employer's National Insurance (13.8%), and any penalties — often for multiple years retrospectively.

This is one of the areas most commonly misunderstood in the UK construction industry. The test is not what the contract says — it is the reality of how the relationship works in practice.

Key Facts

• Employment status test — The three key tests: personal service (must the subcontractor do the work personally?), control (do you direct how and when they work?), mutuality of obligation (are they required to accept work you offer?)
• HMRC CEST tool — Check Employment Status for Tax — free HMRC online tool. The result is not binding on HMRC but demonstrates good-faith effort
• IR35/Off-payroll rules — In the private sector, from April 2021, medium and large businesses must determine employment status for limited company contractors they engage. For small businesses (turnover under £10.2m, fewer than 50 employees), the contractor determines their own status
• CIS registration — Any business paying subcontractors for construction must register as a CIS contractor before the first payment. See cis scheme
• Substitution clause — A genuine right to send a substitute (someone else to do the work) is strong evidence of self-employment. A clause in the contract alone is not enough — the right must be realistic in practice
• Control — If you tell the subcontractor when to arrive, what order to do things in, and how to do the work, this is strong evidence of employment. Self-employed workers typically control their own method
• Equipment — Self-employed workers use their own tools and equipment. Providing all tools, a company phone, and a branded van increases employment status risk
• Exclusivity — If the subcontractor works only for you, they are at higher employment risk. Multiple clients is evidence of self-employment
• Written agreement — Always have a written subcontractor agreement. This does not determine employment status but helps document the intended relationship
• Holiday and sick pay — Self-employed workers are not entitled to holiday pay or sick pay. If you provide these, the relationship may be employment

Quick Reference Table

Detailed Guidance

The Three Key Tests

Personal service: Can the subcontractor send someone else (a substitute) to do the work? A genuine right to substitute, which is actually exercised occasionally, is strong evidence of self-employment. A contract clause that says substitution is allowed but would never be accepted in practice is not genuine.

Control: The degree to which you control what the worker does, how they do it, and when. In construction, some control of method is inevitable for safety and quality — this alone does not make someone employed. The key is whether the level of control is that of a client directing an expert (self-employed) or a manager directing an employee.

Mutuality of obligation: Are you obliged to offer work and is the worker obliged to accept it? If the worker can refuse individual jobs and you have no obligation to keep offering work, this supports self-employment. A regular weekly subcontractor who always works for you and cannot really say no to a job without risking the relationship has an employment-like mutuality.

Practical Steps to Protect Yourself

1. Use a proper subcontractor agreement — In writing, signed by both parties, specifying: the nature of the services, the rate, the payment terms, the substitution right, the right to work for other clients, and that they are responsible for their own tax
2. Run the HMRC CEST tool — Keep a record of the result
3. Verify CIS status before the first payment — Log into HMRC and verify the UTR. Deduct at the correct rate
4. Pay on invoice — The subcontractor should submit invoices. Do not put them on a weekly payroll
5. Do not provide employment benefits — No holiday pay, no sick pay, no pension contribution. If you do provide these, seek legal advice
6. Encourage multiple clients — If a subcontractor has been working exclusively for you for more than a few months, that is an increasing risk factor

IR35 for Limited Company Subcontractors

If a subcontractor operates through a limited company, IR35 (off-payroll working rules) may apply. As a small business (under £10.2m turnover, under 50 employees), the responsibility for determining IR35 status sits with the subcontractor's company — not you. However, if you are a medium or large business, you must determine IR35 status for each limited company contractor and deduct PAYE if they are inside IR35.

For most sole trader construction businesses using other sole traders as subcontractors, IR35 is not directly relevant — IR35 applies specifically to personal service companies (limited companies set up by individuals to supply their personal services).

Subcontractor Agreement — Key Clauses

A well-drafted subcontractor agreement should include:

• Scope of services — What is the subcontractor being engaged to do? Be specific
• Rate and payment terms — Day rate, fixed price per job, or piece-rate. Payment on invoice within X days
• Right to substitute — The subcontractor may provide a suitably qualified substitute to perform the services, subject to the contractor's reasonable approval
• Multiple engagements — The subcontractor is free to work for other businesses and is not exclusively engaged by the contractor
• Equipment and tools — The subcontractor will use their own tools and equipment
• Tax and NI — The subcontractor is responsible for their own income tax, NI, and VAT obligations
• No employment benefits — The subcontractor is not entitled to holiday pay, sick pay, notice pay, or pension contributions
• Termination — Notice period for ending the arrangement (typically 1 week)

Standard template subcontractor agreements are available from FCSA, APSCo, or construction industry trade associations.

When Things Go Wrong

If HMRC conducts an employer compliance review and determines that a subcontractor should have been treated as an employee:

• HMRC can raise assessments for PAYE, NI, and interest going back up to 6 years
• Penalties may be added (up to 100% of the tax in fraud cases, 30% for careless behaviour)
• HMRC may pursue the contractor even if the subcontractor has already paid their own Self Assessment tax

Having documented that you ran the CEST tool, used a proper written agreement, and verified CIS status demonstrates reasonable care — this reduces penalties even if status is reclassified.

Frequently Asked Questions

I always use the same subcontractor. Does that make them an employee?

Not automatically — but it is a risk factor. Long-term, exclusive engagement without genuine substitution rights increases the employment risk. Periodically review whether the three key tests still point to self-employment. If you cannot make a strong case for self-employment, take legal advice.

Can a limited company subcontractor be inside IR35?

Yes. A limited company director who works through their company exclusively for one client, under that client's control, doing the same work as employees in that company, is likely inside IR35. The subcontractor's company would need to deduct PAYE on all payments from the company to themselves. HMRC actively investigates high-risk IR35 cases.

I need to hold back some payment until the job is complete. Is that legal?

Yes — retention is common in construction. Include a retention clause in the subcontractor agreement specifying: the percentage retained (typically 5%), the conditions for release (completion of snagging, expiry of defects liability period), and the retention release date. Late release of retentions is regulated by the Construction Act and Prompt Payment Code.

What if the subcontractor doesn't have insurance?

Self-employed subcontractors should have their own public liability insurance (minimum £1m, preferably £2m). Ask for a copy of their certificate before engaging them. If a subcontractor without insurance causes damage or injury on your site, your own liability may be engaged. Check your own public liability policy conditions — some policies require subcontractors to have their own cover.

Regulations & Standards

• Income Tax (Earnings and Pensions) Act 2003 (ITEPA) — Employment income and IR35 provisions

• Finance Act 2004 — CIS provisions

• Employment Rights Act 1996 — Worker and employee rights (relevant if status is reclassified)

• HMRC Employment Status Manual (ESM) — Detailed HMRC guidance on all employment status factors

• IR35 (Chapter 8 and Chapter 10 ITEPA 2003) — Off-payroll working rules

• HMRC CEST Tool — Official employment status checking tool

• HMRC Employment Status Manual — Detailed guidance on all factors

• CIS Guide HMRC (CIS340) — CIS obligations for contractors

• cis scheme — CIS deduction rates and monthly returns

• self employment tax — Tax obligations for sole traders

• limited company — Limited company vs sole trader

• contracts — Written contracts for construction work