How to pay and manage UK contractors: A practical guide

If you're paying independent contractors in the UK, you need to handle payment, documentation, and potentially IR35 compliance. The payment part is straightforward. The compliance part—especially IR35 assessment and record-keeping—is where most businesses get stuck.

This guide walks through what you actually need to do. Then we'll show you where Kontrable helps organize the work.

The three main things you need to do

1. Make payments correctly based on where you and the contractor are located. If you're a UK business paying UK contractors, use BACS or Faster Payments through your bank—it's free and instant. If you're international paying UK contractors, use Wise for better exchange rates. The contractor receives the payment in GBP.

2. Collect invoices and verify tax status. UK contractors are self-employed and handle their own taxes through self-assessment. You don't withhold tax like in the US. But you need invoices for every payment, and if the contractor is VAT-registered, you need to account for 20% VAT on their invoices. If the contractor works through a limited company and you're a medium or large UK business, you need to assess IR35 status (explained below).

3. Keep all records for 6 years. HMRC requires you to maintain invoices, payment proof, contracts, and any IR35 documentation for 6 years. This protects you in an audit.

That's the foundation. Everything else builds on these three things.

The one thing that makes UK compliance different: IR35

IR35 is HMRC's rule against "disguised employment"—where someone is effectively working as your employee but operates through a limited company to avoid taxes.

Who needs to worry about IR35?

You do if you're a medium or large UK business (turnover over £10.2M, more than 50 employees, or balance sheet over £5.1M) paying a UK contractor who works through a limited company. Public sector organizations also have strict IR35 rules.

You don't need to worry about IR35 if:

• You're a small UK business (under the thresholds above)
• You're paying a sole trader or self-employed individual (not a limited company)
• You're an international business paying UK contractors (your local rules apply instead)

How IR35 works:

If IR35 applies to you, you're responsible for determining whether the contractor would be an employee if not for their limited company structure. The assessment involves five key factors:

Control – Does the contractor decide how, when, and where they work, or do you?

Substitution – Can they send someone else to do the work, or must they do it personally?

Mutuality of obligation – Are you obligated to provide work and are they obligated to accept it?

Financial risk – Do they risk their own money on the engagement, or are costs covered?

Integration – Are they part of your team like an employee, or working at arm's length?

If the contractor looks like an employee on these factors, IR35 applies. You then must:

• Deduct income tax and National Insurance from their payments
• Pay employer National Insurance contributions (15.8%)
• Provide them with a Status Determination Statement (SDS) explaining your decision

If the contractor is outside IR35, you pay them gross (full amount) with no deductions.

How to assess IR35:

Use HMRC's Check Employment Status for Tax (CEST) tool. It's free, online, and takes 15 minutes. Answer questions about control, substitution, and the other factors. The tool gives you a determination—inside or outside IR35. HMRC usually accepts CEST determinations, so this is your safest approach.

Document your reasoning and keep the SDS on file. If HMRC audits you, you have proof you assessed IR35 properly.

The practical reality: Most UK contractors are outside IR35 because they control how they work, can substitute, and work at arm's length. But you have to assess each engagement individually.

Payment methods: What actually works

For UK-to-UK payments:

Use BACS (Bankers' Automated Clearing Services) or Faster Payments through your UK bank. It's free, reliable, and usually instant to 2 hours. The contractor receives GBP directly in their UK bank account.

To set it up: Ask the contractor for their UK sort code and account number. Enter it into your bank's online platform. Schedule the payment. Done.

For international payments to UK contractors:

Use Wise. You'll get mid-market exchange rates (3-4% better than PayPal or traditional banks) and low fixed fees (£2-5 per transfer). The contractor receives GBP in 1-2 business days.

Why Wise works: If you're paying from USD or EUR, Wise converts at the actual market rate, not the inflated rate PayPal or your bank uses. For regular payments, this saves thousands per year.

To set it up: Create a Wise business account (free). Enter the contractor's UK sort code and account number. Send money from your currency. Wise converts to GBP at mid-market rates and deposits it in their UK bank account.

What about PayPal?

It's convenient if the contractor already uses it. But PayPal charges 2.9% + £0.30 per transaction, and the exchange rates are 3-4% worse than Wise. For a £5,000 payment from USD, PayPal costs £150-200 more than Wise. Avoid it unless the contractor specifically asks for it.

What about SEPA (for EU to UK)?

SEPA transfers are useful if you're an EU business paying UK contractors, but they're slower than BACS (1-3 days) and may have fees depending on your bank. For regular payments, Wise is usually cheaper.

What you need from UK contractors

Invoices. Every payment should have an invoice attached. The invoice should include:

• Your company name and address
• Contractor's name/company and address
• Date of invoice
• Description of work
• Amount charged
• Payment terms

If the contractor is VAT-registered (turnover over £90,000), they must include 20% VAT on the invoice. You pay the VAT amount to them, and they remit it to HMRC. If you're VAT-registered, you can reclaim the VAT. If not, it's an additional cost.

IR35 documentation (if applicable). If you assessed IR35 status, document your decision and provide a Status Determination Statement to the contractor. Keep this on file.

Company details (if they work through a limited company). Get their company name and Companies House registration number. This helps you assess IR35 properly.

Bank details. UK sort code and account number for BACS payments.

Records you must keep

HMRC requires 6 years of records. Keep:

• All contractor invoices
• Proof of payment (bank statements, Wise receipts)
• Signed contracts or statements of work
• IR35 Status Determination Statements (if applicable)
• Communications about the work arrangement

This protects you if HMRC audits. If you can't produce records after 6 years, HMRC can disallow the expense and assess back taxes.

Common mistakes and how to avoid them

Mistake 1: Ignoring IR35. Problem: You're a medium/large UK business paying a contractor through a limited company. You don't assess IR35. HMRC audits you and determines the contractor should have been inside IR35. You owe back income tax, National Insurance, penalties, and interest—potentially thousands.

Solution: Use HMRC's CEST tool for every limited company contractor engagement. Document your reasoning. Provide a Status Determination Statement to the contractor. If in doubt, treat it as inside IR35 (safer).

Mistake 2: Paying without invoices. Problem: You pay contractors based on Slack messages, emails, or verbal agreements. When HMRC audits, you have no invoices to justify the expense.

Solution: Require invoices for every payment. No invoice, no payment. This is standard business practice and protects both you and the contractor.

Mistake 3: Using expensive payment methods for international transfers. Problem: You're a US business paying UK contractors via PayPal. PayPal's exchange rate is 3-4% worse than the real market rate. You're overpaying by £150-200 per £5,000 transfer.

Solution: Use Wise for international payments to UK contractors. You'll save 3-4% on every transfer. For £50,000/year in contractor payments, that's £1,500-2,000 saved.

Mistake 4: Losing records before 6 years. Problem: HMRC audits you 4 years after you paid a contractor. You've deleted old invoices and payment records. HMRC disallows the expense because you can't prove you paid.

Solution: Keep all contractor invoices, payments, and contracts organized for the full 6 years. Store them where you can find them in an audit.

Understanding VAT with contractors

If the contractor's turnover exceeds £90,000, they must register for VAT and charge 20% VAT on invoices.

How it works: A contractor invoices you £1,000 + £200 VAT = £1,200. You pay them £1,200. They keep the £1,000 and send the £200 VAT to HMRC.

If you're VAT-registered: You can claim the £200 VAT back from HMRC. Your net cost is £1,000.

If you're not VAT-registered: You pay the full £1,200 and can't reclaim the VAT. It's an additional cost.

If the contractor is not VAT-registered: They invoice £1,000 with no VAT added. You pay £1,000.

This is standard—nothing special you need to do. Just understand that VAT-registered contractors will add 20% to their invoices.

Frequently asked questions

Q: Do I deduct tax from UK contractor payments? A: No, unless IR35 applies to that engagement. UK contractors are self-employed and handle their own taxes through self-assessment. You pay them the full invoice amount. If IR35 applies, you deduct income tax and National Insurance, but this is less common.

Q: What if the contractor is VAT-registered? A: They'll charge 20% VAT on invoices. You pay the VAT amount. If you're VAT-registered, you reclaim it. If not, it's a cost. This is normal—just account for it in your budget.

Q: Can I use Wise if I'm a UK business paying UK contractors? A: Technically yes, but it's unnecessary. Use BACS through your bank—it's free and instant. Wise is best for international businesses paying UK contractors, or UK businesses paying contractors internationally.

Q: How do I assess IR35 if I'm not sure? A: Use HMRC's CEST tool. It's free, online, and takes 15 minutes. Answer questions about control, substitution, and integration. The tool gives you a determination. Document your reasoning and provide a Status Determination Statement to the contractor.

Q: What's the difference between a sole trader and a limited company contractor? A: Sole traders are self-employed individuals who operate under their own name. Limited company contractors operate through a registered company (Ltd). IR35 only applies to limited company contractors. Sole traders are always outside IR35.

Q: Do I need a written contract? A: Not legally required, but highly recommended. A written contract clarifies scope, deliverables, payment terms, and helps demonstrate the contractor relationship for IR35 purposes. It protects both you and the contractor. Kontrable provides contract templates and e-signature workflows.

Q: What if I'm paying contractors in multiple countries? A: Tax rules vary by country. UK tax rules only apply to UK contractors. For contractors in other countries, follow your local requirements and their country's rules. Kontrable tracks contractors globally, but compliance varies by location.

Q: Is there a minimum payment threshold for UK contractors? A: No. There's no minimum payment amount that triggers tax filing, unlike the US $600 threshold for 1099s. You track all payments and the contractor reports them on self-assessment.

Getting started

If you're managing UK contractors, here's the process:

1. Assess IR35 status using HMRC's CEST tool (if you're a medium/large business paying limited company contractors)
2. Set up payment method: BACS for UK contractors, Wise for international
3. Require invoices for all payments
4. Account for VAT if the contractor is VAT-registered
5. Keep all records for 6 years

Kontrable helps with steps 1, 3, and 5 by managing contractor information, organizing invoices, and tracking payments. You stay in control of your records and your payment method.

If you're managing a few contractors, a spreadsheet works. If you're managing dozens or coordinating across a team, Kontrable saves time and keeps contractor data organized.

Ready to get organized?

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