Why recruitment agencies won’t engage sole trader contractors

Setting up as self-employed (i.e., becoming a sole trader) is the most hassle-free way to get started in business. However, contractors will quickly discover that it is extremely difficult to secure contract work through recruitment agencies unless they operate through a limited company or an umbrella company.

This is not due to preference or convention alone, but because of how UK tax law treats agency-supplied workers.

Recruitment agencies will not engage sole traders

The key issue for recruitment agencies is the so-called agency legislation in sections 44 to 47 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA).

Under this legislation, where an individual personally provides services to a client through an agency, and is subject to (or has the right to be subject to) supervision, direction or control, the agency is required to treat the individual as an employee for tax purposes.

This applies regardless of the intentions of the parties involved.

Section 44 of ITEPA 2003 states that:

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.

This means that if a recruitment agency engaged a sole trader contractor, it could be legally obliged to operate PAYE, deduct income tax and National Insurance Contributions, and potentially pay employer National Insurance Contributions as well.

HMRC guidance on this point can be found in the Employment Status Manual, including its explanation of supervision, direction and control: HMRC ESM2037.

In very rare cases (e.g., no SDC at all, proven by evidence), an agency might engage a sole trader without PAYE. However, this is exceptional and risky, so agencies avoid it via blanket policies.

In addition to the tax risk, agencies may also face exposure to employment law claims.

While agency legislation applies for tax purposes only, an individual treated as an employee for tax purposes may attempt to assert worker or employment rights under separate employment law tests. Even where such claims are unlikely to succeed, the commercial and legal risk is one that most agencies are unwilling to accept.

For these reasons, recruitment agencies have largely adopted a blanket policy of refusing to engage sole traders. Instead, they require that contractors operate via a limited company, an umbrella company, or be engaged as PAYE employees from the outset.

Direct (non-agency) clients might engage sole traders more readily, but the article focuses on agency routes, which dominate IT contracting.

Why agencies will engage limited and umbrella companies

Operating through a limited company or umbrella company generally avoids this risk for recruitment agencies, provided the contracts are structured correctly.

With an umbrella company, the individual is already employed under PAYE by the umbrella, so the agency has no additional PAYE obligations.

With a limited company, the contract is made with the company itself (not the individual personally), and when properly structured, the conditions in sections 44-47 are not met because the individual is not personally performing services under supervision, direction or control—the company is providing the services.

This contractual distinction is what usually keeps limited companies outside the scope of agency legislation, though agencies must ensure contracts are properly drafted to maintain this separation.

Limited company benefits

Aside from the practical difficulty of securing contract work as a sole trader, there are several advantages to contracting through a limited company.

Most importantly, working through a limited company is often more tax-efficient than sole trading, although the tax gap has narrowed considerably in recent years due to changes in dividend tax and corporation tax.

Another key consideration is limited liability. Provided the director has acted lawfully and responsibly, personal liability for business debts is generally limited to the company itself. This protection does not exist for sole traders, who are personally liable for all business debts and obligations.

A limited company can also project a more professional, established image to agencies and end clients, which can be beneficial in a competitive contracting market.

While the sole trader route is straightforward to set up, it offers no separation between personal and business risk and is largely incompatible with agency-based contracting.

Sole trader tax calculator

If you are self-employed and want to estimate how much tax you may pay, try our sole trader tax calculator.

You may also find this guide useful if you are considering moving into contracting: How to switch from sole trader to limited company, by Integro Accounting.