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.

The problem for agencies is the way UK tax law treats workers they supply to clients.

Why most recruitment agencies won’t 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 supervision, direction, or control (or the right to do so), the agency may have to treat their pay as employment income and operate PAYE. Simply describing the worker as self-employed does not get around these rules.

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.

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., when there is no SDC at all, as evidenced), 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 issue, agencies may also be wary of potential employment rights claims.

The agency rules themselves are tax rules, so being treated as an employee for tax purposes does not automatically give someone employment rights. However, an individual could still make a separate claim that they are a worker or employee. Most agencies would rather avoid this risk altogether.

This is why most recruitment agencies simply won’t engage sole traders. Contractors are normally expected to use a limited company or umbrella company, or be paid directly through PAYE.

This doesn’t mean you can’t work as a sole trader. If you work directly for clients rather than through an agency, sole trader status is much more common.

Why agencies will engage limited and umbrella companies

Operating through a limited company or umbrella company generally avoids the agency’s direct exposure to the agency legislation.

With an umbrella company, the contractor is employed by the umbrella and paid through PAYE. The umbrella is responsible for operating PAYE and paying the contractor’s salary.

With a limited company, the agency contracts with the contractor’s company rather than engaging the individual as a sole trader. The agency legislation contains an exclusion where the remuneration received by the worker is already treated as employment income under other provisions, so the rules do not simply impose PAYE on agencies when they engage contractors through personal service companies.

Instead, limited company contractors may fall within the separate IR35 and off-payroll working rules. Depending on the client and circumstances, responsibility for determining IR35 status may sit with the client rather than the contractor.

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 increases in dividend and corporation tax rates.

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 apply to sole traders, who are personally liable for any business debts.

A limited company may also appear more established to agencies and clients, which can help when seeking contract work.

Being a sole trader is simpler, but you don’t have the same separation between your business and personal finances. And, as we’ve explained above, most recruitment agencies won’t work with sole traders anyway.

Sole trader tax calculator

To find out how much tax you’d pay if you’re self-employed, try our sole trader tax calculator.

Also read this handy guide for more information: How to switch from sole trader to limited company, by Integro Accounting.