Contractors’ Questions: Why don’t agencies deal with sole traders?

Contractor’s Question: I plan to supply IT services as a sole trader, but would first like to understand why agencies and some prospective clients say they won’t engage sole traders, and insist on limited companies instead. I did think it was due to the unlimited liability status of a sole trader, but I now understand that it’s because of tax rules. Is that right and, if so, is there any way to navigate around these rules, so clients do agree to deal with me if I operate as a sole trader?

Expert’s Answer:  The fundamental reason that agencies and some end clients would rather not deal with contractors operating as sole traders is a piece of tax legislation. Under the Income Tax (Earnings and Pensions) Act 2003, such a dealing could potentially result in the agency having to ensure PAYE and National Insurance are deducted from payments made to individuals (sole traders) who are under a degree of control / supervision from the end client. 

These rules are similar to the IR35 rules, but they put the PAYE risk on the agency, unless the contractor is operating via a limited company.  It is for this reason that many agencies are not prepared to engage with sole traders if they are not subject to PAYE, in spite of the sole trader status being the most popular way to set up in business. 

Similarly, if the end client is engaging with a contractor who is operating as a sole trader, the risk of the contractor being deemed to be a "disguised employee" and subject to PAYE lies with the end client (as well as the worker).

End clients’ views of this risk, and their willingness to engage sole traders directly, tends to vary from industry to industry and sector to sector.  In our experience, those industries which use workers placed via recruitment agencies less tend to have more businesses that are more comfortable engaging individuals rather than companies.

Where a business is prepared to engage you on a sole trader basis, it is therefore important that both you, as the sole trader, and the end client consider your employment status, ideally seeking an opinion from an employment law specialist to provide real confidence. 

The expert was Martin Hesketh, managing director of contractor accountancy firm Brookson