Freelancer or employee? Avoid the hidden costs of misclassification

26 Nov 2025

By Kathleen McAdams, Albany HR.

As an expert HR consultant, I’ll help you understand the crucial difference between freelancers and employees to protect your business from potential claims.

If you’re a small business owner, chances are you’ve worked with freelancers or independent contractors.

But there’s a hidden risk many business owners overlook: accidentally treating a freelancer like an employee.

This isn’t just about a label on a contract; it’s about the day-to-day reality of your working relationship.

Get it wrong, and you could face unexpected tax bills, backdated payments, and even costly tribunal claims that drain your profits and time.

As an independent HR consultant, offering HR consultancy services in Edinburgh, I often see businesses caught out by this…

The hidden costs of getting it wrong

UK law recognises three types of working relationships: employee, worker, and self-employed.

The lines between these can be blurry, and if HMRC or an employment tribunal decides your ‘freelancer’ is actually an employee or a worker, the consequences can be significant for your business:

• Unexpected tax and National Insurance bills: You could be liable for unpaid employer’s National Insurance contributions, income tax, and potentially penalties.
• Backdated employment rights claims: This is where it gets really costly. An individual could claim for things like holiday pay, sick pay, or even unfair dismissal if they were treated as an employee but not given those rights.
• Tribunal claims and financial penalties: Dealing with a tribunal takes immense time, stress, and money, regardless of the outcome. If you lose, the financial penalties can be substantial.

These aren’t just abstract legal issues; they are real threats to your business’s bottom line and peace of mind.

Why the contract isn’t the whole story

You might think a signed contract stating someone is a ‘freelancer’ is enough.

Unfortunately, it’s only the starting point.

The crucial factor is the reality of the working relationship. HMRC and tribunals will look at how you actually work together, not just what’s written on paper.

If there’s a mismatch between your contract and your day-to-day practices, the reality will almost always take priority.

What HMRC and tribunals really look for

When assessing employment status, several key factors come into play. Understanding these can help you align your working practices with your contracts and reduce risk:

• Control: Who decides when, where, and how the work is done? If you dictate their hours, location, and methods, it looks more like employment.
• Substitution: Can your freelancer send someone else in their place if they’re unavailable? True freelancers usually have this right. If you insist on only one specific person doing the work, it points towards an employment relationship.
• Mutuality of obligation: Is there an expectation that you’ll offer work and they’ll accept it on an ongoing basis? Regular, consistent work can suggest employment, whereas a genuine freelancer typically works on a project-by-project basis with no guarantee of future work.
• Integration: Are they treated like a regular staff member? Do they use company equipment, have a company email address, attend team meetings, or are they included in internal communications? The more integrated they are, the more employee-like they appear.
• Financial risk: Does the individual carry their own financial risk, for example, by needing to rectify their own mistakes at their own cost, or by having the potential to make a profit or loss from the work? Employees generally don’t have this risk.

The ‘grey areas’…

Employment status can be complex, and there are many grey areas.

A famous example is the 2021 Supreme Court ruling that Uber drivers were ‘workers’ (a category with more rights than self-employed, but less than employees), despite their contracts labelling them as self-employed.

This case clearly showed that labels are not enough; the actual working relationship determines status.

Protecting your business: practical steps to take

Don’t wait for a problem to arise. Proactive steps can save you significant time, money, and hassle:

• Review your freelancer arrangements regularly: Take a fresh look at how you work with your contractors. Do the actual practices still align with their ‘self-employed’ status?
• Compare contract terms with reality: Go through your contracts and compare them against how work is actually carried out. Identify any mismatches.
• Seek professional advice: If you’re unsure, or if you have several freelancers, getting expert advice is a smart investment. It’s far cheaper to get it right upfront than to deal with the fallout of misclassification.

Need to review your contracts?

As an independent HR consultant in Edinburgh, I help business owners review contracts, advise on correct classifications, and update documentation to reflect actual working relationships.

Book a confidential discovery call today.