Taking On Your First Employee: Employment vs Subcontractor, PAYE & Auto-Enrolment

Summary

Taking on your first employee is a major step for a tradesperson running their own business. It is also heavily regulated, and many small trade businesses get into trouble by treating workers as self-employed when HMRC determines they are employed. This creates retrospective PAYE and National Insurance liabilities that can be devastating.

This article covers the key decisions and obligations: the employment vs self-employment question, what you need to set up before the first day, ongoing payroll obligations, and the workplace pension duty that catches many new employers by surprise.

Key Facts

• Register as employer — register with HMRC as an employer at GOV.UK before paying your first employee; HMRC will send you an employer PAYE reference and activation codes; typically takes 5 working days
• Right to work check — mandatory before the person starts; see right to work
• Written statement of particulars — required within 2 months of start date; key terms (pay, hours, holiday) must be given on day 1; failure is breach of employment law; ACAS template available
• National Minimum Wage — mandatory for all workers; rates change April each year; 2025/26: £12.21/hour (21+); £10.00 (18–20); £7.55 (16–17); failure is a criminal offence
• Holiday entitlement — 5.6 weeks per year minimum (28 days including bank holidays for full-time worker); part-time workers receive proportional entitlement
• PAYE — Pay As You Earn; employer deducts income tax and employee's National Insurance (NI) from wages; employer also pays employer's NI at 13.8% of earnings above the secondary threshold (£9,100/year); payroll software required
• Real Time Information (RTI) — PAYE submissions must be made to HMRC on or before each pay day via payroll software (free HMRC Basic PAYE Tools available); penalties for late submission
• Auto-enrolment — workplace pension scheme must be set up from the employee's start date; eligible workers (aged 22–state pension age, earning above £10,000/year) must be automatically enrolled; employer minimum contribution is 3%; employee minimum 5%; common providers: NEST (free government scheme), The People's Pension, Peoples Pension
• Employer's Liability Insurance — mandatory if you employ anyone; minimum cover £5 million; available from business insurers alongside public liability
• Employment status test — HMRC determines status based on control, substitution, and mutuality of obligation; see right to work for detail
• CIS (Construction Industry Scheme) — self-employed subcontractors in construction are verified and paid net of 20% CIS deduction; does not apply to employees (employees are PAYE only)
• Statutory Sick Pay (SSP) — employer must pay SSP to employees who are ill for 4+ consecutive days; current rate: £116.75/week; first 3 days are "waiting days" (no pay); maximum 28 weeks

Quick Reference Table

Detailed Guidance

Employment vs Self-Employment — Making the Right Call

The distinction matters enormously. If HMRC determines that someone you paid as a self-employed subcontractor was actually an employee, you face:

• All PAYE income tax and employee NI that should have been deducted — backdated
• Employer NI at 13.8% — backdated
• Penalties and interest on unpaid amounts

The three main tests HMRC applies:

Control: If you control what the person does, how they do it, and when — this points to employment. A subcontractor controls their own working methods; you can specify the outcome (a tiled bathroom, a rewired house) but not direct how they achieve it moment-to-moment.

Substitution: Can the person send a substitute if they can't attend? If the answer is yes and they occasionally do, this strongly points to self-employment. If the person must do the work personally and you would not accept a substitute, this points to employment.

Mutuality of obligation: Do you have to offer work and does the person have to accept it? Ongoing regular work where refusal is not really possible looks like employment. Project-by-project engagement with no obligation on either side points to self-employment.

Practical indicators of genuine self-employment:

• The person works for multiple clients
• They invoice on completion of work (not timesheets)
• They use their own tools and materials (or charge for them separately)
• They fix a price and bear the risk of overruns
• They take out their own public liability insurance
• They are VAT-registered or have their own accounts

Before Day One: Setup Checklist

1. Register as an employer with HMRC — go to gov.uk; select "Register as an employer"; takes up to 5 working days to receive PAYE reference
2. Get payroll software — HMRC's free Basic PAYE Tools covers small employers; commercial options include FreeAgent, Xero, QuickBooks Payroll
3. Set up employer's liability insurance — contact your insurer; add to existing policy or get a standalone policy; display the certificate at your premises or on website
4. Complete right to work check — see right to work
5. Choose a workplace pension scheme — NEST is free and accepts all employers; others may offer better terms for larger payrolls
6. Prepare written employment statement — ACAS provides a free template; include: name and address, job title, start date, pay rate and frequency, hours of work, holiday entitlement, sick pay (over and above SSP), notice period, place of work, pension scheme details
7. Check National Minimum Wage rates — confirm the rate for the worker's age group; never pay below this for any hours worked
8. CIS verification (if subcontractors) — separate to PAYE; verify each subcontractor with HMRC before first payment

Running Payroll

Each pay day:

1. Calculate gross pay (hours × rate, or fixed salary)
2. Deduct income tax (using the employee's tax code from HMRC; if no code, use emergency code 1257L M1)
3. Deduct employee National Insurance (12% of earnings between £12,570 and £50,270; 2% above)
4. Add employee pension contribution (if enrolled)
5. Net pay = gross minus tax minus NI minus pension
6. Employer pays: gross pay amount minus PAYE and NI deductions (which go to HMRC); plus employer's NI (13.8%); plus employer's pension contribution (3%)

Submit RTI to HMRC — submit a Full Payment Submission (FPS) to HMRC on or before each pay day via payroll software; the FPS includes details of all employees paid, their earnings, and deductions

Pay HMRC — pay PAYE tax and NI (both employee and employer portions) to HMRC by 22nd of the month following the tax month; for small employers (PAYE <£1,500/month), quarterly payment is possible

Auto-Enrolment — The Key Points

Many small trade employers are caught out by auto-enrolment because the obligations apply from the first eligible employee's start date — not from when you have a certain number of employees.

Who must be enrolled:

• Aged 22 to state pension age AND earning above £10,000/year (£833/month): must be auto-enrolled — no choice
• Aged 16–21 or state pension age to 74 AND earning above £10,000/year: can choose to opt in
• Any worker earning below £6,240/year: no entitlement to be enrolled

Process:

1. Choose a pension provider (NEST, People's Pension, etc.) and set up the scheme before the start date
2. On the start date, enrol all eligible workers in the scheme automatically — do not wait
3. The worker can choose to opt out within one month; if they do, refund any contributions already collected; you don't have to re-enrol for 3 years
4. Pay employer contributions (minimum 3%) with each payroll run
5. Issue a written enrolment notice to the worker within 6 weeks of start date

Staging date and declaration of compliance — for new businesses, your duties start from the first eligible employee's start date; you must complete a Declaration of Compliance with The Pensions Regulator within 5 months; penalties for non-compliance are automatic (£400 fixed penalty) and can escalate.

Frequently Asked Questions

Can I take on a family member and avoid PAYE?

No — if a family member works for you and is paid, they are subject to the same PAYE and employment rules as any other employee. The only exception is if the family member works for no pay (which has its own issues). Working for "mates rates" or a low cash amount does not remove the PAYE obligation.

Do I have to pay apprentices the National Minimum Wage?

Apprentices aged under 19, or in the first year of an apprenticeship regardless of age, can be paid the apprentice rate (£7.55/hour for 2025/26). Once they complete the first year and are 19+, they move to the rate for their age group. Apprenticeships have additional requirements (registered with an approved provider, formal training plan).

What if the employee goes off sick?

You pay Statutory Sick Pay from day 4 of illness (days 1–3 are waiting days with no SSP). To qualify, the employee must earn above the Lower Earnings Limit (£123/week in 2025/26) and have told you they are sick within your notification timeframe (specify in the contract). SSP is currently £116.75/week. You cannot recover SSP from HMRC (recovery was abolished in 2014) — SSP is an employer cost. If the employee is off long-term, consider whether Occupational Sick Pay (enhanced sick pay above SSP) is offered in the contract.

Regulations & Standards

• Employment Rights Act 1996 — right to written employment particulars; unfair dismissal; redundancy

• National Minimum Wage Act 1998 — minimum pay rates; enforcement by HMRC

• Pensions Act 2008 — auto-enrolment duties

• Income Tax (Earnings and Pensions) Act 2003 — PAYE framework

• Health and Safety at Work Act 1974 — employer's duty to employees

• HMRC: Register as an Employer — GOV.UK registration

• ACAS: Employment Contracts — Free templates and guidance

• The Pensions Regulator: Automatic Enrolment — Employer duties guide

• NEST: Workplace Pension — Free government pension scheme

• right to work — Right to work checks before employing

• self employment tax — CIS, self-assessment, and tax for the self-employed

• limited company — Pros and cons of incorporating vs sole trader

• public liability — Insurance requirements when employing