Subcontractor Explained: What is a subcontractor?

If you outsource work that is already outsourced to you, then you will be using a subcontractor. This means that the person carrying out the task has no direct relationship with the end client. In short, subcontracting means working on someone else’s behalf who, themselves, is already contracted to perform certain tasks.

You can be an employee as a subcontractor or you can be self-employed. All sorts of industries make use of subcontractors meaning that this system of service procurement is widespread. It differs from direct employment in many tax regimes, however. Read on to find out more about subcontracting.

Topics in this article:

  • What is a subcontractor?
  • Supply Chains and Commercial Relationships in Subcontracting
  • Which Industries Typically Use Subcontracting?
  • What Is the Difference Between a Contractor and a Subcontractor?
  • Tax Issues and Subcontracting

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What Is a Subcontractor?

To begin with, a subcontractor is a business. The business could be an individual operating as a freelancer or it could be a large corporation. Either way, when a business operates as a subcontractor, it fulfils some of the contractual obligations of another business, known as the main contractor. A simple example of subcontracting in operation would be in the construction industry.

There might be a housing developer, that has bought land and drawn up plans to build houses. He will sell those later. The housing developer appoints a construction firm to build these homes for it. Along with connecting the utilities, such as sewers, electricity and the gas supply.

Subcontractor explained

The construction firm in question may have its own workforce to do the groundworks and to build the walls and roofs of the houses but it may not have the skill base to do all of the necessary plumbing work. It could hire some plumbers to carry out this work in-house or the main contractor could subcontract this work to a specialist plumbing firm.

In this simple example, the end client – the housing developer – will have specified in its contract with its main contractor – the construction firm – what sort of plumbing needs to be installed and where. So long as this is supplied in accordance with the contract, it will not matter to the end client whether the plumbing is fitted by the construction firm itself or by an outsourced third-party; in other words, a subcontractor.

Indeed, the end client may not even know that subcontracting has taken place. So long as the work carried out by the subcontractor meets the contractual requirements set out by the main contractor, the work should be completed without issue.

Supply Chains and Commercial Relationships in Subcontracting

Typically, subcontracting firms will invoice main contractors for their work and the main contractor will invoice their customer. This is an important part of subcontracting. It is worth noting that main contractors do not simply pass on the instructions of what services and goods need to be supplied.

The main contractor has a commercial relationship with both its client and the subcontractor. However, the subcontracted party has no commercial relationship with the end client.

Put simply, if a subcontractor were to be paid directly by the end client, thereby bypassing the main contractor, then the business concerned would no longer be acting in a subcontracting capacity. It would have become a contractor instead.

Subcontractor

Note that some contractors will make use of so-called ‘pay if paid’ clauses in their dealings with their subcontractors. Although subcontracted businesses are under no legal obligation to accept such clauses in their contracts, some choose to do so. What this means is that the subcontractor will only receive payment for their work once the main contractor has been paid by the end client.

This sort of arrangement can cause delays in payment and passes some business risk from the main contractor to the subcontractor concerned. That said, it tends to suit subcontractors who do all – or most – of their work for the same, trusted main contractor.

Some business operate in several capacities

It is worth bearing in mind that many businesses operate in several capacities. Some will work as main contractors for their own clients and also as subcontractors for other contracting firms depending on the project at hand.

Indeed, some subcontracting firms will take on a job from a main contractor only to subcontract part or all of it once more to another firm. In this way, subcontracting firms can make flexible supply chains of manpower that can alter rapidly to meet the demands of the sector they are working in.

Which Industries Typically Use Subcontractors?

As mentioned, the construction industry is one that relies heavily on subcontracting. Nearly all of the main building trades – from bricklaying to electrical installation work – are covered by subcontracting businesses and even big contracting firms with large workforces will make use of subcontractors from time to time. This might be because they need additional manpower to meet deadlines. Or because they require specialist skills that they do not possess in-house.

Other industries that make extensive use of subcontracted working methods include the IT sector and the catering profession. In IT, there are many specialist skills which are expensive to keep trained up in. Employers, therefore, tend to want to only have those skills available to them when they are needed for certain projects, such as updating IT infrastructure or carrying out a data audit.

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Many companies don’t want to pay out for skills they don’t always need on their payroll so pay a fee to an outsourced IT contracting firm instead. In the main, such firms will not have lots of IT professionals on their payroll but they will have lots of skilled individuals they can turn to as subcontractors.

In the catering industry, it is much the same. A main contractor may have won a contract to supply food and drink at a concession stand, for example, but only fulfil its contractual obligations by using subcontractors. Chefs, kitchen staff, waiting personnel and bar staff may all be subcontracted in such a setup. In many cases, cleaning contractors will also use subcontractors to actually carry out the cleaning work. If so, then the cleaning contractor is more likely to fulfil a supervisory or quality control role.

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Other industries that use subcontracting

In many cases, gardening and other horticultural services are carried out by subcontracted firms, too. Some larger agricultural businesses also rely on subcontracting their workloads, typically at busy periods, such as harvest time. The recruitment industry also operates on a subcontracting model in many ways. Although some recruitment professionals are employed, many are effectively self-employed and working as subcontractors.

The same goes for the security services industry. Although security contractors may employ individuals to monitor places remotely, patrolling security guards will often work on a subcontracted basis.

Subcontractors can work in any industry from healthcare to marketing. Even a supply teacher or trainer may be subcontracted in certain circumstances. So long as they are paid by an intermediary, or main contractor, then they are working in the capacity of a subcontractor. It is simply that some sectors of the economy are more geared up to this way of procuring services and skills than others.

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What Is the Difference Between a Contractor and a Subcontractor?

A contractor has a direct commercial relationship with an end client or customer. Typically, this will be to provide services within a given period for an agreed fee. Subcontractors differ because they do not have such a contractual obligation with the end customer, only with the contractor concerned.

A subcontracted firm could feasibly carry out all of the agreed work that the end client has asked for. But the difference is that he or she will not then invoice the end customer for their service provision, but the contractor instead. Subcontractors can outsource some or all of their work to other subcontractors if they like which effectively makes them both contractors and subcontractors at the same time. That said, it is the direct relationship with the end client that is the principal differentiator between these two commercial models.

Tax Issues and Subcontractors

Many subcontractors work as sole traders. In such cases, they are self-employed and responsible for their own yearly tax assessments. However, outsourced work may also be taken on by limited companies operating, in part or in whole, as subcontractors, too. If so, then corporation tax will also come into play alongside the personal taxation rules that affect sole traders.

That said, there are a number of areas in tax law – especially in the UK. Here some interpretation of the rules is needed. People who provide consultative work, collaborative research functions for multiple enterprises or who supply outsourced manpower on a subcontracted basis may need further specialist tax advice to ensure their interpretation of the regulations is correct.

Tas issues for Irish nationals

There is another tax issue that can catch some subcontracting firms out. It is when they work for main contractors in more than one tax jurisdiction. This could affect Irish nationals who provide subcontracted services for contractors in Northern Ireland as well as the Republic, for example. In the UK, the taxation of subcontractors working in the construction industry is very different from other sectors. It relies on what is known as the construction industry scheme (CIS).

In short, CIS works like the pay as you earn (PAYE) scheme. In this sector, the main contractor deducts tax from the subcontractor’s payment on their behalf. It was introduced to combat widespread tax avoidance in the sector. Any excess tax that has been collected under CIS is usually repaid to construction industry subcontractors. This happens at the end of the financial year.

 

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News and information about the global operation and intermediation of subcontractors.

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