What is Subcontracting? How Does Subcontracting Work?

What is Subcontracting?

Subcontracting in business refers to the practice of hiring an external party or business to perform a specific task or service that is part of a larger project. Instead of handling all aspects of a project internally, companies can outsource certain functions to subcontractors who have the necessary expertise and resources. This allows the main business to focus on its core strengths while benefiting from the skills and experience of the subcontractor.

Subcontracting Meaning

Subcontracting is the practice of hiring an external company or individual, known as a subcontractor, to complete specific tasks or parts of a project on behalf of a main contractor. The subcontractor operates under a contractual agreement, delivering specialised services or handling responsibilities that the primary business chooses to outsource.

Key Characteristics and Purpose of Subcontracting

Subcontracting involves a few key features that make it distinct:

• Task Delegation: Specific tasks or parts of a project are outsourced to subcontractors, allowing the main contractor to focus on managing the overall work.
• Short-Term Contracts: Most subcontracting agreements are for a limited period or tied to the completion of a particular project.
• Expertise and Skills: Subcontractors are usually chosen for their specialised skills or resources that the main contractor lacks.
• Cost-Effectiveness: By outsourcing tasks, businesses can often reduce expenses compared to hiring full-time staff or investing in new resources.

The primary purpose of subcontracting is to handle tasks more efficiently, complete projects within deadlines, and tap into skills or expertise that may not be available internally. It allows businesses to remain competitive by delivering high-quality work without overburdening their in-house teams.

Difference Between Contractors, Subcontractors, and Employees

While contractors, subcontractors, and employees all work for a business, there are key differences between them:

• Contractors are usually self-employed individuals or businesses hired to carry out specific tasks or projects for a set period. They typically work on a project basis and have control over how the work is carried out but follow the broad guidelines set by the company. Contractors are responsible for their own taxes, insurance, and work schedules.
• Subcontractors are hired by contractors or businesses to perform specific tasks within a larger project. They work for a contractor, not the main business, and specialise in certain areas of work. Subcontractors may operate independently, offering their own services and tools.
• Employees are full-time or part-time workers employed by a business. They work under a contract of employment and are part of the organisation’s internal team. Employees receive a salary and benefits, and their work is generally more closely controlled by the employer.

Common Industries That Use Subcontracting

Subcontracting is widely used across many industries. Here are some examples:

• Construction: In construction, companies often subcontract specialised tasks like electrical work, plumbing, or roofing to professionals who have specific expertise in those areas.
• IT and Technology: Technology companies often subcontract tasks such as software development, system integration, and cybersecurity.
• Manufacturing: In manufacturing, subcontracting might involve outsourcing certain aspects of production, such as parts assembly or quality control.
• Creative Services: Marketing agencies subcontract work like graphic design, content writing, and video production to freelance professionals.
• Logistics and Delivery: Subcontracting is common in supply chain management, where tasks like transportation or warehousing are handled by external providers.

Other sectors like healthcare, logistics, and marketing also make use of subcontracting to streamline operations and manage workloads effectively.

How does Subcontracting Work?

Subcontracting involves outsourcing specific tasks or parts of a project to external specialists. This allows businesses to manage workloads effectively and benefit from specialised expertise. Here's how subcontracting works step by step:

1. Identifying Need:

‍The main contractor identifies a need for specialised skills, services, or tasks that are outside their core competencies. This could be due to a lack of in-house expertise, the need for additional resources, or a desire to streamline operations.

2. Requesting for Proposal (RFP) or Inviting to Bid

‍The main contractor may issue a Request for Proposal (RFP) or invite potential subcontractors to bid on the specific tasks or services required. This document outlines the project details, scope of work, deadlines, and other relevant information.

3. Selecting Subcontractor

The next step is finding the right subcontractor to do the work. It’s important to choose a subcontractor who has the necessary skills, experience, and reliability to meet the project’s needs. The hiring process usually includes reviewing the subcontractor’s portfolio, checking references, and discussing project requirements in detail.

4. Contractual Agreement

Once a subcontractor is selected, it’s important to set up clear agreements and contracts to avoid confusion later on. This agreement should outline:

• The scope of work: What tasks will the subcontractor perform and by when?
• Payment terms: How and when will the subcontractor be paid?
• Deadlines: When does the subcontractor need to complete the work?
• Quality standards: What are the expectations for the work’s quality?
• Liabilities: Who is responsible if something goes wrong?

Having a written agreement helps protect both parties and ensures there is no ambiguity in the working relationship. A clear contract also lays the groundwork for successful collaboration between the main business and the subcontractor.

5. Communication and Collaboration

Once the subcontractor is hired and agreements are in place, it’s time to manage the relationship. This involves:

• Communication: Regular updates and open lines of communication help both parties stay on the same page.
• Progress checks: The business may need to monitor the work at various stages to make sure it’s on track and up to standard.
• Issue resolution: If any problems arise, addressing them promptly is key to keeping the project moving forward.

6. Quality Control and Assurance

‍As the work progresses, it’s important to monitor the quality of the subcontractor’s output. This can involve regular inspections, reviews, or testing to ensure the work meets the agreed-upon standards.

7. Managing the Deliverables

Managing deliverables involves keeping track of the subcontractor’s progress and ensuring that the work is being completed according to the agreed schedule. This step helps prevent any surprises or issues before the final product is delivered.

8. Completion and Evaluation

‍Once the subcontracted work is finished, the business evaluates the overall performance. This includes checking whether the work was completed on time, within budget, and to the required quality standards.

9. Payment

‍The final step is payment. Payment terms were outlined in the contract, and the business should release payment to the subcontractor once all deliverables are met and quality standards are satisfied. Some businesses may have a payment schedule based on milestones, while others may pay in full upon completion.

What is a Subcontractor?

A subcontractor is a person or business hired by a contractor to perform specific tasks or services as part of a larger project. Subcontractors usually specialise in a particular area, making them valuable for handling specialised or technical aspects of a project. They focus on delivering their assigned responsibilities while the main contractor retains overall project management and client communication.

A subcontractor provides his or her services under a contract for service. This is a legally binding agreement between a business and a self-employed individual.

Subcontractors are commonly used in industries like construction, IT, manufacturing, and event planning, where projects require multiple skill sets or expertise. For example, a construction contractor might hire electricians, plumbers, or roofers as subcontractors to complete specific parts of a building project.

Subcontractors aren’t a part of your business - you don’t manage or supervise them, provide instructions on how they should perform their work or have line management responsibilities over them. Subcontractors deliver the service to your or your client ‘as if they were you’. 

Characteristics of Subcontractors:

Subcontractors possess unique traits that set them apart from contractors and employees. Below are some key characteristics:

1. Specialised Expertise

Subcontractors typically focus on a specific skill, such as plumbing, electrical work, graphic design, or software development. Their expertise allows them to handle tasks that require technical knowledge or precision, contributing to the success of a project.

2. Independent Work Style

Subcontractors operate as independent entities. They manage their schedules, tools, and processes to deliver the required results. While they must meet deadlines and follow project guidelines, subcontractors are not under the day-to-day supervision of the contractor. They typically manage their own business operations, such as taxes, insurance, and equipment costs.

3. Short-Term Contracts

Subcontractors are hired for specific projects or tasks with a defined scope of work. Once the task is completed, their involvement usually ends unless another agreement is made. This makes subcontracting a flexible option for businesses with temporary or specialised needs.

4. Own Tools and Equipment

Subcontractors usually provide their own tools, equipment, or software required to complete their tasks. This reduces the burden on the main contractor and adds convenience to the subcontracting process.

5. Contractual Agreements

Subcontractors work under a contract that outlines the scope of work, deadlines, payment terms, and quality standards. These agreements help both parties understand their responsibilities and avoid disputes.

6. Risk and Accountability

Subcontractors are responsible for the quality of their work and often bear the risk of delays or errors in their tasks. This accountability motivates them to deliver high-quality results.

Subcontractor Examples 

Subcontractors are used across a wide range of industries to handle specialised tasks or services. Here are some common examples:

1. Construction Industry

• Electricians: Install wiring, lighting, and electrical systems.
• Plumbers: Handle water supply, drainage, and plumbing installations.
• Roofers: Install and repair roofing materials.
• Painters and Decorators: Add finishing touches to buildings.
• Carpenters: Build and install wooden structures like doors, windows, and cabinets.

2. Information Technology (IT)

• Software Developers: Create or customise software applications.
• Cybersecurity Specialists: Strengthen network security and protect data.
• Web Designers: Design and develop websites for businesses.
• Database Administrators: Manage and maintain databases.
• IT Support Technicians: Handle technical issues or system upgrades.

3. Manufacturing Industry

• Fabricators: Assemble components for machinery or products.
• Quality Inspectors: Test and inspect products for defects.
• Machinists: Operate tools to create parts or equipment.

4. Event Planning

• Caterers: Provide food and beverage services.
• Photographers/Videographers: Capture events professionally.
• Florists: Design floral arrangements for décor.
• Lighting and Sound Technicians: Set up equipment for events.

5. Marketing and Advertising

• Graphic Designers: Create visual content for campaigns.
• Copywriters: Write engaging content for ads or websites.
• SEO Specialists: Optimise websites to improve search engine rankings.
• Social Media Managers: Handle social media campaigns.

6. Healthcare

• Locum Doctors and Nurses: Provide temporary medical care.
• Medical Coders: Translate patient records into medical codes.
• Lab Technicians: Conduct tests and analyses for healthcare providers.

7. Logistics and Transportation

• Freight Carriers: Transport goods between locations.
• Delivery Drivers: Handle last-mile deliveries for online orders.
• Warehouse Workers: Pack and organise shipments.

8. Film and Media Production

• Scriptwriters: Write scripts for films or TV shows.
• Editors: Edit raw footage to create polished videos.
• Sound Engineers: Handle audio recording and mixing.

9. Legal Services

• Paralegals: Assist with legal research and documentation.
• Contract Lawyers: Review and draft legal agreements.

10. Education and Training

• Freelance Trainers: Deliver workshops or training sessions.
• Tutors: Provide one-on-one academic support.

Advantages of Subcontracting

Subcontracting has become a popular strategy for businesses looking to improve efficiency and handle projects more effectively. It offers several advantages that can benefit companies of all sizes. Here are some key reasons why companies choose to subcontract:

Access to Specialised Skills:

‍Subcontracting allows companies to tap into the specialized knowledge and skills of external experts. When a particular task requires expertise that the main contractor lacks in-house, bringing in a subcontractor with the necessary proficiency can enhance the overall quality and efficiency of the project.

Cost Efficiency and Flexibility:

‍Subcontracting lowers costs by eliminating the need for full-time staff and provides flexibility to scale the workforce based on project demands.

Reduced Workload:

By outsourcing specific tasks, businesses can focus on core activities while avoiding overburdening their teams.

Faster Project Completion:

‍Subcontractors bring expertise that speeds up project timelines, enabling businesses to deliver results quickly and take on more work.

Geographical Reach:

‍Subcontracting allows companies to engage with subcontractors who may be located in different regions or countries. This geographical flexibility enables access to a broader pool of talent, resources, or markets.

In summary, subcontracting is a strategic decision that enables companies to leverage external resources, expertise, and flexibility, leading to improved efficiency, cost savings, and a more competitive position in the market. It allows organisations to focus on their core strengths while efficiently managing projects and tasks beyond their immediate capabilities.

Considerations in Subcontracting

When using subcontracting in business, you should consider several factors to ensure success and minimise risks. Below are key considerations:

1. Define the Scope of Work

Clearly outline the tasks or services the subcontractor will handle. Specify deadlines, deliverables, and expectations to avoid misunderstandings and ensure the work aligns with the project’s goals.

2. Selecting the Right Subcontractor

Choose subcontractors with proven experience, relevant expertise, and a strong track record. Vet potential candidates through references, portfolios, or previous client reviews to gauge their reliability.

3. Legal and Contractual Agreements

Create a detailed contract that covers:

• Scope of work.
• Payment terms and schedule.
• Project timelines.
• Confidentiality clauses.
• Terms for dispute resolution.
  This protects both parties and provides clarity on responsibilities.

4. Cost Management

Review subcontractor quotes to ensure they fit within your budget. Compare rates while considering the quality of work offered. Avoid hidden fees by discussing all costs upfront.

5. Communication Channels

Establish clear communication methods between contractors, subcontractors, and other stakeholders. Regular updates and meetings help track progress and address any issues promptly.

6. Quality Control

Set quality standards for the subcontractor’s work and implement regular checks throughout the project. This helps identify and address any shortcomings before they escalate.

7. Intellectual Property (IP) and Confidentiality

When subcontractors handle sensitive data or proprietary work, include clauses in the contract to protect intellectual property and maintain confidentiality.

Becoming a Subcontractor: Key Insights and Tips

If you’re seeking fresh opportunities or larger-scale projects, subcontracting can broaden your horizons. It allows you to work on projects that might not typically come your way as an independent contractor.

Weigh the Pros and Cons

Subcontracting has its downsides too. You might have to accept lower rates, and your work might not always be credited. This could limit its use in your portfolio. However, these factors can be outweighed by opportunities to learn new skills or secure better-paying jobs in the future.

Understand Your Tax Responsibilities

Subcontractors are responsible for paying taxes on their income. The tax authorities, such as the Internal Revenue Service, may evaluate whether you qualify as a subcontractor or employee, and most businesses adhere to their determination.

Research Contractors and Companies

Before committing to subcontracting work, research potential contractors thoroughly:

• Review websites for testimonials and past projects.
• Check LinkedIn profiles for feedback from subcontractors or collaborators.

Create Detailed Contracts

To avoid disputes, draft comprehensive contracts that cover:

• The scope of work and project timelines.
• Payment terms, such as when and how you’ll be paid. For example, you may request payment within seven days of the contractor receiving payment from the client.

Select the Right Opportunities

Avoid over-committing to every project, especially during quiet business periods. Analyse whether an opportunity aligns with your skills, offers a realistic timeline, and has long-term potential.

Factor in Additional Time

Consider potential delays when planning your schedule:

• Will the contractor review your work before submission?
• Is time allocated for client-requested revisions?
  ‍

Allow enough time to accommodate these factors before confirming deadlines.

Get Proper Insurance

Most clients and prime contractors will want to ascertain that you have an insurance policy in place before they engage you as a subcontractor. Key policies include:

• Public liability insurance: Covers legal costs and compensation if your actions cause injury or property damage.
• Health insurance: Offers essential protection for self-employed individuals, freelancers, and small business owners.

Hiring a Subcontractor

When to Consider Hiring a Subcontractor

If you’re offered a large-scale project that exceeds your capacity as an individual contractor, hiring a subcontractor could be a great solution. It allows you to take on lucrative projects that were previously unmanageable on your own.

Tips for Hiring and Managing Subcontractors

1. Perform a Background Check

Before entering into a job agreement with a subcontractor:

• Check references.
• Review their portfolio to confirm they have the specialised skills and experience you need.

2. Be Aware of Your Changing Role

As a primary contractor, your responsibilities will change. You’ll spend more time:

• Managing projects and meeting deadlines.
• Communicating with clients about progress and addressing concerns.

Factor these responsibilities into your quotes for self-employed projects.

3. Sign a Subcontractor Agreement

A subcontractor agreement protects you from liability and sets clear terms for the working relationship. This agreement should include:

• Project details: Duration, timeline, and scope of work.
• Communication protocols: How and when updates will be shared.
• Payment details: Terms of payment and any covered costs.
• Non-disclosure clauses: To protect sensitive information.
• Non-compete clauses: To safeguard against competition.
• Dispute clauses: Procedures for handling disagreements.
• Termination terms: Conditions for modifying or ending the contract.

You can refer to below sample subcontractor agreements to create or adapt a contract:

• PandaDoc
• Simply-Docs
• TemplateLAB

4. Avoid Micromanaging

In a HBR article, Emergent Research founding partner Steve King and author Dan Pink share an important tip: it's important to give your subcontractors and independent contractors freedom. King states: "You shouldn’t have to manage the work product of a contractor. If you are, find another one."

Allow them flexibility when it comes to their schedules, and give them space to complete their work on an as needed basis.

5. Provide Feedback

Feedback doesn’t need to be complex. After a project, you can:

• Conduct a brief review of what went well and areas for improvement.
• Send an email with concise bullet points highlighting feedback.

There is a good guy on giving feedback to self employed contractors in this HBR article.

Tax Implications of Subcontracting in the UK

Subcontracting arrangements in the UK can have significant tax implications for both contractors and subcontractors. Below is a list of the key tax considerations involved:

Value Added Tax (VAT):

• Main Contractor: The main contractor is usually responsible for charging VAT on the services they provide to the client. If they subcontract part of the work to a subcontractor, the main contractor typically accounts for VAT on the full value of the services provided to the client.
• Subcontractor: Subcontractors, if registered for VAT, will charge VAT on their services to the main contractor. The main contractor can usually reclaim this VAT as input tax, subject to standard VAT rules.

Construction Industry Scheme (CIS):

• Main Contractor: Under the Construction Industry Scheme (CIS), main contractors are required to deduct tax (CIS deductions) from payments made to subcontractors. The rate of deduction depends on the subcontractor's registration status with HMRC.
• Subcontractor: Subcontractors need to register with the CIS and provide their UTR (Unique Taxpayer Reference) to the main contractor. This ensures that the correct amount of tax is deducted.

Income Tax and National Insurance Contributions (NICs):

• Main Contractor: When paying subcontractors, the main contractor must check their employment status for tax purposes. This ensures proper tax treatment, particularly in determining whether a subcontractor should be classified as self-employed or an employee.
• Subcontractor: Subcontractors are generally considered self-employed and are responsible for their own income tax and National Insurance contributions. If they operate as a limited company, different tax rules may apply.

Corporation Tax (for Subcontractors operating as Companies):

• Main Contractor: Main contractors need to be aware of the subcontractor's corporate status, especially when engaging with companies. Payments made to subcontractors that are companies may be subject to withholding tax in certain circumstances.‍
• Subcontractor: Subcontractors operating as limited companies are subject to corporation tax on their profits. They must file annual corporation tax returns with HMRC.

Record Keeping:

• Both Main Contractor and Subcontractor: It is crucial for both the main contractor and subcontractor to maintain accurate and complete records of all financial transactions, invoices, and relevant documentation. This is essential for tax compliance and may be required in case of tax audits.

IR35 (Off-Payroll Working Rules):

• Main Contractor: The IR35 legislations are designed to ensure that individuals working through intermediaries, such as personal service companies, are subject to the correct tax and National Insurance contributions. Main contractors should be aware of the IR35 status of subcontractors to determine the tax treatment of payments.

Subcontracting can be a strategic way to grow your business, manage larger projects, and provide more services to clients without the overheads of hiring full-time staff. If done right, it can help your business expand its reach and capacity in a cost-effective way.

If you’re thinking about using subcontracting to grow your business, it's a good idea to get professional advice to make the most of this strategy. Our Contractor Accountants at GoForma can help with all your accounting needs, from subcontracting tax considerations to contractor services.

Book a free consultation with GoForma today to discuss how we can help with subcontracting, accounting, or managing contractors. Let’s work together to grow your business.

FAQs on Subcontracting

1. What is a subcontractor agreement?

A subcontractor agreement is a legal document that outlines the terms and conditions between a business (the main contractor) and a subcontractor. It defines the scope of work, deadlines, payment terms, and other important details about the project.

2. Can subcontracting help save costs?

Yes, subcontracting can help save costs for businesses. By hiring subcontractors, companies can avoid the expenses associated with full-time employees, such as salaries, benefits, and training. Subcontractors are usually paid for the work they do, without the need for long-term commitments or overheads. This flexibility allows businesses to manage costs more effectively, especially for short-term projects.

3. What is the difference between a contractor and a subcontractor?

A contractor works directly with the client to manage and complete a project, while a subcontractor is hired by the contractor to handle specific parts of that project.

4. Can subcontractors work for multiple contractors at the same time?

Yes, subcontractors are independent and can work for multiple contractors simultaneously, provided they meet their contractual obligations.