Contractors or employees: how to decide, and how IR35 applies.

Contractors and freelancers let a tech startup buy specialist skills for as long as it needs them, without the fixed cost of a salary. Used well, they are one of the best tools a small company has. Used badly, for example by treating someone as a contractor when in reality they are an employee, they create tax and employment law risks. This is general information, not legal or tax advice; see GOV.UK for current guidance.

Employment status in brief

UK law recognises three main types of status for employment rights: employee, worker and self-employed. Status depends on the facts of the relationship, not on what the contract calls it. Factors include whether the person must do the work personally or can send a substitute, how much control you have over how, when and where they work, whether there is an ongoing obligation to offer and accept work, and whether they are in business on their own account. See employment status on GOV.UK. Tax status is assessed separately, with similar factors.

When a contractor is the right choice

• A defined project with a clear end, such as a security review, a data migration or a brand identity.
• Specialist skills you need occasionally, such as a fractional finance director.
• Testing whether a role is needed before committing to a permanent hire.
• Spikes in demand you cannot predict.

When an employee is the right choice

• A core, ongoing role you need to direct day to day.
• Work that builds lasting know-how inside the company.
• A role where loyalty, equity incentives and long-term development matter.

IR35 and off-payroll working

The off-payroll working rules, often called IR35, apply when a contractor provides services through their own intermediary, usually a personal limited company, and would be an employee for tax purposes if engaged directly. Who decides depends on the client:

• If your company is small under the Companies Act tests, the contractor’s own company is normally responsible for deciding whether the rules apply.
• If your company is medium or large, you must decide each contractor’s status, give them a status determination statement with reasons and, if the rules apply, deduct tax and National Insurance through payroll.

Many tech startups start small but cross the thresholds as they grow, so review contractor arrangements when you do. HMRC’s check employment status for tax tool can help structure the assessment.

Step by step: engaging a contractor

1. Define the deliverable, not the hours. Outcomes, deadlines and acceptance criteria.
2. Assess status honestly against the factors above, and record your reasoning.
3. Use a written contract covering scope, fees, payment terms, confidentiality, data protection and, critically, assignment of IP to your company.
4. Manage the relationship to match the contract. If the contract says the contractor controls how the work is done, do not manage them like staff.
5. Review regularly. A six-week project that becomes a two-year, full-time arrangement probably looks like employment.

Worked example

Northvane is a fictional Belfast tech startup making weather risk software for insurers. It engaged a data engineer through her limited company to build a data pipeline, with a fixed-scope contract, IP assignment and a right of substitution she could actually use. Eighteen months later she was in the daily stand-up, working fixed hours on whatever the team needed. Northvane, now approaching medium size, reviewed the arrangement, concluded it looked like employment and offered her a permanent role with share options, which she accepted.

Common mistakes

• Calling someone a contractor to avoid employer costs when the reality is employment.
• Missing IP assignment, so the contractor owns the code or designs.
• Letting the working relationship drift away from the contract.
• Not noticing when the company crosses into medium size for off-payroll rules.

What to measure

• Number of contractors and the length of each engagement.
• Status assessments completed and reviewed, with dates.
• Contracts with signed IP assignment.
• Contractor spend compared with the cost of an equivalent hire.