Employee vs contractor — what's the legal difference (and where does IR35 fit)?
By SuLe · Updated 4 June 2026
The difference is decided by the reality of the working relationship, not the label on the contract — the key tests are personal service, control, and mutuality of obligation. Employees get full employment rights; genuine contractors do not. IR35 is a separate tax question about contractors who work through their own company, deciding whether they should be taxed like employees.
Key facts
- Status turns on reality, not labels: personal service, control and mutuality of obligation are the core tests, with integration and financial risk also weighing in.
- Both a tribunal and HMRC can reclassify a "contractor" as an employee or worker.
- IR35 (off-payroll rules) governs tax where a contractor supplies services through their own company.
- For "small" private-sector clients, the contractor's own company assesses IR35; medium and large clients must assess and issue a status determination.
- "Small" uses the Companies Act thresholds (two of: turnover, balance sheet, employee count); these were uplifted recently, so check the current figures.
What actually decides employment status?
Status is a question of substance. A tribunal looks at how the relationship works in practice and asks whether the person is genuinely in business on their own account.
Three tests do most of the work. Personal service: must the individual do the work personally, or can they send a substitute? Control: who decides what is done, and how, when and where? Mutuality of obligation: are you obliged to offer work and are they obliged to accept it?
Two further factors colour the picture: integration (are they part of your team, with a company email and fixed hours?) and financial risk (do they invest, quote fixed prices, and risk their own money?). No single factor is decisive — tribunals weigh the whole relationship.
Where does IR35 fit in?
IR35, the off-payroll working rules, is about tax, not employment rights. It applies where a contractor provides services through their own limited company but works, in substance, like an employee of the client.
The question IR35 asks is whether — if you stripped away the contractor's company and looked at the person directly — they would be an employee for tax. If yes, employment taxes apply to that engagement.
Crucially, IR35 status and employment-law status are assessed separately and can differ. Someone can be "inside IR35" for tax yet not be an employee with unfair dismissal rights. Founders should treat the two questions as related but distinct.
Who assesses IR35 — the startup or the contractor?
For most early-stage startups, the answer is the contractor. Where the client company is small under the Companies Act thresholds, the contractor's own company is responsible for assessing IR35.
Medium and large clients carry the burden instead: they must assess each engagement and issue a Status Determination Statement to the contractor. "Small" is defined by the Companies Act size test — meeting two of three limits on turnover, balance sheet total and number of employees. Those thresholds were uplifted in recent reforms, with the IR35 definition following, so check the current figures before relying on the small-company exemption.
Even when the contractor assesses IR35, you still carry the employment-status risk. If the person is really a worker or employee, HMRC and a tribunal can look through the arrangement.
| Factor | Points to employee | Points to genuine contractor |
|---|---|---|
| Personal service | Must work personally | Can send a substitute |
| Control | You direct how/when/where | They control their own methods |
| Mutuality of obligation | You must offer, they must accept | Project-by-project, no ongoing duty |
| Integration | Part of the team, company email | Works for multiple clients |
| Financial risk | Paid regardless, no investment | Fixed quotes, own equipment, real risk |
Worked example
Raj builds a two-sided marketplace and engages a developer through the developer's own limited company at £450 a day. The developer works only for Raj, uses a company laptop, attends daily stand-ups, and cannot send anyone else in his place.
On paper he is a contractor; in reality the control, personal service and integration all point to employment. Because Raj's startup is small, the developer's company must assess IR35 — but Raj still faces employment-status risk. If challenged, he could owe back-dated tax and face claims for holiday pay and notice. A cleaner substitution right and genuine project-based scope would strengthen the contractor position.
Where founders go wrong
Treating the contract label as the answer
— tribunals and HMRC look at reality, and a "contractor" who behaves like staff will be reclassified.Assuming IR35 and employment rights are the same test
— they are assessed separately and can reach different results.Relying on the small-company IR35 exemption without checking thresholds
— the limits were uplifted recently; confirm the current figures.Building in control and exclusivity
— daily direction and "work only for us" terms push a contractor towards employee status.
Related questions
Can I just call someone a contractor to avoid employment rights?
No. Status turns on the reality of the relationship, not the label in the contract. If a tribunal or HMRC finds the person is really an employee or worker, they get the rights and tax treatment that go with that status, whatever the paperwork says.
What are the three main status tests?
Personal service (can they send a substitute?), control (who decides how, when and where the work is done?), and mutuality of obligation (must you offer work and must they accept it?). Integration into the team and financial risk also weigh in the overall picture.
Who assesses IR35 for a small startup?
If your company is "small" under the Companies Act thresholds, the contractor's own company assesses IR35, not you. Medium and large clients must assess status themselves and issue a status determination statement — check the current small-company thresholds, which were uplifted recently. [More: Do I need a consultancy agreement for a fractional CTO?]
What is the risk of getting status wrong?
You can face back-dated tax and National Insurance, plus employment claims for holiday pay, notice and unfair dismissal. Reclassification can reach back years, so it is worth getting the arrangement right and consistent with how the work actually happens.
Employment status sits on a fault line between employment law and tax, and getting it wrong can mean back-dated bills plus rights you never intended to grant. A SuLe solicitor can review your contractor arrangements and align the paperwork with how the work really happens. Book a free consultation about your contracts before status becomes a problem.
Keep reading: Do I need a consultancy agreement for a fractional CTO? · What should an advisor agreement include? · What must a UK employment contract include? · Can contractors or advisors receive share options? · Who owns the IP my employees and contractors create?
Primary sources: GOV.UK — Employment contracts · Acas — advice and codes of practice
