If you're considering bringing in a fractional COO (or if you're a fractional COO yourself) IR35 is a question that comes up sooner or later. Usually in one of two ways: a founder asking whether they need to put a fractional COO on payroll, or an operations leader asking whether their engagement is likely to be caught by the off-payroll working rules.

It's a reasonable question, and one that doesn't have a simple universal answer. What it does have is a fairly clear framework for thinking through it and a set of factors that make a fractional COO engagement more or less likely to fall inside or outside IR35.

This post explains what IR35 is, how it typically applies to fractional COO engagements, and what both clients and fractional COOs should be thinking about when structuring an arrangement. It is not legal or tax advice, and the specifics of any individual engagement should always be assessed by a qualified professional such as an accountant or tax adviser with IR35 experience.

What IR35 means

IR35 is shorthand for the off-payroll working rules. It is legislation designed to ensure that contractors who are, in practice, working like employees pay broadly the same tax as employees, rather than the lower tax burden associated with working through a limited company.

The rules apply when a contractor provides services through an intermediary (usually their own limited company) but the nature of the working relationship is more like employment than genuine self-employment. If HMRC determines that, absent the limited company, the contractor would be an employee of the client, the engagement is likely to be caught by IR35.

Since April 2021, the responsibility for making that determination has shifted to the client in most cases, specifically, medium and large businesses. Small businesses (those that meet at least two of: fewer than 50 employees, annual turnover under £10.2m, balance sheet under £5.1m) are currently exempt, meaning the determination remains with the contractor.

Whether your business is in scope for the client-side rules matters when you're considering how to structure a fractional COO engagement.

How IR35 applies to fractional COO engagement

Fractional COO engagements sit in interesting territory when it comes to IR35, because the nature of the role - senior, strategic, embedded - has some characteristics that could point in either direction.

The key question IR35 asks is not what the contract says, but what the working relationship actually looks like in practice. Three factors carry the most weight.

Substitution. Can the contractor send a substitute to do the work, or is the client paying specifically for that individual? A genuine right of substitution points toward self-employment. Most fractional COO engagements are relationship-based and personal-skills-based, which means substitution rights, while worth including contractually, may carry less weight in practice if the client has specifically chosen the individual.

Control. Does the client control how, when, and where the work is done or does the contractor have autonomy over their working methods? A fractional COO who sets their own schedule, works across multiple clients simultaneously, determines their own approach to the work, and isn't subject to the same oversight as an employee is pointing toward outside IR35. A fractional COO who is expected to work set hours, follow internal management directives, and operate in ways that are indistinguishable from an employed COO is pointing in the other direction.

Mutuality of obligation. Is the client obliged to offer work, and is the contractor obliged to accept it? A genuine project-based or retainer engagement with defined scope, clear deliverables, and no expectation of ongoing work beyond the agreed terms points toward self-employment. An open-ended arrangement where the client expects ongoing availability and the contractor expects continuous work is more employment-like.

What typically makes a fractional COO engagement outside IR35

Several characteristics of well-structured fractional COO engagements tend to point toward outside IR35, though this is always fact-specific and no post can substitute for a proper assessment.

Working across multiple clients simultaneously is one of the clearest indicators of self-employment. A fractional COO who is actively working with several businesses at the same time is operating very differently from an employee; they're running a business, not filling a role.

Having a defined scope of work rather than an open-ended employment-style arrangement helps. An engagement structured around specific deliverables like an operational audit, a systems implementation, a defined advisory retainer is more clearly a business-to-business arrangement than one that looks like an employment contract with flexible hours.

Autonomy over working methods, schedule, and approach. A fractional COO who determines how they do the work, when they do it, and what methodology they apply is exercising the kind of independence associated with self-employment.

Financial risk. A fractional COO who has invested in their own business, bears the cost of their own tools and professional development, and takes on the financial risk of their own limited company is operating more like a business than an employee.

Not being integrated into the client's business in the way an employee would be, meaning not receiving employee benefits, not being managed in the same way as staff, not appearing on internal org charts as a permanent fixture, also matters.

What increases IR35 risk

An engagement where the fractional COO works primarily or exclusively with one client over an extended period starts to look more employment-like. One where the client exercises significant control over hours, methods, and priorities carries more risk. One where there's no defined scope and the arrangement has simply continued indefinitely carries more risk than one with clear, renewed terms.

Using an employment-style contract rather than a professional services or consultancy agreement (even if the engagement itself is genuinely fractional) can also create problems if the documentation doesn't reflect the reality of the arrangement.

Practical steps to take

For clients considering a fractional COO engagement, the most important step is to ensure the contract accurately reflects the nature of the working relationship. A well-drafted professional services agreement, reviewed by someone with IR35 experience, is worth the investment.

If your business meets the threshold for medium or large under the Companies Act definition, you'll also need to issue a Status Determination Statement (SDS) to the contractor, setting out your determination of their IR35 status and the reasons for it. Getting this wrong carries liability risk, so it's worth doing properly.

HMRC's Check Employment Status for Tax (CEST) tool is available online and can provide an indication, though it's not definitive and has been criticised for oversimplifying some of the more nuanced cases. A tax adviser with IR35 experience will give you a more reliable picture.

For fractional COOs operating through a limited company, the same principles apply in reverse. Maintaining clear evidence of genuine self-employment such as multiple clients, substitution clauses, defined scope, financial risk, autonomy over working methods is important both for any client-side determination and for your own position if HMRC ever queries an engagement.

RE: VAT

A related question that comes up for fractional COO engagements is VAT. If the fractional COO is VAT-registered, their fees will be subject to VAT, which the client can reclaim if they are also VAT-registered. This is standard for professional services engagements and isn't specific to IR35, but it's worth factoring into budget conversations early to avoid surprises.

In summary

Most well-structured fractional COO engagements sit outside IR35. But "most" is not "all," and the specifics matter enormously. An engagement that looks fractional on paper but operates like employment in practice is at risk regardless of what the contract says.

The sensible approach, for both clients and fractional COOs, is to structure engagements thoughtfully from the outset, ensure the contract reflects the reality of the arrangement, and take proper professional advice rather than relying on a general understanding of the rules.

IR35 is one of those areas where getting it wrong is significantly more expensive than getting proper advice at the start.

This post is intended as an orientation to IR35 as it relates to fractional COO engagements. It is not legal or tax advice. If you need a determination for a specific engagement, please consult a qualified accountant or tax adviser with IR35 experience.

If you're considering a fractional COO engagement and want to understand what working with Systems Rani looks like in practice, find out more here or get in touch.