Fractional CTOs are a growing part of the agency world. You get executive-level technical leadership without the full-time salary and commitment. But these arrangements create a specific IR35 problem that most standard contractor contracts do not solve.

The problem is this: a fractional CTO often looks like a director, acts like a director, and is treated like a director. HMRC sees that and says "that is employment, not a contract for services." The result is a tax bill that can wipe out the cost savings of going fractional in the first place.

This is not about the standard IR35 advice you see everywhere. This is about the specific risk profile of fractional executives who sit on both sides of the table. They attend board meetings. They influence strategy. They have access to everything. And that is exactly what triggers HMRC scrutiny.

As ICAEW qualified accountants who work exclusively with agency founders, we have seen these determinations go wrong more often than they go right. Here is how to write a contract that actually passes a status determination.

Why Fractional CTOs Are Different from Standard Contractors

A web developer working on a six-week project has a clean IR35 profile. They take briefs, deliver code, and leave. There is no ambiguity about control, substitution, or mutuality of obligation.

A fractional CTO is different. They typically:

  • Attend weekly or monthly leadership meetings
  • Make decisions about technology stack and architecture
  • Manage or oversee in-house developers
  • Have access to the company's financial data and strategic plans
  • Stay for 12 to 24 months, not weeks

Each of these factors pushes the engagement toward employment in HMRC's eyes. The contract must explicitly address each one.

The Three Pillars of IR35: Control, Substitution, and Mutuality of Obligation

Every IR35 determination comes down to three tests. If your fractional CTO contract fails any of them, you are at risk.

Control

Control is the biggest issue for fractional CTOs. An employee is told what to do, when to do it, and how to do it. A contractor decides those things themselves.

Your contract must state clearly that the fractional CTO has control over how they deliver the work. They decide their hours, their methods, and their tools. The agency specifies the outcomes but not the process.

Here is the tricky part. If your fractional CTO is making strategic technology decisions, that looks like control. But if the contract says they are providing expert recommendations and the board makes the final decision, that shifts the balance back toward self-employment.

Use language like: "The Contractor shall provide strategic technology recommendations to the Board. The Board retains the right to accept, reject, or modify those recommendations."

Substitution

Substitution is the strongest indicator of self-employment. If the fractional CTO can send someone else to do the work, it is hard for HMRC to argue they are an employee.

Most fractional CTO contracts include a substitution clause. The problem is that many of them are not realistic. If the contract says the CTO can send a substitute but the reality is that the agency hired them for their specific expertise, the clause will not hold up.

Your substitution clause needs to be genuine and workable. That means:

  • The agency cannot unreasonably refuse the substitute
  • The substitute must have comparable skills and experience
  • The fractional CTO remains responsible for the substitute's work
  • The agency pays the same rate regardless of who does the work

A weak substitution clause is worse than no clause at all. HMRC will see it as a sham and treat the whole contract as evidence of avoidance.

Mutuality of Obligation

Mutuality of obligation means the agency is obliged to provide work and the contractor is obliged to accept it. Employees have this. Contractors do not.

Your contract must make clear that the agency has no obligation to offer work beyond the specific engagement, and the fractional CTO has no obligation to accept additional work. Each project or phase should be separately scoped and agreed.

For fractional CTOs, this is harder than it sounds. If they are attending weekly leadership meetings for 18 months, HMRC will argue that there is an ongoing obligation on both sides. The contract needs to frame each meeting or sprint as a separate deliverable under a framework agreement, not a continuous engagement.

Specific Clauses Your Fractional CTO Contract Must Include

Beyond the three pillars, there are specific clauses that make the difference between a passing and failing determination.

Scope of Work Clause

This is the most important clause in the contract. It must define exactly what the fractional CTO will deliver, in measurable terms. Not "provide CTO services" but "deliver a technology roadmap for Q3 2025, including assessment of current stack, recommendations for migration, and cost projections for three scenarios."

Each deliverable should have a deadline, a format, and an acceptance criteria. If the scope changes, you issue a variation or a new statement of work. You do not let it blur into general advisory work.

Right of Substitution Clause

We covered this above. Make it real. Name the process for proposing a substitute, the qualifications required, and the payment terms. Do not hide it in the small print.

Financial Risk Clause

Contractors bear financial risk. Employees do not. Your contract should state that the fractional CTO is responsible for their own tax, National Insurance, and VAT. It should also state that they carry professional indemnity insurance and are liable for rectifying defective work at their own cost.

Include a specific amount for the insurance cover. £1 million is standard for this type of role.

Equipment and Expenses Clause

Employees use company equipment and claim expenses. Contractors provide their own. Your contract should state that the fractional CTO provides their own laptop, phone, and software licenses. If they attend your office, they cover their own travel and accommodation.

If you do provide equipment for security reasons, document why and limit it to what is strictly necessary. A laptop for accessing your systems is acceptable. A company phone, company car, and office desk start to look like employment.

Notice and Termination Clause

Employees have notice periods and often notice pay. Contractors have termination clauses that reflect the commercial nature of the relationship.

Your contract should allow either party to terminate with notice, typically 30 days. There should be no obligation to pay notice if the contractor is not working. Payment is for work done, not for time served.

What to Avoid in a Fractional CTO Contract

Some clauses are red flags for HMRC. Avoid them entirely.

Exclusivity clauses. If the contract says the fractional CTO cannot work for anyone else, that is employment. They should be free to take other clients. If you need exclusivity for a specific period, be prepared to justify it commercially and limit it to the minimum necessary.

Holiday and sick pay. Do not include these. Contractors do not get paid time off. If the fractional CTO is not working, they do not get paid.

Company benefits. No pension contributions, no private medical insurance, no gym membership. These are employment benefits. If you want to offer them, hire the person as an employee.

Appraisals and performance reviews. Employees get appraised. Contractors get feedback on deliverables. If your contract includes a performance review process, HMRC will treat it as evidence of employment.

Working hours. Do not specify core hours or a minimum number of hours per week. Specify deliverables and deadlines. How the fractional CTO organises their time to meet those deadlines is their business.

Since April 2021, medium and large agencies are responsible for issuing a Status Determination Statement (SDS) to every contractor before work starts. This applies to fractional CTOs too.

The SDS must state whether the engagement is inside or outside IR35 and give the reasons for that decision. You cannot just say "outside IR35" and move on. You need to show your working.

HMRC's CEST tool (Check Employment Status for Tax) is the standard way to do this. But CEST has known limitations. It struggles with complex arrangements, and fractional CTO engagements are complex by definition.

If CEST gives you an "undetermined" result, or if you disagree with its conclusion, you need to do a more detailed assessment. That might involve a professional IR35 review from a specialist solicitor or accountant.

Your SDS should reference the specific clauses in the contract that support your determination. For example: "The contract includes a genuine right of substitution clause (clause 4.2), the contractor bears financial risk (clause 7.1), and there is no mutuality of obligation beyond the specific deliverables in the scope of work (clause 2.1)."

Keep a copy of the SDS and the contract on file. HMRC can request them up to six years after the engagement ends.

How the Contract Interacts with the Working Reality

Here is the uncomfortable truth. A perfect contract will not save you if the working reality is different. HMRC looks at what actually happens, not just what the paperwork says.

If your contract says the fractional CTO has control over their working methods, but you call them at 9pm on a Sunday asking for an urgent fix, that is control in practice. If the contract says they can send a substitute, but you have never accepted one, that is a sham clause.

You need to operate the engagement in line with the contract. That means:

  • Do not treat the fractional CTO like an employee in meetings, emails, or day-to-day interactions
  • Do not include them in staff communications, team-building events, or internal training
  • Do not give them company email addresses that look like employee addresses (firstname@agency.com is fine, but make sure the domain is not restricted to employees only)
  • Do not expect them to work fixed hours or attend every meeting
  • Do pay them on invoice, not on the company payroll run

One of our clients, a 15-person digital agency in Manchester's Northern Quarter, had a fractional CTO who was clearly outside IR35 on paper. But in practice, the CTO was attending all-staff meetings, using a company laptop, and being cc'd on internal HR emails. HMRC challenged the determination and the agency ended up paying £47,000 in back taxes and penalties. The contract was fine. The reality was not.

When to Use a Umbrella Company Instead

Some fractional CTO arrangements are genuinely inside IR35. If the CTO is effectively acting as a director, making unilateral decisions, and managing staff, the contract will not change that reality.

In those cases, the cleanest solution is to use an umbrella company. The umbrella company employs the fractional CTO and handles PAYE and National Insurance. You pay the umbrella company and they handle the compliance. It is simpler and removes the risk entirely.

The downside is cost. The fractional CTO will need a higher day rate to compensate for the tax they pay as an employee. But if the engagement is inside IR35 anyway, this is the honest way to structure it.

What to Do Before You Sign

Before you engage a fractional CTO, do three things:

One: Get the contract reviewed by a solicitor who specialises in IR35. Do not use a template from a generic contract library. Fractional CTO engagements need bespoke drafting.

Two: Run the CEST tool with the actual contract terms. If it comes back "outside IR35," document that result and keep it. If it comes back "undetermined" or "inside IR35," get professional advice before proceeding.

Three: Brief your team. Make sure everyone who interacts with the fractional CTO understands that they are a contractor, not an employee. That means no treating them like a staff member, no expecting them to attend non-essential meetings, and no giving them employee perks.

If you are working with an agency that has a fractional CTO or is considering one, and you want to check whether your current contracts would pass a status determination, speak to your accountant. If your accountant is not familiar with the specific risks of fractional executive arrangements, find one who is. Our ICAEW qualified team at Agency Founder Finance works with agency founders on exactly these issues.

Fractional CTOs can be a great solution for growing agencies. But the tax consequences of getting the IR35 determination wrong are severe. Get the contract right, operate it correctly, and keep the documentation. That is the only way to make it work.