What Is IR35?
IR35 is a set of tax rules that decides whether a contractor who works through their own limited company is genuinely running a business, or is really an employee in all but name. If you are the second kind, HMRC wants you taxed like an employee, and IR35 is the mechanism that makes that happen.
The name is odd because it is not really a name at all. It comes from an Inland Revenue press release numbered 35, published back in 1999, and the label stuck. The formal name is the Intermediaries Legislation, and more recently the reformed version is called the off payroll working rules. Whatever you call it, the target is the same: what HMRC calls disguised employment.
Here is the problem the rules are trying to solve. A worker leaves a permanent job on a Friday, sets up a limited company over the weekend, and starts back at the same desk on Monday doing the same job for the same manager, but now invoicing through their company. On paper they are a business. In reality nothing has changed except the tax they pay, because taking money out as a mix of small salary and dividends through a company usually costs far less in tax and National Insurance than being on the payroll. IR35 exists to stop that.
Inside IR35 and Outside IR35: What They Mean
Almost every conversation about these rules comes down to two phrases, so it is worth getting them straight.
Outside IR35 means the rules do not apply to you. HMRC accepts that you are genuinely in business on your own account, and you can pay yourself through your company in the normal way, taking a modest salary and the rest as dividends. This is the position most contractors want to be in, because it is the more tax efficient one.
Inside IR35 means the rules do apply. The engagement is treated as employment for tax purposes, so income tax and National Insurance are deducted from your fee more or less as if you were on the payroll, through PAYE. You lose most of the tax advantage of working through a company, though you still do not get holiday pay, sick pay or other employment rights, which is the part contractors find hardest to accept.
The difference in take home pay between the two can be large, often a fifth or more of your income, which is exactly why status is fought over so hard.
How HMRC Decides Your Status
There is no single tick box that settles IR35. Status comes from decades of employment case law, and the courts look at the real working relationship rather than what the contract says on its cover. Three factors carry the most weight.
Personal service and substitution. Employees do the work themselves. A genuine business can send someone else. If you have a real, unfettered right to send a suitably qualified substitute in your place, and the client cannot simply refuse, that points strongly towards being outside IR35. If the client hired you personally and only you will do, that points inside.
Control. This is about how much say the client has over what you do and, more importantly, how, when and where you do it. A contractor decides their own methods and hours within reason. An employee is told. The more the client directs the detail of your work, the more you look like an employee.
Mutuality of obligation. This is the clumsy phrase for a simple idea: is the client obliged to keep offering you work, and are you obliged to accept it? A rolling expectation of continuous work looks like employment. A defined project with a clear end, after which neither side owes the other anything, looks like business.
Beyond the big three, HMRC weighs up whether you take real financial risk, whether you provide your own equipment, whether you are "part and parcel" of the organisation with a permanent desk and a place on the internal directory, and whether you work for several clients or just one. No single factor decides it. It is the overall picture that counts.
HMRC provides a free online tool called CEST, which stands for Check Employment Status for Tax, to help work out where an engagement sits. It is worth running, and HMRC says it will stand behind the result if your answers are accurate, but it has a reputation for returning "undetermined" on the borderline cases where you most need an answer, so treat it as a starting point rather than the final word.
Who Is Responsible: The 2017 and 2021 Reforms
For the first seventeen years of IR35, the rule was simple in one respect: it was the contractor's own company that had to decide its status and pay the right tax. HMRC found this hard to police, because very few contractors ever put themselves inside, so the rules were reformed to move the responsibility onto the client.
In April 2017 the reform hit the public sector. From that date, public sector bodies had to decide the status of the contractors they hired, and the organisation paying the invoice had to deduct tax at source where the engagement was inside IR35.
In April 2021, after a year's delay caused by the pandemic, the same reform reached the private sector. Now medium and large private sector clients are responsible for deciding your status and must give you a Status Determination Statement explaining the decision and their reasons. If you are inside, the business that pays your company, known as the fee payer, deducts income tax and National Insurance before your company sees the money, and pays employer National Insurance on top.
There is one important exception. If your end client is a small company, the old rules still apply and your own company remains responsible for deciding status. A company counts as small if it meets at least two of three tests: turnover no more than £15 million, balance sheet total no more than £7.5 million, and no more than 50 employees. Those thresholds were raised from £10.2 million and £5.1 million for accounting periods beginning on or after 6 April 2025, which pulled more clients into the small bracket and handed the decision back to more contractors.
What Inside IR35 Actually Costs You
When an engagement is inside IR35 under the reformed rules, the fee payer treats your invoice as a deemed employment payment. Income tax and employee National Insurance come off through PAYE, and the fee payer also pays employer National Insurance, which rose to 15 percent from April 2025 and makes inside engagements noticeably more expensive to offer.
The money that lands in your company is what is left after all of that, and it has effectively already been taxed as employment income, so you can usually draw it out without a second tax charge. What you lose is the ability to leave profit in the company, split it as dividends, or time it across tax years. In practice an inside contractor keeps much less of the same day rate than an outside one, which is why day rates for inside roles are often quoted higher to compensate.
A genuine grievance sits underneath all this. An inside contractor pays tax like an employee but gets none of the employment rights, no paid holiday, no sick pay, no pension contributions and no redundancy protection. The rules tax the relationship as employment without granting the protections of employment, and that mismatch is the single most criticised feature of the whole regime.
Blanket Assessments and Reasonable Care
When the private sector reform landed in 2021, some large clients reacted by declaring every contractor inside IR35, regardless of the individual facts, simply to remove their own risk. This is known as a blanket determination, and it is not allowed. The law requires a client to take reasonable care when deciding status, which means looking at each engagement on its own terms. A client that fails to take reasonable care becomes liable for the tax itself, so a blanket "everyone is inside" approach is both unfair to contractors and legally shaky.
If you receive a determination you think is wrong, you have the right to challenge it through the client's dispute process, and the client must respond within 45 days with either a changed decision or its reasons for holding firm. Do not let an unfair inside determination go unquestioned, especially if it was clearly applied across the board rather than to your actual working arrangement.
Our View
IR35 has had one of the most chaotic recent histories of any tax rule, and that is worth remembering when you read confident advice about it. In the September 2022 mini Budget the government announced it would scrap the 2017 and 2021 reforms entirely, only to reverse that decision a few weeks later in October. Contractors were told the rules were gone, then told they were staying, inside a single month. Anyone who made a decision on the strength of the first announcement was left exposed.
Our honest view is that IR35 is here to stay, and the sensible response is to make sure your outside status is genuine rather than hoped for. That means contracts that reflect how you really work, working practices that back up the paperwork, more than one client where you can manage it, and a real willingness to turn work down. A contract that says you can send a substitute is worth little if everyone knows you never could. HMRC looks at reality, so your defence has to be built on reality too.
We would also flag one piece of good news that gets missed. Since April 2024, when HMRC finds that a client wrongly put a contractor outside IR35, it can now offset the tax the contractor already paid through their company against the client's bill. Before that change the same income could effectively be taxed twice, which made clients even more nervous about outside determinations. The offset makes a fair outside decision a little less frightening for clients, which is quietly helpful for contractors trying to secure one.
How IAK Can Help
IR35 is one of those areas where a second opinion pays for itself. Our tax planning team reviews your contracts and your actual working practices, gives you a straight answer on where you sit, and helps you arrange engagements so a genuine outside position holds up if HMRC ever asks. If you are inside IR35, or moving between contracts and employment, our personal tax service makes sure your Self Assessment, your PAYE and your company all line up so you are not paying more than you owe.
If you are still weighing up whether to trade through a company at all, our guide to sole trader versus limited company is a good place to start, and if you are a contractor or freelancer wondering whether professional help is worth it, see what an accountant actually does. You can also model your take home pay with our salary calculator. Contact us for a free consultation and we will tell you where you stand.
Sources
- Understanding off-payroll working (IR35), GOV.UK, on what IR35 is and how the rules work.
- Off-payroll working rules for clients, GOV.UK, on the client responsibilities from April 2021 and the small company exemption.
- Check Employment Status for Tax (CEST), GOV.UK, on HMRC's status checking tool.
- Employment status manual: the key status tests, GOV.UK, on control, personal service, substitution and mutuality of obligation.
- Off-payroll working: set-off of tax already paid, GOV.UK, on the set-off rules introduced from 6 April 2024.