IR35: The Tax Rule That Decides If You’re Paid as a Contractor or Employee

IR35: four seemingly harmless characters that can strike fear into the heart of any UK contractor. Think of it as HMRC’s way of asking, “Are you really your own boss, or just pretending while collecting a company payslip?”

If you invoice clients through a limited company, personal service company (PSC), or anything fancier than a lemonade stand, IR35 is the rule that decides whether you’re a bona fide entrepreneur or, in the taxman’s eyes, just an employee in clever disguise.

Ignore it, and your tax bill could suddenly grow teeth.

Ready to find out if IR35 is about to turn your freelance dream into payroll déjà vu? Let’s break it down—minus the legal snooze.

What is IR35?

IR35 (also known as the intermediaries legislation) is HMRC’s rulebook for spotting “disguised employees”—that is, people who work like regular employees but get paid through a limited company or personal service company (PSC). In other words: if it looks like employment and smells like employment, HMRC wants it taxed like employment.

The goal? To make sure anyone working off-payroll—whether you call yourself a contractor, freelancer, or umbrella company worker—pays the right income tax and national insurance contributions. No special treatment just because you’ve got your own letterhead.

Who decides your tax status under IR35?

Understanding who makes the call on your IR35 status is crucial—it’s not always up to you. The answer depends entirely on the type and size of the client you’re working for.

Public sector and medium/large private sector clients

If you’re working for the public sector or for a private company that qualifies as “medium” or “large,” the responsibility is on your client. They must:

• Assess your working arrangement to determine your IR35 status.
• Issue a Status Determination Statement (SDS) with their decision.
• Ensure “reasonable care” is taken when making the determination.
• If an agency (the “fee-payer”) pays you, that agency must operate PAYE and deduct the correct tax and national insurance.

Small private sector clients

If your client is a small private business (fewer than 50 employees, with turnover and balance sheet totals under Companies House limits), the responsibility shifts to you, the contractor. In this case, you must:

• Assess whether your work falls inside or outside IR35.
• Make sure you pay the correct amount of tax and national insurance.
• Take on the risk of penalties if you get it wrong.

📌 Pro Tip: Who decides your IR35 status depends entirely on your client’s size and sector. Get it right, and you’ll avoid an unwelcome surprise from HMRC.

Inside vs outside IR35: What does it mean?

Think of IR35 as the ultimate tax sorting hat: are you truly self-employed, or is HMRC about to declare you an employee in contractor’s clothing? The difference isn’t just academic—it decides who gets your tax money, how much you take home, and how many headaches you’ll have come tax year-end.

Here’s how the two sides break down:

Inside IR35

If you’re inside IR35, HMRC sees you as a “disguised employee” for tax purposes, even if you’re operating through your own limited company or PSC. What this means for you:

• Income tax and employee National Insurance contributions (NICs) are deducted through PAYE—handled by the client or agency (the fee-payer).
• No more cherry-picking tax advantages—dividends and clever salary planning are off the table.
• Your tax bill and payslip look a lot like an employee’s, but you may still miss out on workplace perks.

Outside IR35

If you’re outside IR35, you’re considered genuinely self-employed under UK tax legislation. That means:

• You work (and invoice) through your own limited company or PSC.
• You get to decide how you pay yourself—dividends, salary, or a tax-savvy mix.
• Your business keeps the classic tax advantages, and your company handles the taxes due (no PAYE from the client or agency).

Why it matters

This simple status changes everything:

• How much tax you pay
• How much you keep
• How your finances look at the end of the tax year

It’s a crucial distinction for off-payroll workers, small business owners, and anyone in the private sector supply chain. The end client’s decision, under the off-payroll working rules, has a real impact on your bottom line.

If you’re not sure which side you fall on, don’t leave it to guesswork. Use the gov.uk CEST tool, and if in doubt, get advice from a qualified tax professional. A quick check now could save you a lot of grief (and cash) later.

📌 Pro Tip: Sometimes, HMRC will focus less on your contract and more on how you actually work day-to-day. If your working practices look like those of a regular employee—same hours, same desk, same boss—you’re far more likely to land inside IR35, no matter what your paperwork says.

How IR35 is assessed: The key tests

You can have the fanciest written contract in the world, but when it comes to IR35, HMRC cares even more about how you actually work. Assessment hinges on a few classic tests designed to sniff out “disguised employment”—and keep the tax playing field level.

When HMRC assesses IR35, they don’t just glance at your contract and call it a day. Instead, they run through a series of classic tests—the red flags and green lights that separate true contractors from disguised employees.

1. Supervision, direction and control

Are you genuinely in control of how, when, and where you do your work? Or is your client calling the shots, setting your hours, and double-checking your every move? The more control they have, the more you look like an employee.

2. Right of substitution

Can you send someone else in your place to do the job? True contractors can usually provide a substitute—employees can’t.

3. Mutuality of Obligation (MOO)

Does your client have to keep giving you work, and do you have to accept it? Regular, ongoing obligation points to employment. One-off projects and freedom to say no look more like genuine contracting.

4. How you’re paid

Are you paid a fixed salary or by the project? Do you invoice, or just pick up a payslip? Contractors invoice and take commercial risk; employees get regular pay, whatever happens.

5. Equipment and risk

Whose laptop are you using? Whose insurance covers you? Contractors typically use their own equipment and shoulder their own business risks.

Beyond the contract: What HMRC really check

HMRC and the courts will always look at your day-to-day working practices. Case law is full of examples where the reality didn’t match the contract—and the tax bill followed the reality, not the paperwork.

For extra certainty, you (or your client) can use the gov.uk CEST tool to assess IR35 status. It’s not perfect, but it’s a good starting point—and demonstrates that you’re taking compliance seriously.

📌 Pro Tip: Don’t rely on contract templates alone. Regularly review how you actually work on-site (or off-site), and keep a record of anything that shows you’re truly independent—like project-based invoicing, bringing your own kit, or having other clients on the go.

Off-payroll rules: Recent changes, new rules and private secitor impacts

IR35 hasn’t stood still—recent years have brought some of the biggest shakeups in contractor tax history. The so-called “off-payroll rules” are the reason even seasoned contractors now double-check who’s making the IR35 call.

What changed in 2021?

Since April 2021, for medium and large private sector businesses, the responsibility for determining IR35 status no longer sits with contractors. It shifted to the client—the company benefiting from your work. This was already the norm in the public sector, but now the same rules apply to most private sector contracts as well.

• Clients (the end users) must review every contractor’s working practices and issue a Status Determination Statement (SDS).
• Fee-payers—often agencies or intermediaries—are responsible for deducting income tax and employee National Insurance (NICs) and paying employer NICs when IR35 applies.
• The deemed employer is whoever actually pays the contractor. If that’s an umbrella company, they become responsible for all tax deductions.

Where do PSCs and umbrella companies fit in?

Not every contractor operates the same way. Some work through their own personal service company (PSC); others use an umbrella company. Where you fit in the supply chain changes how the IR35 rules—and your tax—are handled.

• PSC contractors: If you contract through your own personal service company (PSC), the rules above apply. Your tax treatment depends on the client’s IR35 assessment.
• Umbrella company workers: If you work via an umbrella company, they act as your employer for tax purposes, handling all PAYE tax and NICs for you. IR35 doesn’t apply to you directly—but you’ll likely be taxed as an employee anyway.

Who’s responsible in the supply chain?

Depending on how many layers stand between you and the end client, responsibility for tax can land with:

• The client (medium/large private sector)
• The recruitment agency (as fee-payer)
• The umbrella company (if that’s who pays you)

What happens if the rules aren’t followed?

Non-compliance isn’t just a slap on the wrist. If the wrong party fails to follow the off-payroll working rules:

• The tax bill (plus interest and penalties) lands on their desk, not yours.
• HMRC may demand backdated PAYE, NICs, and even apply the Apprenticeship Levy in some cases.
• Being “outside IR35” on paper doesn’t help if your working practices tell a different story.

Staying up to date

Both HM Revenue & Customs and gov.uk provide regular updates as IR35 legislation evolves. If you’re not sure whether your business—or your supply chain—is up to speed, now’s the time to check.

📌 Pro Tip: Don’t rely on old rules or hearsay. If your contract or working practices changed recently, get a fresh IR35 assessment. It’s easier to stay compliant than to fight an unexpected tax bill.

Why IR35 matters: Pay, tax, and financial strategy

Why does IR35 strike fear (and mild irritation) into the heart of so many contractors? Because it can seriously change your financial picture—sometimes overnight.

How IR35 affects your take-home pay

Here’s the simple truth: IR35 can make a huge difference to what actually lands in your bank account each month.

• Inside IR35: You’re taxed like an employee. Income tax and national insurance contributions (NICs) are taken before you ever see your money. You’ll also miss out on many classic contractor perks—like taking income as dividends or planning your salary for tax efficiency.
• Outside IR35: You keep full control of your company finances. Pay yourself with a tax-efficient mix of dividends and salary, and often take home more at the end of the tax year.

The difference isn’t small. Inside IR35, your tax liability and overall tax bill can jump, and you may see less money hit your bank account—even with the same headline rate.

How IR35 affects employer costs

When your contract is caught by IR35, the company paying you (the “deemed employer”) must also pay employer NICs, and in some cases, the apprenticeship levy. That’s extra cost for them—and a factor that can affect your day rate negotiations.

Risks of non-compliance

Tempted by “creative” workarounds or clever-looking schemes? HM Revenue & Customs (and the good old Inland Revenue) are always on the lookout for tax avoidance. If your setup looks suspicious, you could face a tax investigation, a backdated tax bill, and eye-watering penalties.

📌 Pro Tip: Don’t be dazzled by anything that promises easy tax savings. When in doubt, get a professional review—peace of mind now beats a surprise from HMRC later.

How to check and stay compliant with IR35

The good news: you don’t need a crystal ball to stay on the right side of IR35. A little diligence (and some well-organised paperwork) can keep both your tax bill and your stress levels in check.

1. Check your IR35 status

Start with the official Check Employment Status for Tax (CEST) took. It asks straightforward questions about your contract, your actual working practices, and your client relationship. While not perfect, using CEST demonstrates you’re taking IR35 compliance seriously—and gives you a documented result.

2. Keep the right records

Staying compliant is much easier when your paperwork is in order. Be sure to:

• Save all written contracts and contract reviews.
• Keep email chains and communication about your working relationship.
• Store copies of any Status Determination Statements (SDS).
• Document actual day-to-day working practices, not just what’s on paper.

Reasonable care matters. If you can show you’ve acted carefully and kept good records, you’re far less likely to face penalties if HMRC comes calling.

3. Seek professional advice

If you run a PSC or limited company, or if your IR35 status is even a little bit murky, don’t be afraid to call in an expert. Independent tax advisors or specialist accountants can review your contracts, help you understand the off-payroll working rules, and make sure your business model keeps up with the latest IR35 tax changes.

Steps to improve IR35 compliance

Staying compliant isn’t just about one contract—it’s about building a culture of careful, consistent documentation. Treat your IR35 file like a parachute: you hope you never need it, but you’ll be glad it’s there if you do.

• Schedule regular contract reviews to check you’re still compliant.
• Make sure you fully understand the off-payroll working rules for your sector.
• Update your business practices and contracts if HMRC or industry guidance changes.
• Structure your contracts and communications to support your preferred IR35 status—consistency is key.

Take control of your IR35 status

IR35 isn’t just tax fine print—it’s central to your working life if you’re a contractor, PSC, or running a small business. Whether you’re “inside” or “outside,” your IR35 status affects everything from your take-home pay to your year-end tax bill. Understanding your status, checking every contract, and keeping your paperwork in order are the best ways to avoid any nasty surprises from HMRC.

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