IR35 is the shorthand name for the UK’s off-payroll working legislation. The core principle is straightforward: if a worker provides services through their own intermediary — typically a limited company or personal service company — but their day-to-day arrangement would look and feel like employment if they contracted directly with the end client, they should pay broadly the same Income Tax and National Insurance as an employee would.

The rules have been part of UK tax law since 2000, but the practical landscape shifted significantly in 2017 and again in April 2021, when responsibility for determining a contractor’s employment status moved away from the contractor themselves and towards the end client in most medium and large engagements.

Understanding the IR35 rules explained clearly is essential for anyone operating through a limited company, whether you are an IT contractor in Wrexham, a consultant working remotely for a London-based firm, or a freelance engineer across multiple public sector projects. Getting the status wrong — in either direction — has real financial consequences. This guide walks through how IR35 works, how status is assessed, and what you should do to protect your position.

IR35 targets arrangements where a worker sets up a limited company — often called a personal service company (PSC) — and then contracts their labour to clients through it. Without the off-payroll rules, that structure would allow the worker to draw income as dividends rather than salary, paying less National Insurance and often less Income Tax as a result.

The legislation does not ban that structure. What it says is that if the underlying relationship between the worker and the end client is, in substance, one of employment, then the tax treatment should reflect that — regardless of what sits in between them contractually.

What triggers the rules

The rules are triggered when all of the following are true:

• A worker provides services to an end client.
• The worker uses an intermediary — most commonly their own limited company — to do so.
• If the intermediary were removed and the worker contracted directly with the client, they would be considered an employee.

That last point is where most of the complexity lives, because deciding whether someone would be an employee involves applying a series of employment status tests developed through decades of case law.

What happens if IR35 applies

If a particular engagement is determined to be inside IR35, the fees paid by the client to the worker’s company are treated as a deemed payment of employment income. Income Tax and employee National Insurance are deducted from those fees by the deemed employer (either the end client or the fee-payer in the chain). Employer National Insurance — and the Apprenticeship Levy where it applies — also becomes due on top of those fees.

In practical terms, a contractor working inside IR35 takes home significantly less than one working outside IR35 on the same gross day rate, because the dividend tax efficiency of a limited company is lost entirely for that engagement.

IR35 status is not determined by what your contract says alone — HMRC and the courts look at the actual working practices on the ground. Three tests carry the most weight in any status determination.

1. Personal service and substitution

A genuine business sells a service, not a specific person. If you have the unfettered right to send a suitably qualified substitute to complete the work in your place, and the end client cannot veto that substitution simply because they prefer you, that points firmly towards outside IR35. If the client engaged you specifically because of who you are and would refuse any substitute, the arrangement looks much more like employment.

The key word is unfettered. A substitution clause that only applies with the client’s prior written approval provides little real protection.

2. Control

Employees are, by definition, subject to their employer’s control over how, when, and where they work. A genuinely self-employed contractor controls their own working methods. If your client dictates the tools you use, the hours you work, the office you must sit in, or the way you perform your tasks, that level of control points towards inside IR35.

This does not mean contractors can never work set hours or attend a client’s site — but the control must relate to the outcome, not the methodology.

3. Mutuality of obligation

In an employment relationship, the employer is expected to offer work and the employee is expected to accept it. A contractor, by contrast, has no obligation to take on further engagements and the client has no obligation to keep offering them. If your client is effectively keeping you on a rolling basis with the expectation of continued work and you are expected to accept it, mutuality of obligation points toward employment.

Beyond these three core tests, additional factors — such as whether you have your own business equipment, carry financial risk, work for multiple clients, and present yourself as a separate business rather than part of the client’s workforce — all inform the overall picture.

One of the most important — and most misunderstood — aspects of the current IR35 rules is that contractors operating through a limited company are no longer always responsible for deciding their own employment status. The responsibility depends on the size of the end client.

Public sector and medium or large private sector clients

Since April 2021, if your end client is either a public authority or a medium or large private sector business, they are responsible for assessing your employment status and issuing you with a written Status Determination Statement (SDS) for each engagement. The SDS must give their determination — inside or outside IR35 — and their reasons for reaching it.

A private sector company is treated as medium or large if it meets at least two of the following criteria:

• Annual turnover above £10.2 million
• Balance sheet total above £5.1 million
• More than 50 employees

Where an agency sits between the end client and your limited company, the agency typically becomes the fee-payer responsible for operating PAYE deductions on inside-IR35 engagements.

Small private sector clients

If your end client is a small company — below the thresholds above — the responsibility for making the employment status determination remains with your own intermediary, just as it did under the original IR35 rules before 2017. You assess your status, and if the engagement falls inside IR35, your company is responsible for the tax.

This is an important nuance. Many contractors assume the client always decides, but for small private sector engagements that is not the case. If you operate primarily in that space, the original off-payroll working rules still apply to you directly.

The financial impact of an inside versus outside IR35 determination is substantial, and worth understanding in concrete terms before accepting any engagement.

Working outside IR35

If a contract is outside IR35, your limited company receives the gross fee from the client. You pay Corporation Tax on the company’s profits, draw a tax-efficient mix of salary and dividends, and keep the benefit of the limited company structure. Your effective tax rate depends on how you extract profit, but it will generally be lower than the equivalent PAYE position.

Working inside IR35

If a contract is inside IR35, the fee-payer (the client or agency) must deduct Income Tax and employee National Insurance from the payment before passing it to your company. On top of that, employer National Insurance is also due — and that cost typically comes out of the rate you were quoted, reducing what your company actually receives.

By the time the fee reaches your company, it has already been taxed at roughly employment rates. You can still draw a salary and dividends, but there is no meaningful tax advantage in doing so for that income. Your limited company may also still incur its fixed overheads — accountancy fees, insurance, subscriptions — without the tax efficiency to offset them.

The tax cost in practice

A contractor on a day rate that produces £80,000 of gross annual fees working entirely inside IR35 could find their net take-home is broadly similar to what an employee on a £58,000–£62,000 salary would receive — before accounting for the additional overhead of running a limited company. Working outside IR35, the same gross fees would typically produce meaningfully higher net income through a tax-efficient salary and dividend structure.

This is why IR35 status matters so much, and why it deserves proper attention rather than a hurried self-assessment the day before a contract starts.

HMRC provides a free online tool called Check Employment Status for Tax (CEST) to help workers, clients, and agencies determine IR35 status. You work through a series of questions about the engagement and the tool produces a determination of either employed, self-employed, or unable to determine.

CEST is a reasonable starting point and HMRC has stated it will stand by a result provided the information entered is accurate and complete. However, it has well-documented limitations worth understanding before relying on it exclusively.

What CEST does not fully capture

The tool has historically been criticised for giving insufficient weight to mutuality of obligation — one of the three core employment status tests. Employment tribunal and IR35 case law places significant emphasis on mutuality, but CEST’s question structure does not always reflect this. A result of ‘outside IR35’ from CEST is not a guarantee that HMRC would reach the same conclusion on investigation.

CEST also works from the answers you provide, which means the quality of the determination is only as good as the accuracy of what you enter. Where working practices differ from what the written contract says, answering on the basis of the contract rather than reality creates a determination that does not reflect the true position.

When to go beyond CEST

For most straightforward contracts with clear substitution clauses and limited client control, CEST will give a reliable steer. For longer engagements, contracts where control is high, or situations where you are uncertain about working practices, a professional IR35 contract review carried out by an accountant or specialist is a worthwhile investment. The cost of a review is trivial compared with the tax exposure of an incorrect inside IR35 determination going unchallenged.

HMRC’s Employment Status Manual also provides detailed guidance on how the courts approach each status test and is worth reading alongside any CEST result.

If you receive an inside IR35 Status Determination Statement from a client and you disagree with it, you are not without recourse. A formal client-led disagreement process exists under the off-payroll working rules for medium and large private sector and public sector engagements.

The formal disagreement process

You can raise a written disagreement with the client, setting out why you believe the determination is incorrect. The client is required to respond within 45 days, either confirming the original determination or issuing a revised SDS. During that period the original determination stands, which means deductions continue — but if the determination is overturned, any over-deducted tax should be refunded.

What makes a challenge succeed

A challenge is most likely to succeed where the working practices on the ground genuinely support outside IR35, but the client’s SDS was based on a blanket determination (applying a single status to all contractors in a particular role rather than assessing each engagement individually) or where the client failed to properly consider the evidence. Clients are not permitted to issue blanket inside IR35 determinations without genuine case-by-case assessment.

It helps considerably to have documentary evidence to support your position: a well-drafted contract with a meaningful substitution clause, evidence of working for multiple clients, records of business expenses and financial risk, and a professional IR35 review opinion all strengthen a challenge.

HMRC disputes

If the dispute is not resolved through the client process, or if HMRC opens an enquiry directly, the matter can ultimately be heard by the First-tier Tribunal. The history of IR35 case law is significant and outcomes are not always predictable — which is why getting the status right before the engagement begins, rather than litigating it afterwards, is almost always the better approach.

Rather than waiting for a determination to land on your desk, the most effective approach is to review each engagement proactively before it starts. Here is a practical sequence to follow.

These are the errors that come up repeatedly in practice, and the ones that tend to be most costly to unwind.