IR35 is one of the most misunderstood areas of UK tax law, and getting it wrong can be expensive. This article explains what IR35 is, how the off-payroll working rules apply to contractors operating through a limited company, and what you can do to protect yourself. Whether you are a freelancer, IT contractor, or consultant, this guide is for you.
- What is IR35?
- How IR35 works
- Inside versus outside IR35
- The off-payroll working rules (Chapter 10)
- The employment status tests HMRC uses
- How IR35 affects personal service company contractors
- Practical steps to protect your IR35 position
- The tax and financial impact of IR35
- Frequently asked questions
What is IR35?
IR35 is the shorthand name for off-payroll working legislation. It was introduced in 2000 and takes its name from the Inland Revenue press release that announced it — Inland Revenue 35. The rules exist to catch what HMRC calls “disguised employment”: a situation where a worker operates through a limited company but is effectively working like an employee of the end client.
Without IR35, a contractor could take income as dividends through their own limited company, pay less National Insurance, and benefit from a lower overall tax rate compared to a permanent employee doing the same role. HMRC views this as a tax avoidance arrangement when the underlying relationship is really one of employment.
It is worth being clear: IR35 does not stop you working through a limited company. It simply means that if your working arrangements look like employment, you must pay broadly the same tax and National Insurance as an employee would.
How IR35 works
IR35 applies to contractors who work through an intermediary — most commonly a personal service company (PSC), which is usually their own limited company. The legislation asks one question: if the limited company did not exist and the contractor worked directly for the end client, would they be an employee?
If the answer is yes, the engagement is “inside IR35” and the contractor must pay income tax and National Insurance on their income as if they were employed. If the answer is no, the engagement is “outside IR35” and the contractor can continue to take a combination of salary and dividends through their company.
Who decides whether an engagement is inside or outside IR35 depends on where the contractor works. That is where the off-payroll working rules come in.
Inside versus outside IR35
Outside IR35
An outside IR35 engagement is one where the contractor is genuinely self-employed in the way they carry out the work. They have control over how and when they work, they can send a substitute to do the job, they bear financial risk, and they are not integrated into the client’s organisation. Contractors in this position can receive income through their limited company and structure their remuneration tax-efficiently.
Inside IR35
An inside IR35 engagement mirrors employment. The contractor works set hours, follows the client’s direction, cannot send a substitute, and is treated much like a permanent member of staff. Income from these engagements is subject to income tax and National Insurance through PAYE. In this situation, the main benefit of operating through a limited company disappears.
The off-payroll working rules (Chapter 10)
The off-payroll working rules, contained in Chapter 10 of ITEPA 2003, changed the way IR35 is administered for medium and large private sector clients. They were extended to the private sector in April 2021, having already applied to the public sector since April 2017.
Small client exemption
If the end client is a small company, the responsibility for determining IR35 status remains with the contractor’s own limited company. A company is small for these purposes if it meets at least two of the following conditions:
- Annual turnover of no more than £10.2 million
- Balance sheet total of no more than £5.1 million
- No more than 50 employees
If your end client is small, you assess your own IR35 status. If you get it wrong, the liability falls on your company.
Medium and large clients
If the end client is medium or large, the responsibility for the IR35 determination shifts to them. They must issue a Status Determination Statement (SDS) setting out whether the engagement is inside or outside IR35. The fee-payer in the chain — usually a recruitment agency — is then responsible for deducting and paying the tax if the engagement is inside.
This does not mean contractors have no role. You can challenge an SDS you disagree with through the client’s disagreement process. You should always keep records of the SDS and any correspondence.
The employment status tests HMRC uses
There is no single test that determines IR35 status. HMRC looks at the overall picture, but several factors carry significant weight.
Substitution
Can you send someone else to do the work in your place? A genuine right of substitution — one the client must accept without veto — points strongly towards self-employment. If the client is paying for you personally, that points towards employment.
Control
Does the client control what you do, when you do it, where you do it, and how you do it? The more control the client has, the more the relationship looks like employment.
Mutuality of obligation
Is there an obligation on the client to offer you work and an obligation on you to accept it? If both sides expect the relationship to continue and work to keep flowing, that looks like employment.
Other factors
Additional factors HMRC considers include:
- Whether you provide your own equipment
- Whether you bear financial risk (for example, fixing a mistake at your own cost)
- Whether you work for multiple clients at the same time
- How integrated you are into the client’s team
- Whether you have a business presence beyond a single contract
HMRC offers the Check Employment Status for Tax (CEST) tool online. It gives a determination based on your answers, but it has limitations. HMRC has committed to standing by CEST results provided answers are accurate and in good faith, but it does not cover every scenario. Professional advice is worth considering for complex engagements.
How IR35 affects personal service company contractors
Most freelancers and contractors who operate through a limited company will be familiar with the tax-efficient structure of taking a low salary and topping up income with dividends. In 2025/26, the dividend allowance is £500, with dividend income above that taxed at 8.75% at the basic rate, 33.75% at the higher rate, and 39.35% at the additional rate.
If an engagement is inside IR35, this structure largely ceases to be effective. The deemed employment payment rules mean that the income received by your company from that contract must be treated as salary. You pay income tax and National Insurance as if you were employed, with no benefit from the dividend route.
Employer’s National Insurance at 15% (in 2025/26) applies above the £5,000 secondary threshold. This can be a significant cost, particularly for higher earners. For medium and large clients, the fee-payer handles this. If you are working for a small client and responsible for your own determination, you bear this cost through your company.
Your corporation tax position is also affected. Allowable deductions in inside IR35 contracts are limited — you cannot claim the same range of business expenses you might offset against outside IR35 income. You are entitled to a 5% allowance for expenses (which is being removed for public sector and medium/large clients where the client makes the determination), plus actual allowable expenses such as pension contributions.
Practical steps to protect your IR35 position
If you are contracting, there are practical things you can do to support an outside IR35 position and reduce your exposure.
Get your contract reviewed
Your written contract needs to reflect the reality of how you work. A contract that grants you a right of substitution but where substitution is never exercised in practice will not save you if HMRC investigates. The contract must match the actual working arrangements.
Work in practice, not just on paper
HMRC looks at the actual working practices, not just the contract. Avoid the trappings of employment: do not use the client’s equipment exclusively, do not attend their internal appraisals, and avoid fixed hours wherever possible.
Work for multiple clients
Having more than one client at a time strengthens a self-employment argument. It demonstrates that you are running a genuine business rather than acting as a dedicated resource for one employer.
Obtain IR35 insurance
IR35 insurance policies cover the cost of a tax investigation and any unpaid tax liability if HMRC determines that an engagement was inside IR35. Some professional bodies include this as part of membership benefits. It is worth considering, particularly if you rely on a single contract.
Keep records
Keep evidence of how engagements operate in practice. Emails showing you declined a project because you were busy with another client, invoices to multiple clients, and records showing you bore financial risk all help build a picture of genuine self-employment.
Review each contract separately
IR35 status is determined contract by contract. Being outside IR35 on one engagement does not mean you are automatically outside IR35 on the next. Review each contract before you start work.
The tax and financial impact of IR35
The financial difference between inside and outside IR35 can be substantial. Consider a contractor earning £80,000 per year through their limited company.
Outside IR35, they might take a salary of £12,570 (up to the personal allowance in 2025/26) and the remainder as dividends. Above the £500 dividend allowance, dividend income between £12,570 and £50,270 is taxed at 8.75%, and income above that at 33.75%. The combined tax and National Insurance burden is considerably lower than employment.
Inside IR35, the full £80,000 is treated as employment income. After deducting the personal allowance of £12,570, income up to £50,270 is taxed at 20% basic rate, and income above that at 40% higher rate. Employee National Insurance applies at 8% on earnings between £12,570 and £50,270. Employer’s National Insurance at 15% is also payable on earnings above £5,000. The net income after tax and NI is markedly lower.
If you are operating a limited company and managing your finances across inside and outside IR35 contracts, accurate bookkeeping and regular management accounts are important. You need to know exactly how much you are earning from each engagement and what the tax exposure looks like throughout the year — not just at year end.
If your company has a payroll, make sure it reflects the correct position. Inside IR35 payments may need to run through PAYE, and that requires proper payroll administration.
Directors of limited companies should also be aware that IR35 does not change the requirement to file annual accounts and a corporation tax return, even if all contract income has been subject to deemed employment payment treatment.
The rules around IR35 are not going away. HMRC has invested heavily in compliance activity and continues to pursue contractors it believes have been wrongly operating outside IR35. Understanding your position, keeping good records, and taking professional advice when you need it are the most effective defences available to you.
Frequently asked questions
Does IR35 apply if I work through my own limited company?
Yes. IR35 was specifically designed to apply to contractors working through their own limited company, also known as a personal service company. Whether it affects your tax position depends on whether your engagement is inside or outside IR35.
Who decides my IR35 status?
It depends on the size of your end client. If the client is small (meeting at least two of: turnover under £10.2m, balance sheet under £5.1m, fewer than 50 employees), you determine your own status. If the client is medium or large, they must assess your status and issue a Status Determination Statement.
What happens if I disagree with an inside IR35 determination?
You can formally challenge the determination through the client’s disagreement process. The client must respond within 45 days with either a revised determination and reasons, or the original determination with reasons for keeping it. Keep records of all correspondence.
Can I be investigated by HMRC for historic IR35 non-compliance?
Yes. HMRC can open an enquiry into past tax years if it believes IR35 applies to historic contracts. The risk is greater if you have been operating through a limited company for several years on contracts that look like employment. Taking out IR35 insurance can help manage this risk.
Does IR35 apply to sole traders?
IR35 in its technical form applies to workers using an intermediary such as a limited company. Sole traders do not use a company intermediary, so the IR35 rules do not apply to them directly. However, HMRC can still challenge the employment status of a sole trader under general employment status rules if it believes they are a disguised employee.
I only have one client — does that mean I am automatically inside IR35?
Not automatically, but it does make the argument for self-employment harder. HMRC looks at the full picture. If you have one client but genuine control over your work, no obligation to accept further work, and a right to substitute, you may still be outside IR35. Get the contract reviewed and take advice if you are unsure.
