IR35 and off-payroll working for limited company contractors

Understanding IR35 and the Off-Payroll Working Rules

IR35 is the common name for tax rules designed to combat 'disguised employment'. This is where a client engages a worker through their own limited company (often called a Personal Service Company or PSC) to perform a role that, in substance, is one of employment. The aim of such arrangements is often to reduce the tax and National Insurance Contributions (NICs) paid by both the worker and the client. The IR35 rules ensure that if the relationship is genuinely one of employment, the worker pays broadly the same income tax and NICs as an employee would.

The legislation exists in two forms. The original rules, known as Chapter 8 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003), apply when a contractor works for a small private sector client. Under these rules, the responsibility for determining employment status and accounting for any tax due falls on the contractor's own limited company. This is a significant administrative and financial burden.

The newer rules, known as Chapter 10 of ITEPA 2003, are often called the 'off-payroll working rules'. These apply to engagements with all public sector clients and medium or large-sized private sector clients. Under these rules, the responsibility for determining the worker's employment status shifts from the contractor's PSC to the end client. If the client determines the contract is 'inside IR35', the 'fee payer' (the entity that pays the PSC, which could be the client or an agency) must deduct income tax and NICs before paying the PSC.

Worth knowing: The key difference between the two sets of IR35 rules is who holds the responsibility for determining employment status and managing the tax.

Who Decides Your IR35 Status: Client Size Matters

The responsibility for determining your IR35 status depends entirely on the size and type of your end client. For all engagements with public authorities, the off-payroll working rules (Chapter 10) apply, meaning the client must assess your status. This has been the case since April 2017. For private sector engagements, the rules changed in April 2021. Since then, medium and large-sized private sector businesses are also required to determine the status of the contractors they engage. This means for the majority of contracts, the decision is now out of the contractor's hands.

The critical question, therefore, is whether your private sector client qualifies as 'small'. If they do, the responsibility for determining status falls back to your limited company under the original IR35 rules (Chapter 8). A private sector company is defined as small if it meets at least two of the following three conditions for its most recent two financial years: an annual turnover of not more than £10.2 million, a balance sheet total of not more than £5.1 million, and not more than 50 employees. It is the client's responsibility to confirm whether they are small if you ask them.

If your client is based wholly overseas with no UK presence (such as a UK branch or office), the responsibility for the IR35 assessment also falls to your PSC, regardless of the client's size. This is because HMRC cannot enforce the rules on an overseas entity with no UK connection. As a contractor, it is crucial to establish the size and location of your end client at the start of any new engagement to understand where the compliance responsibility lies. Misunderstanding this can lead to significant unexpected tax liabilities for your company.

Worth knowing: Always confirm if your private sector client qualifies as 'small' to determine whether you or they are responsible for the IR35 assessment. Source: Companies Act 2006, section 382. Conditions apply to two consecutive financial years.

Key Tests for Employment Status: Inside vs. Outside IR35

Determining whether a contract falls inside or outside IR35 involves applying established employment status tests derived from decades of case law. There is no single definitive checklist; instead, a holistic view of the contractual terms and actual working practices is required. HMRC's 'Check Employment Status for Tax' (CEST) tool attempts to codify these tests, but the underlying principles are what matter. The three most significant tests are control, substitution, and mutuality of obligation (MOO).

Control refers to the client's right to direct how, when, and where the contractor performs the work. A high degree of client control points towards an employment-like relationship ('inside IR35'). For instance, if you are required to work specific hours at the client's office, follow their internal procedures, and are managed by a line manager in the same way as an employee, this indicates control. Conversely, a genuine contractor typically has autonomy over their working methods and schedule, focusing on delivering an agreed outcome rather than being managed day-to-day.

The right of substitution is another crucial test. A genuine business-to-business contract should allow the contractor's company to provide a substitute to perform the services. This right must be genuine and unfettered; if the client can reject a substitute for reasons other than a lack of required skills or qualifications, or if the contractor is personally required to deliver the service, the right is likely a sham. Mutuality of Obligation (MOO) refers to the obligation for the client to offer work and for the worker to accept it. In a genuine contract for services, there is no obligation beyond the current project; once it ends, neither party is obliged to offer or accept further work.

• Financial Risk: Are you exposed to financial risk? Genuine contractors may bear the cost of rectifying errors, have to purchase their own business insurance, and face potential losses if a project overruns.
• Part and Parcel: Are you integrated into the client's organisation? Having a line manager, attending staff meetings, appearing on organisation charts, or having company business cards suggests you are 'part and parcel' of the business, pointing towards employment.
• Provision of Equipment: Do you use your own equipment? A contractor providing their own laptop, software licences, and tools demonstrates a degree of independence. Relying entirely on client-provided equipment points towards employment.
• Exclusivity: Are you working for other clients? While not decisive on its own, having multiple clients concurrently or in succession strengthens the case for being a genuine business operating 'on your own account'.

Worth knowing: The overall picture of your working relationship, not just the contract, determines your IR35 status, with control and substitution being key indicators.

The Status Determination Statement (SDS)

When a public sector or medium/large private sector client assesses your engagement under the off-payroll working rules, they are legally required to provide you with a Status Determination Statement (SDS). This is a critical document that must state whether the client considers you to be an employee for tax purposes ('inside IR35') or self-employed ('outside IR35'). Crucially, the SDS must also include the reasons that led to this conclusion. The client must exercise 'reasonable care' when making this determination; a failure to do so can result in the tax liability transferring to them.

The client must provide the SDS to you, the contractor, directly. If there is an agency in the contractual chain, the client must also provide the SDS to the party they contract with (the agency). This ensures the decision is passed down the supply chain to the fee payer, who is responsible for the tax deductions. The client is obliged to provide the SDS on or before the first payment is made for the services. Without a valid SDS, the responsibility for tax and NICs can remain with the client, so they are strongly incentivised to comply with this requirement.

1. 1

   Receive the Status Determination Statement (SDS) from your client, which will state their decision and the reasons for it.

2. 2

   If you disagree with the determination, you have the right to make representations to the client. You should do this in writing, explaining why you believe the decision is incorrect and providing evidence by referencing the key employment status tests.

3. 3

   The client is legally obligated to consider your representations and respond within 45 days of receiving them.

4. 4

   The client's response must state whether they are upholding their original determination or changing it. They must provide reasons for their final decision.

5. 5

   If the client upholds their 'inside IR35' decision, the fee payer will proceed with deducting tax and NICs. The disagreement process does not halt payments or tax deductions while it is ongoing.

6. 6

   Keep meticulous records of all correspondence, including the initial SDS, your written disagreement, and the client's final response.

Worth knowing: You have a legal right to challenge a client's status decision, and they have a legal obligation to respond to your challenge within 45 days.

What Happens if a Contract is 'Inside IR35'?

When an engagement is determined to be 'inside IR35' under the off-payroll working rules (for public sector or medium/large private clients), the financial mechanics change significantly. The responsibility for tax falls to the 'fee payer' – the entity in the supply chain that pays your limited company. This is usually the end client or a recruitment agency. The fee payer must calculate a 'deemed employment payment', which is the value of your invoice less any VAT. From this amount, they must deduct PAYE Income Tax and employee's National Insurance, just as they would for a regular employee.

In addition, the fee payer is also liable for paying employer's National Insurance Contributions (NICs) on top of the fee they pay. As of the 2025/26 tax year, this is calculated at 15% on earnings above the secondary threshold of £5,000 per year. The fee payer may also be liable for the Apprenticeship Levy. These employer costs are often factored into the day rate offered for inside-IR35 roles, meaning the headline rate may be lower than for an equivalent outside-IR35 role to account for the client's or agency's extra tax burden.

Your limited company then receives the net payment after these deductions. This income has already been taxed, so it's crucial that it is not taxed again as corporation tax. To prevent this, your company can pay this net amount directly to you as a salary, which carries no further tax or NICs liability as it has already been accounted for. This should be processed through your company's payroll. You should ensure your accountant correctly offsets the tax-paid income against the salary payment in your company accounts to ensure no double taxation occurs. The income is not treated as turnover for corporation tax purposes.

Illustrative Calculation: Inside vs. Outside IR35

The financial difference between a contract being inside or outside IR35 is substantial. To illustrate, let's consider a contractor working for a large client, invoicing £115,000 over a year. We'll compare the net take-home pay in both scenarios, using the tax rules for 2025/26 as specified for this guide, including a Corporation Tax small profits rate of 19% and a main rate of 25%, and employer NICs at 15% above a £5,000 threshold. For simplicity, we assume the contractor has no other income, uses their full personal allowance (£12,570), and in the 'outside' scenario, takes a tax-efficient salary up to the NIC primary threshold with the remainder as dividends.

In an 'outside IR35' scenario, the £115,000 is paid gross to the contractor's limited company. The company pays its costs, such as a salary to the director. Let's assume a salary of £12,570 and other business expenses of £5,000. The company's profit is £115,000 - £12,570 - £5,000 = £97,430. Corporation Tax is calculated on this profit. Using marginal relief, the tax would be (£50,000 * 19%) + (£47,430 * 25%) = £9,500 + £11,857.50 = £21,357.50. The post-tax profit available for dividends is £76,072.50. The director receives a £12,570 salary (tax-free) and can draw dividends. After accounting for personal tax on dividends, the contractor's approximate net take-home pay would be in the region of £77,400.

In an 'inside IR35' scenario, the client must account for employment taxes from the £115,000 fee. First, the fee payer must pay employer's NICs. The 'deemed salary' (X) is calculated such that X + (X - £5,000) * 15% = £115,000. This gives a deemed salary of approximately £100,652. This is the amount subject to PAYE and employee's NICs. After deducting income tax and employee's NICs from this amount (roughly £32,800), the net amount paid into the limited company bank account would be approximately £67,852. This can be paid out to the contractor with no further tax. The difference in net income is stark, with the 'inside' contract resulting in nearly £10,000 less for the contractor in this illustration. The primary difference arises from the payment of both employee's and employer's National Insurance.

Working with Small Private Sector Clients

When your end client is a 'small' private sector company, the off-payroll working rules (Chapter 10) do not apply. Instead, the original IR35 legislation (Chapter 8 ITEPA 2003) comes into play. Under these rules, the legal responsibility for determining the IR35 status of the engagement rests with your own limited company, the PSC. This places a significant compliance burden squarely on your shoulders. Your company must assess the contract and working practices against the key employment status tests to decide if the engagement is 'inside' or 'outside' IR35.

If your company determines the contract is inside IR35, it must calculate and pay the necessary tax and National Insurance to HMRC. This is done by calculating a 'deemed employment payment' at the end of the tax year. The calculation involves taking the fees received from the IR35-caught engagement, deducting a 5% flat-rate allowance for business expenses (this allowance is not available under the Chapter 10 rules), plus any pension contributions and employer's NICs on any salary already paid. The remaining amount is the deemed payment, on which your company must pay PAYE tax and employer's NICs to HMRC. This payment must be made by 19th April following the end of the tax year.

The risk of getting this wrong is substantial. If HMRC investigates and finds that your company incorrectly determined a contract as 'outside IR35', they can demand the back-dated tax and NICs, plus interest and potentially significant penalties. This liability falls on your limited company. Therefore, when working with small clients, it is essential to conduct a thorough and documented IR35 assessment for every contract. Seeking professional advice or using a reputable contract review service is highly recommended to mitigate this risk. Meticulous record-keeping is not just good practice; it is your primary defence in the event of an HMRC enquiry.

• Confirm your client's size in writing before the contract starts.
• Formally assess and document the IR35 status for each small-client engagement.
• If inside IR35, inform your accountant so they can prepare to calculate the deemed employment payment.
• Set aside funds throughout the year to cover the potential tax and NICs liability.
• Consider professional IR35 contract review services and tax investigation insurance for peace of mind.

Worth knowing: When your client is a small company, the full responsibility and liability for determining IR35 status falls upon your own limited company.

Contractual Terms vs. Working Practices: What Really Matters?

A well-drafted contract is a cornerstone of demonstrating an 'outside IR35' relationship, but it is only half the story. HMRC and the courts will always prioritise the reality of the working relationship over the written terms. If your day-to-day working practices contradict the clauses in your contract, the contract will be deemed a sham and ignored. For example, a contract might contain a robust substitution clause, but if in practice you have previously asked to send a substitute and been refused, or if it's understood that the client expects you personally to do the work, the clause is worthless.

Therefore, it's vital to ensure that your behaviour and the client's expectations align with the 'outside IR35' status you are trying to establish. You must operate as an independent business providing a service, not as an employee filling a role. This means focusing on deliverables and project milestones rather than working set hours, maintaining a degree of autonomy in how you complete the work, and avoiding becoming 'part and parcel' of the client's organisation. Small details matter, such as using your own email signature, not having a client line manager, and not attending general staff meetings or social events.

The best approach is to ensure your contract accurately reflects the intended working relationship from the outset, and then to consciously uphold those terms throughout the engagement. If the client's behaviour starts to blur the lines – for example, by asking you to manage their staff or take on duties outside the scope of the contract – you should professionally address this to re-establish the correct boundaries. A good contract sets the stage, but it's your performance as a genuine independent business that convinces the audience, including HMRC.

Managing IR35 Risk and Compliance

Proactive risk management is essential for any contractor operating through a limited company. The financial consequences of an incorrect IR35 assessment can be severe, whether the liability falls on your company (for small clients) or the client shifts to risk-averse 'inside IR35' determinations. The first step is to treat every contract as a distinct engagement requiring assessment. Do not assume that because one contract was 'outside', the next one will be too, even with the same client. Changes in scope, responsibilities, or working practices can alter the IR35 status.

Maintaining a clear and consistent business profile is crucial evidence that you are in business on your own account. This involves more than just having a limited company. You should have a professional website detailing your services, business stationery, a separate business bank account, and crucially, business insurance. Professional Indemnity and Public Liability insurance are standard for genuine businesses and are often required by clients. Demonstrating that you are actively marketing your services to multiple potential clients and not solely reliant on one source of income further strengthens your position.

Keeping meticulous records is your best defence. For each contract, you should have a file containing the signed contract, any Status Determination Statement (SDS) and your response, correspondence clarifying working practices, and evidence of your independent operation. Consider investing in professional support. An accountant specialising in contractors can provide invaluable advice on tax planning and compliance. IR35 contract review services can give you an expert opinion on a contract's strengths and weaknesses before you sign it. Furthermore, tax investigation insurance, which often comes bundled with contract reviews, can cover the professional fees of defending your case in the event of an HMRC enquiry, providing a vital financial safety net.

• Assess every contract individually for IR35 status.
• Obtain and retain a Status Determination Statement (SDS) for every engagement with a medium/large or public sector client.
• Ensure your contract and working practices are aligned and point towards self-employment.
• Maintain a strong business presence with a website, insurance, and professional branding.
• Keep detailed records of all contracts, correspondence, and status assessments.
• Work with a specialist contractor accountant.
• Consider professional contract reviews and tax investigation insurance.

Worth knowing: A combination of due diligence, meticulous record-keeping, and professional advice is the most effective way to manage your IR35 compliance risk.

Common questions

Official sources & further reading

This guide draws on the official guidance below. Rules, fees and individual circumstances can change; check the relevant source before acting.

• GOV.UK - Understanding off-payroll working (IR35)
• GOV.UK - Check Employment Status for Tax (CEST) tool
• Legislation.gov.uk - ITEPA 2003, Part 2, Chapter 10 (Off-payroll working in public and private sectors)
• Legislation.gov.uk - ITEPA 2003, Part 2, Chapter 8 (Workers' services provided through intermediaries to small clients)

General UK information, primarily for private companies limited by shares. This is not personalised legal, tax or financial advice. An accountant or solicitor can help apply the rules to your situation.