IR35 (also called the off-payroll working rules) is tax legislation designed to identify contractors who work like employees but operate through their own limited company to pay less tax. If IR35 applies ('inside IR35'), the contractor pays similar tax and National Insurance to an employee. If it does not apply ('outside IR35'), the contractor benefits from the tax efficiencies of operating through a limited company.

Who decides my IR35 status?

For private sector medium and large companies: the end client decides. For small private sector companies: the contractor decides (as before). For public sector organisations: the end client decides. The determination must be made using HMRC's Check Employment Status for Tax (CEST) tool or professional assessment. The responsibility for correct determination carries significant financial risk.

What happens if I am inside IR35?

If you are inside IR35, the fee-payer (usually the agency or end client) must deduct PAYE income tax and employee's National Insurance from your fee, and pay employer's National Insurance. You can claim a 5% flat-rate expense deduction. Effectively, you are taxed similarly to an employee — but without employee benefits like holiday pay, sick pay, or pension contributions.

IR35 Guide UK — Off-Payroll Working Rules Explained | PocketWise

IR35 is one of the most significant tax considerations for UK contractors and freelancers working through a limited company. Getting it wrong can result in substantial tax bills, penalties, and business disruption.

How IR35 Works

Concept	Detail
Purpose	Prevents tax avoidance by disguised employees
Who it affects	Contractors working through intermediaries (usually Ltd companies)
The test	Would the contractor be an employee if directly engaged?
Inside IR35	Taxed similarly to an employee
Outside IR35	Benefits from limited company tax structure

Key Tests for IR35 Status

HMRC and tribunals consider three main factors:

1. Control

Factor	Outside IR35	Inside IR35
How the work is done	You decide the method	Client dictates methods
When you work	You set your own hours	Client sets your hours
Where you work	Your choice	Client specifies location
Supervision	Minimal or none	Regular oversight

2. Substitution

Factor	Outside IR35	Inside IR35
Right to send a substitute	Yes (genuine, unfettered right)	No — client expects you personally
Substitute must be accepted by client	No unreasonable refusal	Client can refuse
Who pays the substitute	You pay them	Not applicable
Has substitution occurred?	Evidence of actual substitution strengthens position	Never substituted

3. Mutuality of Obligation (MOO)

Factor	Outside IR35	Inside IR35
Client must offer work	No obligation (project-based)	Ongoing expectation of work
You must accept work	No obligation	Expected to accept
Between engagements	No pay, no obligation	Retained or on standby

Additional Factors

Factor	Outside IR35	Inside IR35
Financial risk	You bear risk (e.g. fix defects at own cost)	Client bears risk
Equipment	You provide your own	Client provides everything
Part of the organisation	Separate business identity	Integrated into client team
Exclusivity	Free to work for others simultaneously	Cannot work for competitors
Benefits	No holiday pay, sick pay, pension	Receive employee-like benefits

Who Decides IR35 Status?

Client Type	Who Determines Status
Public sector	End client
Large/medium private company	End client
Small private company	Contractor decides their own status

Definition of Small Company

A company is “small” if it meets 2 of 3 criteria:

Criteria	Threshold
Annual turnover	£10.2 million or less
Balance sheet total	£5.1 million or less
Employees	50 or fewer

Tax Impact

Inside IR35

Component	Treatment
Income tax	Deducted via PAYE
Employee’s NI	Deducted via PAYE
Employer’s NI	Paid by the fee-payer (agency/client)
5% expense allowance	Flat-rate deduction from deemed payment
Pension	No employer pension contribution
Holiday/sick pay	None

Comparison: Inside vs Outside IR35

Component (£600/day, 220 days)	Outside IR35	Inside IR35
Gross annual fees	£132,000	£132,000
Corporation Tax	~£23,000	N/A
Salary	~£12,570	N/A
Dividends	~£80,000	N/A
PAYE deductions	N/A	~£55,000
Approximate take-home	~£85,000–£90,000	~£72,000–£77,000
Tax difference		~£13,000–£18,000 less

Illustrative figures — actual amounts depend on individual circumstances.

CEST Tool

HMRC’s Check Employment Status for Tax tool:

Detail	Info
What it is	HMRC’s online tool to determine IR35 status
How it works	Answer questions about working arrangements
Result	“Employed for tax purposes” / “Self-employed” / “Undetermined”
Binding?	HMRC says it will stand by the result if information is accurate
Criticism	Often returns “undetermined”; does not fully consider MOO
Recommendation	Use CEST as a starting point; get professional advice for borderline cases

Protecting Your IR35 Status

Action	Purpose
Written contract reflecting reality	Evidence of working arrangements
Right of substitution clause (and exercise it)	Demonstrates you are not personally providing services
No mutuality of obligation	Project-based, no ongoing commitment
Use your own equipment	Shows independence
Work for multiple clients	Demonstrates business status
Bear financial risk	Fix defects at own cost, invoicing, bad debt risk
IR35 contract review	Professional review of your contract
Working practices review	Insurance or specialist assessment

Consequences of Getting It Wrong

Who	Risk
Contractor (small company)	HMRC investigation, back-tax, interest, penalties
End client (medium/large)	Liable for unpaid tax/NI if status determination is wrong
Agency	May be liable as fee-payer

Penalties

Offence	Penalty
Careless error	Up to 30% of unpaid tax
Deliberate error	Up to 70% of unpaid tax
Deliberate and concealed	Up to 100% of unpaid tax
Plus	Interest on unpaid amounts going back up to 6 years

Options If Inside IR35

Option	Detail
Umbrella company	Employed by umbrella; they handle PAYE; lower admin
Work through agency PAYE	Agency handles deductions
Accept inside IR35 determination	Work through your Ltd with deemed payment
Challenge the determination	If you believe the status is wrong
Seek contracts outside IR35	Restructure your working arrangements

For related guidance, see our limited company guide and self-assessment guide.