IR35 is the common name for off-payroll working rules. The rules mainly target situations where a worker provides services through an intermediary. This intermediary often takes the form of a limited company.
However, the legislation can also apply when services pass through:
- A partnership
- Another individual
- Certain agencies or intermediaries
The main question always remains the same: Would the worker count as an employee for tax purposes if they worked directly for the client?
| If the answer is yes | The arrangement sits inside IR35 |
| If the answer is no | The arrangement sits outside IR35 |
Moreover, the off-payroll working rules do not automatically create employment rights. Instead, it creates a “deemed employee” position for tax purposes only. Therefore, a worker may pay tax like an employee without receiving employee benefits.
The Reason for IR35
Before IR35, many individuals left employment and returned to the same role through their own limited company. This often reduced Income Tax and National Insurance.
For instance, someone could:
- Take a small salary
- Withdraw profits as dividends
- Reduce National Insurance Contributions
- Claim business expenses
HMRC viewed many of these arrangements as employment in practice. As a result, the government introduced the off-payroll working rules to tackle what it considered tax avoidance.
Simply, the rules came into effect to prevent disguised employment.
Reforms in 2017 and 2021
Originally, contractors carried responsibility for assessing IR35. This position changed in 2017 for public sector engagements. The government then extended the reforms to medium and large private sector businesses from April 2021.
Under the current rules, the client needs to decide whether the contract sits inside or outside IR35. This reform therefore shifted responsibility away from many contractors.
However, small private sector businesses remain exempt from the off-payroll reforms.
Who the IR35 Rules Affect
The IR35 off-payroll working rules affect the following:
- Contractors working through intermediaries
- Businesses that hire contractors
- Recruitment agencies
- Labour supply chains
- Fee-payers responsible for payroll deductions
The client means the business receiving the worker’s services. The rules apply on a contract-by-contract basis. Therefore, each engagement requires its own assessment.
Small Companies and Exemptions
Client size plays an important role.
Small private sector businesses do not normally fall under the off-payroll reforms. Instead, the contractor’s company remains responsible for deciding IR35 status.
A company usually counts as small if it meets at least two of these conditions:
- Turnover does not exceed £15 million
- Balance Sheet total does not exceed £7.5 million
- Average employee numbers remain below 50
These are the new threshold from April 2025. However, HMRC says the impact may not fully apply until April 2027. This delay exists because company size depends on previous accounting periods.
Additionally, group structures matter. If a company belongs to a group, the parent company may also need to qualify as small.
Medium and Large Clients
Medium and large clients carry more responsibility.
They must:
- Assess contractor status
- Take reasonable care
- Produce a Status Determination Statement and pass it through the supply chain
- Handle disagreements fairly
If the client fails to meet these obligations, tax liability can move back to them.
Inside IR35 vs Outside IR35
Inside IR35 means the working arrangement resembles employment. In this situation, the fee-payer treats the contractor’s income like employment income for tax purposes.
The fee-payer may be:
- The client
- A recruitment agency
- Another intermediary
The fee-payer must:
- Deduct Income Tax
- Deduct employee National Insurance
- Pay Employers’ National Insurance
- Process payments through payroll
- Report payments through Real-Time Information
- Pay Apprenticeship Levy where relevant
The contactor then receives a net payment.
Outside IR35 means the contractor operates as a genuine independent business.
Here, the contractor normally:
- Controls how work happens
- Works on projects or deliverables
- Carries financial risk
- Uses business insurance
- Provides services to several clients
- Operates independently from the client’s staff
The contractor’s company can usually receive payment without PAYE deductions.
Status Tests
No single test determines IR35 status. Instead, HMRC and the courts review the whole picture. However, several factors appear repeatedly in employment status case law.
1. Control
Control remains one of the most important IR35 tests. This factor examines who controls the work. The client may naturally set project deadlines and expected outcomes. That alone does not create employment.
However, risk increases when the client controls:
- What tasks happen
- How the work happens
- Where the work happens
- When the work happens
Strong contractor arrangements usually allow the worker freedom over methods. Control over “how” the work happens often carries the greatest weight.
2. Substitution
Substitution looks at whether the contractor can send someone else to complete the work. A genuine substitution clause strongly supports outside IR35 status. However, the right must exist in practice, as a contract alone will not always help.
3. Mutuality of Obligation
Mutuality of Obligation examines ongoing obligations.
Employment relationships usually involve:
- An obligation to offer work
- An obligation to accept work
Contractor relationships should look different, as a genuinely project-based arrangement normally:
- Defines specific deliverbales
- Limits the scope of work
- Allows the contractor to reject additional tasks
- Avoids promises of ongoing work
In Business On Your Own Account
Courts often ask whether the contractor works “in business on their own account”. This principle developed through employment status case law. A genuine business usually demonstrates independence.
For instance, contractors operating outside IR35 often:
- Invest in their business
- Advertise their services
- Carry insurance
- Manage financial risk
- Work for several clients
- Supply their own equipment
Status Determination Statements (SDS)
A Status Determination Statement records the client’s IR35 decision. Medium and large clients must issue an SDS where the off-payroll rules apply.
The SDS should:
- Confirm whether the contract sits inside or outside IR35
- Explain the reasons for the decision
- Reach the decision using reasonable care
The client must pass the SDS to:
- The worker
- The next party in the labour chain
If the client fails to pass on the SDS correctly, tax liability may remain with them.
Reasonable Care
Reasonable care means the client should carry out a genuine assessment.
HMRC expects businesses to:
- Review the contract
- Review working practices
- Gather relevant evidence
- Understand employment status principles
- Avoid blanket assessments
A blanket approach rarely satisfies HMRC. Therefore, a business should not automatically place all contractors inside IR35. Instead, each contract needs individual consideration.
Challenging an SDS
Contractors and fee-payers can challenge a Statement Determination Statement. This process forms part of the Status Disagreement Process.
The challenge may agrue that:
- The client ignored key evidence
- The client misunderstood working practices
- The client failed to take reasonable care
The client then has 45 days to respond. They must either confirm the original decision or issue a new SDS. If the client ignores the challenge, tax liability may transfer back to them.
When a Contracts Falls Inside IR35
Inside IR35 contracts trigger payroll deductions.
The fee-payer usually:
- Deducts PAYE
- Deducts employee National Insurance
- Pays Employers’ National Insurance
- Reports through payroll systems
However, Employers’ National Insurance should not reduce the worker’s deemed employment income directly. The fee-payer remains responsible for this cost. Contractors inside IR35 often notice lower take-home pay.
While IR35 focuses on Income Tax and National Insurance, VAT rules remain separate. Therefore, invoices may still include VAT even when the assignment sits inside IR35.
HMRC’s CEST Tool
HMRC offers the Check Employment Status for Tax (CEST) tool. CEST helps businesses and contractors assess employment status.
HMRC says it will stand by the result where:
- Users provide accurate information
- Users answer questions honestly
- Users apply the tool correctly
However, many specialists believe the tool places too much emphasis on certain factors. Others argue it does not fully reflect court decisions. Therefore, businesses should treat CEST as part of the process rather than the entire answer.
Users should also save:
- The final result
- Supporting notes
- Copies of answers
- Relevant evidence
These records may help demonstrate reasonable care later.
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This article is for general informational purposes only and does not constitute legal or financial advice. While we aim to keep our content up to date and accurate, UK tax laws and regulations are subject to change. Please speak to an accountant or tax professional for advice tailored to your individual circumstances. Pi Accountancy accepts no responsibility for any issues arising from reliance on the information provided.