IR35 Rules Explained: A Plain English Guide for Contractors

What is IR35?

IR35 is a set of tax rules aimed at people who supply their services through an intermediary — typically their own limited company — but who would be treated as employees if they worked directly for the client. In simple terms, it asks whether you are genuinely in business on your own account or operating like a disguised employee.

The rules have existed since 2000; responsibility for deciding status and operating PAYE has shifted over time between contractors and clients (especially in the public sector since 2017 and for medium and large private sector organisations since April 2021). Official guidance lives on gov.uk guidance on off-payroll working (IR35).

Inside vs outside IR35 — what it means

Outside IR35

If a contract is outside IR35, HMRC accepts that your limited company is genuinely providing services in business form. The company invoices the client, pays corporation tax on profits, and you can typically extract income through a mix of salary and dividends within normal company law and tax rules.

Inside IR35

If a contract is inside IR35, most of the fee is treated like employment income for tax purposes — PAYE income tax and employee National Insurance are deducted at source (usually by the fee payer or umbrella). Your company’s ability to use low salary / high dividend extraction on that engagement is largely removed for that income.

Who decides IR35 status?

Private sector medium and large companies

Since April 2021, medium and large private sector clients must decide whether rules apply to each engagement and give you a written outcome — a Status Determination Statement (SDS) — with reasons. They must take reasonable care when reaching that decision.

Whether a client is “small” or not uses the Companies Act small companies tests (turnover, balance sheet total and employee numbers — two of three must be below thresholds for the client to count as small). Current figures are on gov.uk — don’t guess from memory.

Criterion	Role in the small-company test
Annual turnover	One of three measures HMRC uses with balance sheet total and employees.
Balance sheet total	Compared against statutory thresholds together with turnover and headcount.
Number of employees	If two of the three tests exceed limits, the client is generally not “small” for off-payroll purposes.

Small companies

If the client qualifies as small under the regulations, the intermediary (your company) usually remains responsible for assessing IR35 — similar to the original IR35 regime.

Public sector

In the public sector, since April 2017 the public authority or agency paying your company is generally responsible for deciding IR35 status and operating PAYE where applicable.

How is IR35 status determined?

No single factor decides status — HMRC and tribunals look at the whole picture of the contract and working practices.

Substitution

Can your company send someone else to do the work, in practice as well as on paper? A genuine, unfettered right of substitution suggests business-to-business supply rather than personal service.

Control

How much say does the client have over how, when and where you deliver the work? High levels of day-to-day control point towards employment; deliverable-based autonomy points the other way.

Mutuality of obligation

Is there an ongoing expectation that the client will offer work and that you must accept it? Strong mutual obligation across engagements looks more like employment; project-based finite contracts can look more commercial.

Other factors

• Provision of equipment vs using client kit
• Financial risk — corrections at your own cost, rectification time unpaid
• Exclusivity vs multiple concurrent clients
• Integration into the client’s organisation vs standing apart
• Business presence — website, insurance, marketing

HMRC's CEST tool

HMRC provides the Check Employment Status for Tax (CEST) questionnaire online. It can be a useful sanity check but it does not cover every scenario, depends on honest answers about working practices, and HMRC has stated it is not binding on its own. Keep screenshots and contemporaneous notes alongside any CEST printout.

What happens if you disagree with a determination?

If you receive an SDS you disagree with, the rules include a formal client-led disagreement process. The client must respond within 45 days — either confirming the decision with reasons or issuing a revised determination. Liability for deducting tax can shift depending on whether the client meets its obligations — read the current gov.uk liability chain for your circumstances.

IR35 and umbrella companies

Many contractors working inside IR35 are paid through umbrella employment. The umbrella employs you, deducts PAYE and employee NI, may deduct employer NI and apprenticeship levy from the assignment rate, and retains a margin for its service.

You should receive Key Information Documents before signing up and payslips showing gross pay and deductions. Employment rights depend on your contract with the umbrella.

Protecting yourself outside IR35

Contract wording should match reality — get specialist IR35 contract review. Maintain evidence of autonomy: emails showing control levels, purchase orders scoped as services, proof of substitution clauses acted on where possible, multiple clients, professional insurance and your own equipment.

Some contractors carry IR35 enquiry insurance for defence costs — weigh premiums against your risk tolerance.

Frequently asked questions

Does IR35 apply to sole traders?

IR35 in its current form applies to contractors operating through limited companies. Sole traders are already taxed as individuals through Self Assessment. However HMRC can still challenge a sole trader's self-employed status.

Can I work both inside and outside IR35?

Yes. IR35 status is determined contract by contract. You can have one contract inside IR35 and another outside simultaneously. Each engagement must be assessed independently.

What is a Status Determination Statement?

A written document from a medium or large client setting out their IR35 determination and reasons. Legally required since April 2021. You have a right to challenge an inside determination through a formal disagreement process.

Does IR35 affect my pension?

Inside IR35 you are treated as an employee but this does not automatically entitle you to employer pension contributions. Outside IR35 you can make employer pension contributions through your limited company — one of the most tax-efficient ways to save as a contractor.

Can HMRC investigate historical IR35 status?

Yes. HMRC can open an enquiry into past years — 4 years for innocent errors, 6 for careless, 20 for deliberate non-compliance. This is why contemporary evidence of outside IR35 status is important.