What is IR35?
IR35, also known as the off-payroll working rules, is a set of tax laws introduced by HMRC to tackle tax avoidance through “disguised employment.” It specifically targets individuals who provide services via a personal service company (PSC) but operate in a manner that resembles an employee-employer relationship.
In such cases, IR35 ensures that workers pay broadly the same income tax and National Insurance Contributions (NICs) as employees, regardless of the intermediary (usually a limited company) they use.
How IR35 Applies in Practice
In practice, IR35 assesses the nature of the working relationship between the contractor and the end client. If the contractor would be considered an employee if the intermediary didn’t exist, then the engagement falls “inside IR35.”
Being inside IR35 means:
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Income tax and NICs must be deducted at source.
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The contractor receives a net payment like an employee.
If the contract is “outside IR35,” the contractor remains responsible for managing their own taxes, often benefiting from more favorable tax treatment.
Who is Affected by IR35?
The following individuals and entities are affected by IR35:
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Contractors/Freelancers working through a limited company or PSC.
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Public and private sector clients hiring contractors.
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Agencies involved in supplying contractors.
Since April 2021, medium and large private sector clients have been responsible for determining IR35 status—shifting the burden from contractors to end clients.
Determining Employment Status
Determining someone’s employment status under IR35 depends on several key factors:
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Control: Does the client control how, when, and where the contractor works?
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Mutuality of Obligation (MOO): Is the client obliged to provide work, and is the contractor obliged to accept it?
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Substitution: Can the contractor send someone else to do the job?
These tests are not always straightforward, and many cases sit in grey areas. HMRC provides a Check Employment Status for Tax (CEST) tool, though its accuracy is frequently debated.
How IR35 Works in the Public and Private Sectors
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Public Sector: Since April 2017, the responsibility for assessing IR35 status lies with the public authority hiring the worker.
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Private Sector: Since April 2021, medium and large businesses in the private sector also carry this responsibility. Small companies are exempt, and the contractor remains responsible.
Working Through an Umbrella Company
To avoid IR35 risk, some contractors choose to work through umbrella companies. In this model:
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The umbrella company acts as the employer.
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Taxes are deducted via PAYE.
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The contractor receives payslips similar to a traditional employee.
While this setup simplifies compliance, it often leads to lower take-home pay due to employer’s NICs and umbrella fees.
Record Keeping and Compliance
For those affected by IR35, especially businesses determining employment status, record keeping is essential. You should:
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Keep copies of contracts and working arrangements.
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Document the status determination process.
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Communicate decisions clearly to contractors.
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Maintain proof of tax deductions where applicable.
Clear documentation can protect against disputes and potential HMRC audits.
Penalties for Non-Compliance
Failing to comply with IR35 can result in serious penalties:
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Unpaid tax and NICs.
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Interest on the unpaid amounts.
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Penalties of up to 100% of the unpaid tax for deliberate avoidance.
Since reforms shifted the liability to clients in some sectors, businesses must take these rules seriously to avoid financial and reputational damage.
FAQs
1. What does it mean to be “inside IR35”?
It means your contract falls under IR35, and you’re considered a deemed employee for tax purposes. You’ll pay PAYE tax and NICs.
2. How can I tell if my contract is inside or outside IR35?
Evaluate factors like control, substitution, and mutuality of obligation. Use HMRC’s CEST tool, but also seek independent advice when in doubt.
3. Can I still work through my limited company?
Yes, but if the contract is inside IR35, you’ll be taxed similarly to an employee, even if you use a PSC.
4. What if my client disagrees with my IR35 status?
You can request a Status Determination Statement (SDS) and appeal through their disagreement process. However, the final decision rests with the client (unless they’re exempt as a small business).
5. Are umbrella companies IR35 compliant?
Yes, because they operate under PAYE. However, you may lose tax efficiency and have to pay umbrella fees.
Understanding what IR35 is and how it applies is essential for both contractors and hiring businesses. With serious penalties and changing responsibilities, staying compliant is not optional. Whether you’re navigating IR35 for the first time or reviewing existing contracts, ensure you document your decisions, seek advice where needed, and maintain full transparency.
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