IR35 Explained

What is IR35?

IR35 — formally the “off-payroll working rules” — is anti-avoidance legislation designed to ensure that contractors who work in a way that is equivalent to employment pay broadly the same tax as employees. The name comes from the original HMRC press release in 1999 (Inland Revenue press release 35).

The core idea: if you remove the intermediary (your limited company), and the working relationship would look like employment, then HMRC expects employment-level taxes to be paid. It prevents a situation where someone does the same job as an employee but takes home significantly more because they extract income as dividends and avoid National Insurance.

IR35 is a contract-by-contract determination. You might have one contract that sits outside IR35 and another that sits inside. Your status is not fixed — it depends on the nature of each individual engagement.

Who IR35 affects

IR35 applies to you if you:

• Provide services through a Personal Service Company (PSC) — typically your own limited company
• Work for a client (the “end client”) who would be considered your employer if the company did not exist

IR35 does not apply if you work as a sole trader billing clients directly. Sole traders are assessed on employment status through different rules (primarily relevant if HMRC questions whether you are genuinely self-employed). If you are a sole trader, skip to the sole traders section below.

The three key employment status tests

When assessing IR35, HMRC (and the courts) look at three primary factors drawn from employment case law:

1. Personal service

Does the contract require you personally to do the work, or could you send a substitute? If you have an unfettered right to substitute — meaning you can send a qualified replacement without needing the client's approval — this points strongly to outside IR35. If the client specifically needs you and you cannot send someone else, this points toward employment (and inside IR35).

Note: the substitution right must be genuine, not just a clause on paper. If a substitute clause exists but has never been exercised and the client would refuse one in practice, HMRC may disregard it.

2. Mutuality of obligation

Is the client obliged to offer you work, and are you obliged to accept it? In a true employment relationship, the employer offers work and the employee is expected to do it. If there is no obligation on either side between contracts — you can walk away, they can stop calling — this points to outside IR35.

In practice, this test is harder to pass than it sounds. If you have been working for the same client continuously for two years on rolling contracts, HMRC may argue that an implicit expectation of ongoing work has developed.

3. Control

Who controls how, when, and where the work is done? An employee is told what to do, how to do it, and when to show up. An independent contractor decides their own working methods, sets their own hours, and delivers an output. The more control the client exerts over the day-to-day work, the more it resembles employment — pointing toward inside IR35.

Working exclusively in a client's office, using their equipment, attending their staff meetings, and following their internal processes are all hallmarks of control.

Other relevant factors

Beyond the three key tests, tribunals also consider:

• Financial risk: a genuine business bears financial risk — quoting for fixed-price projects, bearing the cost of mistakes, carrying professional indemnity insurance. If you are paid regardless of outcome and bear no financial risk, this points toward employment
• Part and parcel of the organisation: are you treated as part of the client's team? Do you attend staff away days, appear on the org chart, have a company email address? These suggest employment rather than an independent contractor relationship
• Provision of equipment: do you use your own tools and equipment, or the client's? Genuine contractors typically bring their own
• Length of engagement: long-term, continuous relationships with a single client are more likely to resemble employment. Short, project-based engagements with multiple clients point toward genuine self-employment
• Right of exclusivity: can you work for other clients simultaneously? An exclusivity clause is a strong indicator of an employment-like relationship

Who determines your IR35 status?

This changed significantly in April 2021 with the off-payroll working reform:

• Medium and large private sector clients (and all public sector clients): the end client determines your IR35 status and is responsible for deducting tax at source if you are inside IR35. You cannot self-determine your own status on these contracts
• Small private sector clients: the contractor (you, via your company) determines your own IR35 status on a self-assessment basis

A company is “small” if it meets at least two of: annual turnover of £10.2 million or less; balance sheet of £5.1 million or less; 50 employees or fewer. Most small and medium-sized businesses you encounter as a freelancer will be small companies, meaning you assess your own status.

Inside IR35: what it means for your tax

If a contract is determined to be inside IR35, the income from that contract is treated as a “deemed salary” and taxed accordingly:

• The fee payer (client or agency) deducts Income Tax and National Insurance at source before paying you — just as an employer would under PAYE
• You cannot extract the income as dividends and benefit from the lower dividend tax rates
• Your company receives the net amount; you can still pay yourself a salary from the company, but there is no tax advantage to doing so
• You lose the ability to claim most business expenses against the income

The effective tax rate inside IR35 is significantly higher than outside. For a contractor billing £500 per day, the difference between inside and outside can be tens of thousands of pounds per year.

If you are inside IR35 on most of your contracts, a limited company structure offers little or no tax advantage. It may be worth reviewing whether to continue as a company or revert to sole trader status — read our sole trader vs limited company guide for more.

Outside IR35: maintaining your position

If your contracts are outside IR35, you can continue to operate through your company and extract income as a mix of salary and dividends in the most tax-efficient way. To maintain an outside determination:

• Ensure your contract accurately reflects reality — rights of substitution, no mutuality of obligation, clear deliverables rather than time-based attendance
• Actively exercise contractor-like behaviours: use your own equipment, submit project deliverables rather than timesheets where possible, avoid being integrated into the client's team
• Work for multiple clients simultaneously where possible
• Do not accept exclusivity clauses
• Review your contracts with a specialist IR35 adviser before signing, especially for high-value or long-term engagements

HMRC's CEST tool

Check Employment Status for Tax (CEST) is HMRC's online tool for assessing IR35 status. You answer a series of questions about the contract and it provides a determination of “employed”, “self-employed”, or “unable to determine”.

HMRC says it will stand by CEST results provided the information entered is accurate. However, the tool has been criticised for not adequately testing mutuality of obligation, and it fails to provide a determination in a significant proportion of cases.

Use CEST as a starting point, not a definitive answer. For any high-value or long-duration contract, commission an IR35 review from a specialist contractor accountant or employment law solicitor. The cost (typically £200–£500) is trivial compared to the potential tax exposure of getting it wrong.

Status Determination Statement (SDS)

When a medium or large client determines your IR35 status, they must provide you with a written Status Determination Statement (SDS) stating whether you are inside or outside IR35, and their reasons. You are entitled to receive this before the contract begins.

If you disagree with the determination, you can raise a disagreement through the client's formal review process. The client must respond within 45 days. If you still disagree after the review, you can challenge it further — though in practice this is rarely straightforward.

Always request an SDS in writing before accepting a contract where the client is responsible for the determination. If a client refuses to provide one, treat this as a significant red flag.

IR35 and sole traders

Sole traders are not subject to IR35 — the legislation specifically applies to contractors working through an intermediary (a company). However, sole traders are not immune from employment status scrutiny. HMRC can investigate whether a sole trader is genuinely self-employed or effectively an employee of a single client, which would mean the client should be deducting PAYE tax.

The practical difference: HMRC targets IR35 at the contractor's company level, whereas disguised employment for sole traders is tackled at the client level. For most sole trader freelancers working with multiple clients on varied projects, this is not a concern.

Practical steps to protect yourself

• Get your contracts reviewed before signing, especially for new or high-value engagements. An IR35 specialist costs far less than a tax investigation
• Keep contemporaneous evidence: save emails showing you decided how and when to do work, proof of working for other clients simultaneously, invoices showing you quoted a fixed price rather than a day rate where applicable
• Avoid “employed person” behaviours: do not attend staff socials, do not use a company email address, do not appear on the client's team pages or org chart
• Diversify your client base: the more clients you work for, the stronger your case for genuine self-employment
• Use professional indemnity insurance: it demonstrates financial risk, which is an indicator of genuine contractor status
• Review your structure regularly: if you find yourself inside IR35 on most contracts, the limited company may no longer be worth the admin overhead