IR35 and Off-Payroll Working UK — Complete Guide 2026/27

IR35 is the tax legislation that determines whether a contractor working through a limited company should be taxed as an employee or as a genuinely self-employed business. Getting it wrong costs money — for contractors outside IR35, the salary/dividend structure can be worth thousands of pounds per year compared to being treated as an employee.

The rules were significantly reformed in April 2017 (public sector) and April 2021 (medium/large private sector). If you contract through a personal service company (PSC), understanding IR35 is essential.

How IR35 Works: The Core Principle

IR35 asks one question: does this contractor work like an employee in disguise?

If the answer is yes, HMRC expects that contractor to pay the same income tax and National Insurance as an employee — regardless of the company structure they use.

The legislation applies to contractors who:

• Provide services to a client through an intermediary (typically a limited company or PSC)
• Would be classified as an employee if engaged directly

Inside vs Outside IR35: What It Means in Practice

The financial impact: On a £500/day contract (220 working days = £110,000 gross), inside IR35 can reduce net take-home by £8,000–£15,000 per year compared to an outside-IR35 structure with the same contract value.

The Three Key IR35 Status Tests

Employment status for IR35 is determined by case law — not a checklist. Courts have consistently identified three primary factors:

1. Substitution

Can you send a substitute to do the work in your place, without the client’s approval of that specific individual?

• Strong outside IR35 indicator: A genuine, unconditional right of substitution — the client cannot veto your choice
• Weak indicator: A nominal substitution clause that the client would never accept in practice
• Inside IR35 indicator: The client insists on you personally, or the contract has no substitution clause

2. Control

Does the client control not just what work is done, but how, when, and where you do it?

• Outside IR35: Client specifies the deliverable but you decide how to achieve it, set your own hours, and work from your own location
• Inside IR35: Client dictates hours, location, methods, dress code, and day-to-day supervision

3. Mutuality of Obligation (MOO)

Is the client obliged to offer you work, and are you obliged to accept it?

• Outside IR35: No obligation on either side — each project is a new agreement
• Inside IR35: Implied expectation of ongoing work, rolling contracts renewed automatically, no genuine break in engagement

Other supporting factors

Who Decides: The Off-Payroll Rules (2021 Reform)

The off-payroll working rules (Chapter 10, ITEPA 2003) shifted responsibility for IR35 determination from the contractor to the client for most engagements from April 2021.

Small company definition (two of three):

• Fewer than 50 employees
• Annual turnover not more than £10.2 million
• Balance sheet total not more than £5.1 million

Status Determination Statement (SDS)

When a medium/large client determines a contract’s IR35 status, they must issue an SDS to the contractor and the fee payer (agency). The SDS must state whether the engagement is inside or outside IR35 and give reasons.

If you disagree with the SDS, you can raise it through the client’s formal disagreement process. The client must respond within 45 days.

HMRC’s CEST Tool

HMRC’s Check Employment Status for Tax (CEST) tool provides a non-binding determination based on answers to questions about the engagement. HMRC will stand behind a CEST result — provided the information entered was accurate and complete.

CEST is useful as a starting point, but it has limitations: it does not always address MOO directly and cannot replace legal advice for borderline cases.

Inside IR35: How Tax Is Deducted

If a contract is inside IR35, the fee payer (usually the agency, or the client if there is no agency) operates PAYE:

1. The contractor invoices as normal
2. The fee payer deducts income tax and employee NI from the payment
3. The fee payer also pays employer NI (13.8%) on top
4. The contractor receives a net amount — equivalent to a deemed salary

The contractor’s PSC can still receive the net amount but has limited further tax planning available. There is a 5% allowance for limited company costs (reduced from 5% to 0% for some intermediaries in certain scenarios — take advice).

Practical Steps for Contractors

• Before signing a contract: Ask the client for their SDS process and timeline
• Review the contract wording: Ensure substitution clauses are real, not nominal. Avoid “personal service” language
• Document working practices: Keep evidence that matches outside-IR35 status — emails showing you manage your own methods, multiple client relationships, use of your own equipment
• Use an IR35 specialist: Contract review services (typically £200–£400 per contract) are worth it for long or high-value engagements
• Get IR35 insurance: Specialist policies cover HMRC investigation costs and any unpaid tax liability

Articles in This Cluster

• Contractor Day Rate to Salary Equivalent UK — convert your day rate to annual income
• Contractor Expenses — What Can a Limited Company Claim? — allowable expenses guide
• Contractor vs Freelancer vs Sole Trader UK — which structure is right for you?

Related Guides

• Limited Company vs Sole Trader UK — choosing your business structure
• Self-Employment Tax Guide UK — tax and NI for the self-employed
• Self-Assessment Tax Return Guide — filing your annual return