IR35 is the UK tax legislation designed to prevent contractors and freelancers from operating as “disguised employees” through a limited company to reduce their tax bill. If your working arrangement looks like employment — but is structured as a company-to-company contract — HMRC may determine that you owe income tax and National Insurance as if you were an employee.
Understanding IR35 is essential for any UK contractor, IT worker, consultant, or freelancer working through a personal service company (PSC) or limited company.
What Problem Does IR35 Solve?
Before IR35 (introduced in April 2000), a common arrangement was:
- Worker leaves employer
- Worker sets up a limited company
- Former employer rehires the worker through the company as a “contractor”
- Worker pays themselves a small salary and large dividends — saving thousands in NI
HMRC viewed this as unfair: the worker had the same job, same desk, same hours, same manager — but paid far less tax. IR35 was designed to close this gap.
Two Sets of Rules: Chapter 8 vs Chapter 10
Since April 2021, IR35 operates differently depending on the size of the end client:
| Chapter 8 (Small clients) | Chapter 10 (Medium/Large clients) | |
|---|---|---|
| Who decides IR35 status | The contractor | The end client |
| Small client definition | Fewer than 50 employees AND under £10.2m turnover AND under £5.1m balance sheet | Does not meet small client criteria |
| Status Determination Statement | Not required | Required — client must provide in writing |
| Where liability falls | Contractor’s PSC | The “fee-payer” (often the agency or client) |
| HMRC challenge possible? | Yes | Yes |
If your client is small: You decide your own IR35 status. You are responsible for getting it right. HMRC can investigate and challenge your determination.
If your client is medium or large: They must give you a Status Determination Statement. If they get it wrong, the tax liability falls on them (not you), unless the fee-payer has also failed to act.
The Three Key IR35 Tests
No single factor determines IR35 status. HMRC and courts look at the overall picture of the working relationship, but three factors carry the most weight:
1. Right of Substitution
Outside IR35 indicator: You have a genuine right to send a substitute — another person — to fulfil the contract instead of you, and the client would accept a suitably qualified substitute.
Inside IR35 indicator: The client engaged you specifically, the contract requires personal service, and you could not practically send someone else.
A substitution clause in your contract is helpful, but HMRC looks at whether it is genuine — if it has never been used and would never be accepted in practice, the clause carries little weight.
2. Mutuality of Obligation (MOO)
Outside IR35 indicator: The client has no obligation to offer you more work after the current contract ends, and you have no obligation to accept further work even if offered.
Inside IR35 indicator: There is an ongoing expectation of work — the client offers and you accept as a matter of course, creating an employment-like pattern.
MOO is harder to demonstrate clearly from a contract document alone — HMRC often looks at the actual working pattern over time.
3. Control
Outside IR35 indicator: You decide how, when, and where to work. You set your hours, use your own equipment, and the client cares only about the deliverable.
Inside IR35 indicator: The client directs your working hours, requires you in the office, provides your equipment, and supervises how you work day-to-day.
Other Factors HMRC Considers
| Factor | Outside IR35 | Inside IR35 |
|---|---|---|
| Financial risk | You can make a profit or loss; you may fix defects at your own cost | No financial risk beyond losing the contract |
| Equipment | You provide your own equipment | Client provides equipment |
| Integration | You are clearly separate from the workforce | You attend staff meetings, use employee systems, appear on the org chart |
| Exclusivity | You work for multiple clients | You work exclusively for one client |
| Length of engagement | Short, project-based | Long-term, rolling contracts |
| Benefits | No employee benefits | Receive holiday pay, sick pay, canteen access |
Using HMRC’s CEST Tool
HMRC provides the Check Employment Status for Tax (CEST) tool online. Answering the questions gives a determination of “inside IR35”, “outside IR35”, or “unable to determine”. HMRC will stand behind a CEST result — provided you have answered the questions accurately.
Limitations of CEST:
- Does not currently account for Mutuality of Obligation as a separate factor
- The tool is controversial among tax professionals who believe it is weighted towards “inside” determinations
- An “unable to determine” result leaves you exposed
Many contractors commission an independent IR35 review from a specialist contractor accountant or IR35 specialist before accepting a contract.
What “Inside IR35” Means in Practice — The Numbers
Example: £500/day contract rate (£120,000/year)
| Outside IR35 (Ltd company) | Inside IR35 (deemed employment) | |
|---|---|---|
| Gross contract income | £120,000 | £120,000 |
| Employer NI (deducted by fee-payer) | £0 | ~£12,000 |
| Income subject to PAYE | — | ~£108,000 |
| Income tax + employee NI | ~£25,000 (optimised salary/dividend split) | ~£42,000 |
| Net take-home | ~£95,000 | ~£66,000 |
| Effective difference | — | ~£29,000 less per year |
Figures are illustrative and depend on individual circumstances, expenses, and tax planning.
Challenging an IR35 Determination
If a medium or large client determines you are inside IR35 and you believe this is wrong:
- Ask for their Status Determination Statement in writing
- Use the client’s formal disagreement process (they must have one)
- Provide evidence supporting outside IR35 status (contract wording, substitution records, working practices)
- If unresolved, consider engaging a specialist IR35 adviser
- In extreme cases, dispute through HMRC’s own process or the tax tribunal
IR35 and Umbrella Companies
Working through an umbrella company is sometimes presented as the “safe” option. It removes IR35 risk entirely — but at a cost:
- You are an employee of the umbrella, paying full PAYE tax and NI
- The umbrella charges a margin (£15–£30/week typically)
- You lose the income-splitting and expense advantages of a limited company
Umbrella is appropriate when: your contract is inside IR35, or you want to work in the UK temporarily without setting up a company.
For a cost comparison, see PAYE vs umbrella vs limited company. For the breakeven analysis on whether a limited company is worth it see ltd vs umbrella breakeven. For protecting your business against IR35 investigation costs, see IR35 insurance.