If you’re a contractor, you’ve probably heard the term IR35. But what does it actually mean, when does it apply, and how could it affect the way you’re paid?
IR35, more formally known as the off-payroll working rules, is designed to ensure that contractors who work in a similar way to employees pay broadly the same Income Tax and National Insurance contributions as permanent employees.
For contractors, agencies and end clients, understanding these rules is important because an IR35 determination can affect everything from how a contract is structured to how tax is deducted from the contractor’s fees.
What are the off-payroll working rules?
The off-payroll working rules apply when an individual provides services to a client through their own intermediary — usually a Personal Service Company (PSC) — but would be considered an employee for tax purposes if they provided those services directly.
In simple terms, HMRC looks beyond the fact that you operate through a limited company and considers the actual working relationship between you and the client.
If that relationship resembles employment, the engagement may fall inside IR35.
If the relationship is genuinely one of self-employment, the engagement may fall outside IR35.
Importantly, IR35 is assessed on a contract-by-contract basis. This means the same contractor could have one assignment that falls inside IR35 and another that falls outside it.
Who can be affected by IR35?
The off-payroll working rules don’t only affect contractors. They can have implications for several parties within the contractor supply chain, including:
- Contractors providing services through their own intermediary, such as a limited company or PSC.
- End clients receiving the contractor’s services.
- Recruitment agencies and other intermediaries involved in supplying the contractor’s services to the client.
The responsibilities of each party depend on several factors, including the size and type of organisation engaging the contractor.
What is a Personal Service Company (PSC)?
Many contractors provide their services through their own limited company, commonly referred to as a Personal Service Company or PSC.
Although PSC isn’t a specific legal definition, it generally describes a limited company that is owned or controlled by the contractor and is used to provide that contractor’s professional services to clients.
For example, rather than a client engaging and paying you personally, it contracts with your limited company, which then invoices for the work performed. It is this type of arrangement that can potentially fall within the off-payroll working rules.
Who decides whether a contract is inside or outside IR35?
One of the most important questions is: who is responsible for making the IR35 determination? The answer depends largely on the client.
For public-sector organisations and medium and large private or voluntary-sector clients, the client is generally responsible for determining the contractor’s employment status for tax purposes.
The client should consider the working arrangements and decide whether the engagement falls inside or outside the off-payroll working rules.
However, where a contractor provides services to a small private-sector client, responsibility for assessing IR35 generally remains with the contractor’s intermediary, such as their PSC.
It is therefore important to establish who is responsible for the determination at the beginning of an engagement.
What is a Status Determination Statement?
Where the client is responsible for determining the contractor’s employment status, it should provide a Status Determination Statement (SDS). The SDS sets out the client’s conclusion about the contractor’s employment status for tax purposes and the reasons behind that decision.
The client should take reasonable care when reaching its conclusion rather than simply making blanket determinations for its contractor workforce. For contractors, the SDS is an important document because it tells you how the client has assessed your engagement and whether it believes the off-payroll working rules apply.
Inside IR35 vs outside IR35: What’s the difference?
You’ll commonly see contracts advertised as either inside IR35 or outside IR35.
Inside IR35
If an engagement is considered inside IR35, the contractor is treated as an employee for tax purposes in relation to the relevant payments. Where the off-payroll rules apply, the organisation acting as the deemed employer is responsible for deducting the relevant Income Tax and employee National Insurance contributions before the payment reaches the contractor’s intermediary.
The deemed employer may also be responsible for employer National Insurance contributions and, where applicable, the Apprenticeship Levy. It’s important to understand that being treated as employed for tax purposes does not automatically give a contractor all the employment rights associated with being a permanent employee.
Outside IR35
An outside-IR35 engagement is one where the contractor is considered genuinely self-employed for tax purposes under the relevant rules. Payments can generally be made to the contractor’s limited company without the fee payer first making PAYE deductions under the off-payroll working rules.
However, an outside-IR35 label alone isn’t enough. The contractual terms and, crucially, the actual working practices need to support that status.
How is IR35 status determined?
Employment status can be complicated, and there isn’t always a single factor that determines whether an engagement falls inside or outside IR35. Instead, the overall relationship between the contractor and client needs to be considered.
Factors commonly relevant to employment-status assessments include the degree of control the client has over the contractor’s work, whether there is a genuine right of substitution, the parties’ ongoing obligations, and the wider commercial relationship.
The written contract is important, but it shouldn’t be considered in isolation. How the relationship works in practice matters too. For example, an agreement may contain clauses designed to indicate self-employment, but those clauses may carry less weight if the day-to-day working relationship looks substantially different.
HMRC provides its Check Employment Status for Tax (CEST) service to help individuals and organisations assess employment status for tax purposes.
IR35 applies to individual contracts
A common misconception is that a contractor is simply “inside IR35” or “outside IR35.” In reality, the rules apply to individual engagements. You could therefore work on an outside-IR35 contract for one client and subsequently accept an inside-IR35 assignment with another.
Your working arrangements could also differ considerably between clients. That’s why each new engagement should be considered on its own circumstances rather than assuming that a previous IR35 assessment will automatically apply to the next contract.
What happens when a contract is inside IR35?
Where the off-payroll working rules apply and the contractor is determined to be employed for tax purposes, the deemed employer has responsibilities for the relevant payment. This generally means deducting Income Tax and employee National Insurance contributions from the payment made in respect of the contractor’s services.
The deemed employer is also responsible for paying employer National Insurance contributions and, where applicable, the Apprenticeship Levy to HMRC. The practical result is that the contractor’s take-home position can look considerably different from an outside-IR35 engagement. This is one reason contractors should understand the IR35 status of an assignment before agreeing to a rate.
Does IR35 apply if you work through an umbrella company?
Generally, the off-payroll working rules are unlikely to apply in the same way when you are employed by a compliant umbrella company. That’s because the umbrella company employs the contractor and operates PAYE on their employment income.
Income Tax and employee National Insurance contributions are therefore already deducted through payroll before the contractor receives their net salary. This is why umbrella employment is commonly used for contractors accepting assignments that clients or agencies require to be operated through PAYE.
However, contractors should still understand exactly how their umbrella arrangement works, including the difference between the assignment rate paid to the umbrella and the gross salary paid to the contractor.
What about student and postgraduate loans?
There is an additional point worth knowing for contractors working under the off-payroll rules. HMRC states that deemed employers do not deduct student or postgraduate loan repayments from the fees paid to an off-payroll worker’s intermediary.
Where repayments are due, the contractor may instead need to account for them through Self Assessment. This is an area where obtaining professional tax advice may be worthwhile if you’re unsure of your individual obligations.
Be wary of IR35 avoidance schemes
Contractors should be particularly cautious of businesses claiming they can legally “get around IR35” while offering unusually high take-home pay. Tax arrangements can sometimes be presented using complicated terminology, loans, advances, credit facilities, trusts or other mechanisms designed to make payments appear to be something other than ordinary taxable income.
The fact that a scheme is being marketed professionally does not necessarily mean HMRC accepts it.
Warning signs can include:
- Claims that you can retain an unusually high percentage of your contract income.
- Some of your earnings being described as non-taxable loans or advances.
- Complex payment arrangements that are difficult to understand.
- Promises that a structure is “HMRC approved”.
- Pressure to join quickly or assurances that there is “no tax risk”.
- Arrangements where only a small proportion of your income appears on your payslip.
- If an arrangement sounds too good to be true, investigate it carefully before signing up.
What should contractors do before accepting a contract?
Before starting a new assignment, make sure you understand how you are being engaged and how you will be paid. If you’re contracting through your PSC, establish whether the client is responsible for the IR35 determination and, where appropriate, ask to see the Status Determination Statement.
If the engagement is outside IR35, make sure the contract and actual working practices support that position. If the assignment is inside IR35 and you’ll be working through an umbrella company, understand the umbrella’s employment model, fees and deductions before agreeing to the arrangement.
Most importantly, don’t base your decision purely on the advertised day rate. The tax treatment and payment structure can make a significant difference to your actual take-home pay.
