Why IR35 Matters Right Now
The legislation, often simply called IR35, has evolved from an occasional worry to a central pillar of UK contract law and taxation. The central question for contractors and clients alike is no longer, what is IR35? But rather, how does IR35 work and “how does it actually affect my contracts, income, and risk?”
The reforms that came into force in the public sector in 2017 and were later extended to the private sector (for medium and large clients) in April 2021 shifted the responsibility for determining IR35 status away from the contractor’s PSC and onto the end-client. This major change, often referred to as the IR35 off-payroll working rules, introduced new complexity, administrative burdens, and risks for everyone in the supply chain. If you are a contractor, it directly impacts your take-home pay. If you are a client, it directly impacts your tax compliance and potential liability.
Who this guide is for
This guide is designed to provide clarity and expertise for two primary audiences:
- Limited company contractors, freelancers, and consultants who operate through a Personal Service Company (PSC) and need to understand the financial and compliance impact of being inside IR35 or outside IR35.
- SMEs and hiring clients (the ‘engagers’) who need to understand their responsibilities for IR35 determination when engaging contractors.
What will this guide cover?
We will define IR35, explain the core IR35 rules, detail the financial differences between inside IR35 and outside IR35, review the practical status tests used by HMRC, and provide actionable compliance advice, including when to seek professional help from a specialist like Lanop.
What is IR35?
IR35 (which stands for Inland Revenue 35, the press release that announced the legislation in 1999) is a UK tax law designed to prevent “disguised employment“. In simple terms, it targets individuals who work for a client through an intermediary, usually their own limited company (a PSC), but whose working arrangement is, in reality, that of an employee.
The core IR35 definition is that the tax treatment should reflect the true nature of the relationship, not just the contractual structure. HMRC introduced IR35 to ensure these individuals pay the appropriate amount of tax (Income Tax and National Insurance Contributions) that an equivalent employee would pay.
IR35 vs “Off-Payroll Working Rules”
While many use the terms interchangeably, the original IR35 legislation focuses on the tax liability. The “Off-Payroll Working Rules” (OPWR) are the specific set of rules introduced in 2017 and 2021 that dictate who is responsible for making the IR35 assessment and collecting the associated tax.
In current practice, when people discuss IR35IR35 off-payroll working or IR35 rules UK explained, they are usually referring to the OPWR framework, in which the end-client performs the IR35 determination and issues the Status Determination Statement (SDS).
Who does IR35 apply to
IR35 applies to individuals who provide their services to a client through an intermediary, primarily:
- Personal Service Companies (PSCs): One-person limited companies where the contractor is the director and principal shareholder.
- Freelancers and Consultants: Those using a limited company structure to contract for services.
The goal is to identify the IR35-disguised employee, meaning someone who gains the tax advantages of being self-employed (e.g., paying lower tax on dividends) while enjoying the control, security, and working practices of an actual employee.
Lanop Case Study: PSC Risk Assessment. A new creative director, Ms. K (Sarah Khan), was setting up her first limited company. Lanop provided a structural review, explained that her PSC was subject to IR35 legislation, and helped her draft service contracts and working practices that clearly demonstrated genuine self-employment.
“Starting my PSC felt daunting until Lanop explained the IR35 rules in the UK and helped me start correctly."
Who Is Caught by IR35 and When?
Contractors, freelancers, and self-employed
The typical IR35 contractors’ profile is a highly skilled professional (e.g., an IT architect, project manager, or engineer) working on specific projects for a client through their own PSC. They aim to be seen as genuinely in business on their own account, a key factor for being outside IR35. HMRC scrutinises these arrangements closely, looking past the contract to the actual working relationship.
Lanop Case Study: Contractor Audit Defence Mr. J (James White), an engineer, faced an HMRC enquiry into an IR35 and contractor status from three years ago. Lanop helped him compile a defence file showing evidence of financial risk, multiple clients, and the use of genuine substitution clauses, leading to HMRC closing the enquiry with no tax due.
Sole traders and IR35
Does IR35 apply to sole traders? The answer is technically no. IR35 specifically targets those working through an intermediary, like a limited company. However, sole traders are still subject to the broader employment status rules, and an expert self-employed accountant can help clarify borderline cases. HMRC could still challenge a sole trader’s self-employment status if the relationship with their client heavily resembles permanent employment. The principle of distinguishing between employment and self-employment remains paramount.
Umbrella companies and IR35
Using an umbrella company changes the tax mechanics entirely. If you work through an umbrella, you are classified as an employee of the umbrella company. They run your pay through PAYE, deducting income tax and National Insurance Contributions (NICs) at source. Therefore, the contractor is paying employee-level taxes, and the IR35 tax liability concern is typically removed. However, the regulatory environment is changing: new rules on Joint and Several Liability (JSL) for unpaid PAYE/NICs are being introduced from April 2026, shifting more risk to agencies and end-clients when working with non-compliant umbrellas.
Clients and company-size thresholds
The crucial factor in the current framework is the size of the end-client:
- Small Clients (exempt): The responsibility for determining IR35 status and the associated tax liability remains with the contractor’s PSC.
- Medium/Large Clients (non-exempt): The client must perform the IR35 determination, issue a Status Determination Statement (SDS), and the liability for tax collection falls on the ‘fee-payer’ (usually the agency or the client).
A small company’ meets two or more of the following:
| Threshold | Current (2025/26 Tax Year) | Companies Act Change (From 6 April 2025 Financial Years) |
|---|---|---|
| Annual Turnover | £10.2 million or less | £15 million or less |
| Balance Sheet Total | £5.1 million or less | £7.5 million or less |
| Employees | 50 or fewer | 50 or fewer (unchanged) |
Important Note for the 2025 View:
The higher thresholds of £15m / £7.5m apply to financial years beginning on or after 6 April 2025. Due to the two-year test and filing requirements, for most companies, the earliest the increased thresholds will pull clients out of the IR35 off-payroll working rules is the 2027/28 tax year. For 2025/26, the £10.2m / £5.1m figures generally still apply.
Lanop Case Study: Client Threshold Advice ‘ScaleUp Consulting’, a rapidly growing SME, was reviewing the impact of the new threshold uplifts. Lanop advised them on the exact date they would become responsible for IR35IR35 determinations and helped them implement a robust, preemptive compliance system to manage their contractor status reviews from day one.
Cross-border / non-UK scenarios (high-level)
Contracts involving non-UK residents, overseas clients with a UK presence, or UK-based contractors working for international companies are highly complex. IR35 can still apply if the services are performed in the UK and there is a UK tax connection. This is an area where blanket advice is dangerous; professional advice is a necessity, ideally from a firm offering specialist cross-border tax and accounting services.
How IR35 Works in the UK (2025 View)
Timeline and key reforms
The history of IR35 is a history of reform:
- 2000: IR35 was first introduced.
- 2017: Off-Payroll Working Rules introduced in the UK Public Sector, shifting liability to the client.
- 2021: Off-Payroll Working Rules extended to the UK Private Sector (for medium and large clients).
- April 2024: Introduction of the Offset Rule, significantly reducing financial risk for clients on misdetermined statuses.
- April 2026 (Upcoming): Anticipated major reforms to the umbrella company sector via Joint and Several Liability.
Who decides IR35 status now?
The burden of IR35 assessment is now mainly on the end-client (unless they are a small company).
- End-Client Responsibility: They must take reasonable care when determining the contractor’s status.
- Status Determination Statement (SDS): The client must issue an SDS to the contractor and the party they contract with (e.g., the agency), explaining their conclusion (inside IR35 or outside IR35) and the reasons for it. This is the IR35 status determination meaning document.
- Offset Rule (Post-April 2024): Crucially, if HMRC successfully challenges an outside IR35IR35 determination and the fee-payer/client owes tax, HMRC must now offset any tax already paid by the contractor’s PSC against the client’s liability. This removes the unfair double-taxation risk and has reduced client reluctance to issue outside IR35 determinations where appropriate.
Lanop Case Study: SDS Challenge A financial services contractor, Ms. P (Elena Petrov), received an inside IR35 SDS that she believed was incorrect. Lanop reviewed the SDS, successfully helped her challenge the client’s reasoning by citing the lack of control in the role, and facilitated a new outside IR35 SDS, protecting her tax efficiency. The client was more receptive when they learned that the HMRC IR35 offset rule mitigated their residual risk.
CEST and other tools
HMRC’s Check Employment Status for Tax (CEST) tool is a free resource designed to help determine status. What it checks is based on HMRC’s interpretation of case law.
However, CEST has limitations: it cannot provide a conclusive result if the answers are unclear, and critically, it only looks at the hypothetical contract and the answers given. The true assessment requires the tool result + real working practices, + professional review. An advisor will always look beyond a simple tool to assess actual risk and documentation.
Inside vs Outside IR35 – What It Actually Means
What does “inside IR35” mean?
To be inside IR35 means HMRC considers the working arrangement to be one of employment for tax purposes. What does inside IR35 mean in practice?
- Tax Treatment: You will pay Income Tax and NICs almost exactly as an equivalent employee would. The fee-payer deducts these at source.
- Take-Home Pay: Significantly lower than an outside IR35 arrangement (see Section 6).
- Main Pain Point: You “tax like an employee, but not necessarily employee rights” (such as holiday pay, sick pay, or redundancy protection) unless the contract explicitly grants them. This is often the biggest financial and emotional stress point.
What does “outside IR35” mean?
To be outside IR35 means the arrangement is deemed a genuine business-to-business contract. What does outside IR35 mean?
- Tax Treatment: Your PSC is treated as a genuine business on your own account. You typically have more flexibility in how profits are extracted (salary plus dividends), which leads to greater tax efficiency.
- Flexibility & Control: You must be able to demonstrate genuine self-employment traits like financial risk, control over how and when you work, and the right of substitution.
Lanop Case Study: Outside IR35 Strategy Mr. R (Robert O’Connell), a construction project manager, wanted assurance on his outside IR35 status. Lanop reviewed his master service agreement, drafted a robust Statement of Work (SoW) for the current project, emphasising clear deliverables, and documented evidence of his genuine financial risk.
“Knowing Lanop had reviewed and approved my setup made all the difference to my confidence about being outside IR35."
Difference between inside and outside IR35
The core difference between inside and outside ir35 boils down to:
| Factor | Inside IR35 (Deemed Employment) | Outside IR35 (Genuine Business) |
|---|---|---|
| Tax | PAYE/NICs deducted at source (Fee-Payer) | PSC pays Corporation Tax; owner takes efficient salary/dividends |
| Risk | Lower liability risk for the PSC, but the client/fee-payer is at risk if determination is wrong | Higher personal/PSC risk if status is successfully challenged by HMRC |
| Control | Similar to employee (directed on “how” the work is done) | High degree of autonomy (responsible for “what” is delivered) |
| Take-Home | Significantly lower | Higher tax-efficient take-home pay |
Is contracting still worth it in an IR35 world?
This is a big, explicit question many search for. The honest answer is yes, but it requires a strategic mindset. You should also review dedicated tax tips for contractors in the UK to understand how structure and planning affect your net take-home pay. While the financial benefit of an outside IR35 role is clear, even inside IR35 roles can be worthwhile if the day rate reflects the tax burden (a necessary uplift), if the contract offers desirable non-financial factors (e.g., specific experience, better work/life balance), or if the market conditions mean there are limited permanent opportunities. The key is to run the numbers and assess the overall value, money, risk, control, and lifestyle.
Negotiating rates for inside IR35 roles
When a client determines that a role falls within IR35, contractors often request a pay uplift to compensate for the loss of tax efficiency. A common request is 15-25% above an equivalent permanent salary, though the market dictates the achievable rate. Communication with agencies and clients should focus on the total cost of employment; the client is avoiding employer NICs, holiday pay, and other benefits, so there is room for negotiation.
Mixing inside and outside IR35 in the same year It is completely acceptable to have a mixed portfolio of engagements, e.g., an inside IR35 engagement for a large client and several small outside IR35 projects with small clients. This requires meticulous record-keeping and careful tax planning, as the two income streams are taxed very differently within the same PSC. This is where specialist accounting is invaluable. Impact on mortgages, loans, and long-term finances
The income volatility and potential drop in take-home pay from moving from outside IR35 to inside IR35 can complicate major financial decisions. Lenders often prefer the predictability of PAYE income from inside IR35IR35 contracts, but high-value outside IR35 earnings can be advantageous if the PSC accounts are well managed. Clear, documented evidence of consistent status and income is key to successful borrowing.
IR35 Status Tests – How HMRC Actually Looks at You
The fundamental question in any IR35 assessment is whether, had there been no intermediary (the PSC), the contractor would have been considered an employee of the client. This is determined by looking at key factors derived from case law. Overview of status factors HMRC looks at both the contract and the actual working practices; you must pass both. A perfect contract is worthless if the day-to-day reality of the work mimics employment.
Control
This is often the most important factor. Control relates to who dictates how, when, and where the work is done.
- Employment-style control: Being told which tasks to perform, the order to perform them, using a specific desk/equipment, and working set hours.
- Project-style control: Being engaged for a specific deliverable, with the freedom to decide the method and schedule to meet the agreed deadline.
Right of substitution
A right of substitution means the contractor can send a replacement worker to perform the service.
- Genuine Substitution: The contractor’s business must genuinely bear the cost and risk of the substitution, and the client must only have the right to reasonably vet the replacement’s competence, not veto them arbitrarily.
- “Paper-only”: A clause in the contract is meaningless if the client would never practically accept a substitute due to security, specialism, or policy.
Mutuality of obligation (MOO)
MOO is the ongoing obligation for a client to offer work and for a worker to accept it. A key trait of employment is a consistent flow of work. In contrast, a genuine contractor relationship is typically project-by-project, with no expectation of ongoing work once the current Statement of Work (SoW) is complete.
Other key factors
These secondary factors support the primary tests:
- Financial Risk: Does the contractor bear the cost if things go wrong, or are they paid regardless?
- Provision of Equipment: Does the contractor use their own equipment, or is the client providing it?
- Integration: Is the contractor integrated into the client’s organisation (e.g., attending all staff meetings, having a client email address)?
- In Business on Own Account: Does the PSC have its own marketing, website, multiple clients, and business insurance?
Special Cases & Edge Questions
Sole traders and freelancers
Again, while IR35 targets PSCs, employment status risks still exist for sole traders. The same tests of Control, MOO, and Substitution determine if a sole trader should be treated as an employee and taxed under PAYE by the client.
Sector-specific notes
- IT/Engineering: High HMRC focus due to the volume of contractors. Substitution is often genuinely difficult to prove.
- Healthcare/Locums: Complex rules apply, but often clear MOO and control in place (e.g., set shifts in a hospital).
- Consultants: Often easier to demonstrate genuine business status if they have multiple clients, their own brand, and high control over deliverables.
Remote and hybrid working
Flexible hours or working from home do not automatically change IR35 risk. If a client dictates that the work must be done remotely but still controls the working hours and method, the control factor points to inside IR35. Genuine flexible working, where the contractor manages their time to meet deliverables, supports an outside IR35 conclusion.
UK vs overseas contracts
If a UK-resident contractor provides services to an overseas client, the IR35 rules in the UK can still apply if the client has a UK presence or is otherwise connected to the UK tax system. The complexity of cross-border tax law makes a strong case for professional advice.
IR35 Compliance for Businesses and Clients
Why IR35 matters for engagers
For medium and large clients, getting IR35 wrong is a significant risk. If HMRC successfully challenges an outside IR35 determination, the client (or fee-payer) is liable for the underpaid tax, plus interest and penalties. In severe cases, you may need support from specialist HMRC tax investigation accountants to manage enquiries and negotiations. However, the new Offset Rule (2024) significantly reduces the net liability, reducing the financial fallout.
Building a robust SDS process
The key to IR35 compliance is to build a demonstrable, robust, and recorded process for every role. This includes:
- Detailed role assessment using the status factors.
- Documenting the decision and issuing a comprehensive, reasoned SDS.
- Ensuring the SDS is given to the contractor and the agency.
Lanop Case Study: Client Compliance Setup. A new finance director at a large logistics company (Mr. Ayan) approached Lanop seeking a comprehensive IR35 compliance framework. Lanop created a bespoke, defensible Status Determination Statement (SDS) process and trained the client’s internal legal team on ‘reasonable care’ obligations.
Avoiding unlawful blanket assessments
While efficient, a blanket approach to IR35 determinations without individual role review fails the statutory ‘reasonable care’ test. Given the reduction in liability risk due to the Offset Rule, blanket decisions are even more challenging for clients to justify than before.
Working with contractors fairly
Clients can structure engagements to genuinely facilitate an outside IR35 status where appropriate. This means:
- Using Statements of Work (SoWs) with clear deliverables.
- Granting maximum project control to the contractor.
- Minimising integration into the client’s internal hierarchy.
Businesses should seek advice for complex arrangements, high-value contracts, or whenever a contractor challenges a status determination. External advice demonstrates the client has taken ‘reasonable care’. Businesses must also seek advice on the upcoming Umbrella Company Reforms (2026) to understand their new supply chain liabilities.
When to Get Professional Help
Situations where DIY is risky
- Large contracts or long-term single-client engagements.
- Complex working arrangements (e.g., cross-border or involving multiple agencies).
- Any time an IR35 determination tool (like CEST) returns an ‘undetermined’ result.
How a specialist (Like NALOP) accountant can help
A specialist firm like Lanop acts as your expert partner, providing the necessary expertise, authoritativeness, and trustworthiness. We help by:
- Providing independent IR35 contract reviews and documented status opinions.
- Advising on the correct business structure and tax planning for mixed contracts.
- Assisting with HMRC enquiry support and defense file preparation.
- Review your PSC’s tax position to ensure maximum tax efficiency.
Conclusion:
IR35 is a tax law designed to stop disguised employment. The 2017/2021 reforms shifted the IR35 determination of responsibility to medium and large clients, though the client thresholds are set to rise in the coming years. The introduction of the Offset Rule (2024) has de-risked the system for clients, while the upcoming Umbrella Reforms (2026) introduce new supply chain liabilities. Success hinges on ensuring your contract and working practices align with genuine self-employment traits, and proactive compliance is key to mitigating risk.
Don’t navigate the complex world of IR35 alone. Contact Lanop Business & Tax Advisors today for a personalized review and professional advice that protects your income and compliance.
FAQs
What is IR35 in simple terms?
IR35 is UK tax legislation designed to stop what HMRC calls “disguised employment,” where an individual works like an employee but uses a limited company (a PSC) to pay less tax. It ensures the correct tax (PAYE/NICs) is paid based on the working relationship’s reality.
How do I know if I am inside or outside IR35?
You are either inside IR35 (taxed like an employee) or outside IR35 (taxed as a genuine business). For large clients, the end client issues a Status Determination Statement (SDS) based on key tests such as Control and Substitution.
How does IR35 work for contractors in the UK?
If your contract is with a medium- or large-sized client, the client determines your IR35 status. If you are inside IR35, the fee-payer must deduct Income Tax and NICs. If you are outside IR35, your PSC handles its own tax affairs.
Does IR35 apply to self-employed sole traders?
No, IR35 only applies to individuals working through an intermediary, such as a limited company. However, IR35 self-employed sole traders are still subject to broader employment status rules.
What does inside IR35 mean for my take-home pay?
Inside IR35 means your take-home pay will be significantly lower than an outside IR35 role, as you are paying employee-level tax (PAYE/NICs) instead of more tax-efficient dividends.
Is it still worth becoming a contractor if roles are inside IR35?
Yes, but you must negotiate a rate uplift to compensate for the tax difference. Contracting still offers higher flexibility and potentially higher long-term gross earnings than many permanent roles.
How do I challenge an IR35 status determination I disagree with?
You must formally challenge the determination using the client’s statutory challenge process, providing clear, reasoned evidence that the working practices point towards an outside IR35 status.
Can I work both inside and outside IR35 in the same tax year?
Yes, you can have a mixed portfolio of engagements, but you must keep meticulous records, as the income streams and tax treatments are separate within your PSC.
Does IR35 apply if I work through an umbrella company?
No, the IR35 tax liability is removed because you become an employee of the umbrella company and pay PAYE/NICs, satisfying the tax requirement.
What are the main IR35 status tests HMRC uses?
The three primary tests are: 1) Control (who dictates how the work is done); 2) Right of Substitution (can you send a genuine replacement); and 3) Mutuality of Obligation (is there an ongoing expectation of work).
When should I speak to an IR35 specialist or accountant?
You should speak to a specialist like Lanop before signing any new contract, if you receive an inside IR35 SDS you disagree with, or if your client is close to the small company thresholds.
