IR35 Explained

What Is IR35?

IR35 (officially called the Intermediaries Legislation) was introduced in 2000 to stop workers avoiding tax by operating through a limited company when they are effectively employees.¹

If you're a genuine contractor with multiple clients, control over your work, and business risk, you're outside IR35 and can operate tax-efficiently through your company. If you work like an employee but via a limited company, you're inside IR35 and must pay tax as an employee.

Inside vs Outside IR35

Outside IR35 (genuine contractor):

• You pay yourself a small salary (around £12,570/year) plus dividends
• Dividend tax is 8.75% to 39.35%, cheaper than income tax + NI for most people
• Your company pays 19% corporation tax on profits

Inside IR35 (treated as employee):

• Your fee is treated as employment income
• Income tax (20% to 45%) and National Insurance (8% to 2%) are deducted by the client or agency
• You don't get the tax efficiency of dividends
• The client pays employer's National Insurance (13.8%)

Being inside IR35 typically costs 20-25% more in tax compared to outside IR35 for the same gross income.

Who Determines Your IR35 Status?

Since April 2021, the rules changed:²

• Medium and large companies (turnover over £10.2m, or 50+ employees, or assets over £5.1m) must assess your status and issue a Status Determination Statement (SDS)
• Small companies are exempt. You determine your own status.

Most contractors working for large corporates or public sector bodies have their status determined by the client. If the client says you're inside IR35, tax is deducted at source and you have little room to argue unless you challenge the determination.

The Three Key Tests

HMRC uses three tests to decide if you're inside or outside IR35:³

Control

Does the client control what, when, where, and how you work? High control suggests inside IR35.

Substitution

Can you send someone else to do the work? If yes, suggests outside IR35. Most contracts say no.

Mutuality of obligation

Is the client obliged to offer you work and are you obliged to accept? If yes, suggests inside IR35.

Other factors include:

• Do you provide your own equipment?
• Do you have financial risk (e.g. fixing mistakes at your own cost)?
• Can you work for multiple clients at once?
• Are you part of the client's organisation (email address, integration into teams, appraisals)?

HMRC's CEST Tool

HMRC provides the Check Employment Status for Tax (CEST) tool to help clients determine IR35 status.⁴ You answer questions about the working arrangement and CEST gives a determination.

Problems with CEST:

• It gives an inconclusive result in around 15-20% of cases
• It doesn't consider all case law factors
• Clients often use it defensively and mark contractors as inside IR35 to avoid liability

HMRC says it will stand by CEST determinations as long as you answered honestly. But the tool is not legally binding.

What If You Disagree?

If a client determines you're inside IR35 and you think you should be outside, you can:

• Ask the client to reconsider using their Status Disagreement Process (they must have one)
• Provide evidence that you meet the outside IR35 tests
• Walk away from the contract and find a client who will assess you correctly

In practice, many large organisations blanket-assess all contractors as inside IR35 to avoid risk. This has pushed contractors to raise their day rates or switch to permanent roles.

Penalties for Getting It Wrong

If you're caught operating outside IR35 when you should be inside, you'll owe back-taxes, National Insurance, and penalties. HMRC can investigate up to six years of past contracts (or 20 years in cases of deliberate non-compliance).

For contracts with medium and large companies, the client is liable for unpaid tax if they get the determination wrong. This is why many large companies err on the side of caution and assess everyone as inside IR35.