What Is IR35?
IR35 determines whether a contractor working through their own company is genuinely self-employed or effectively an employee. Major tax implications for both sides.
Key Takeaways
- IR35 determines whether a contractor through a personal service company is genuinely self-employed
- Medium and large businesses are responsible for determining contractor IR35 status since 2021
- If inside IR35, the contractor is taxed as an employee but without employment rights
- The three key tests are: substitution, control, and mutuality of obligation
What IR35 is
IR35 (the off-payroll working rules) determines whether a contractor working through their own limited company (Personal Service Company or PSC) is genuinely self-employed or effectively an employee of the end client. If inside IR35, the contractor must pay income tax and National Insurance as if an employee, losing the tax advantages of a limited company. If outside IR35, they retain the lower effective tax rate of a limited company director.
Who determines IR35 status
Small private sector businesses (fewer than 50 employees, turnover under £10.2 million) — the contractor's PSC makes the determination. Medium and large private sector businesses and all public sector bodies — the end client (the hiring company) is responsible for the determination and must issue a Status Determination Statement (SDS). This reform from April 2021 significantly increased compliance burden on medium and large businesses using contractors.
The three key tests
Status is assessed based on the overall relationship. Control: does the client control when, where, and how work is performed? High control points inside IR35. Substitution: can the contractor send a substitute without the client's approval? If yes, this points strongly outside IR35. Mutuality of obligation: is the client obliged to offer work and the contractor obliged to accept it? An ongoing obligation points inside IR35. No single factor is determinative — all are weighed together.
Compliance for businesses hiring contractors
Medium and large businesses hiring contractors must: take reasonable care in making IR35 status determinations (using HMRC's CEST tool or a specialist employment tax adviser), issue a Status Determination Statement to the contractor and fee-payer, and ensure PAYE operates correctly for any contractor determined to be inside IR35. Failure to take reasonable care can result in HMRC shifting liability for unpaid PAYE and NIC to the end client.
Practical risk management
To reduce IR35 risk: write contracts that reflect genuine self-employment — avoid specifying hours, workplace, and day-to-day methods. Ensure substitution clauses are genuine. Use contracts for defined projects with clear deliverables. Document your status determination process. If in doubt, seek specialist employment tax advice before engaging a contractor on a long-term basis rather than after HMRC begins an inquiry.