What IR35 actually is
IR35 is a set of rules that decide whether a contractor working through their own company is genuinely running a business, or whether they are really like an employee of the client they work for. The concern HMRC has is straightforward. If you would be an employee were it not for the company sitting in the middle, then in HMRC's view you should be taxed broadly like an employee.
When a contract is judged to be inside IR35, the work is taxed broadly like employment, which means income tax and National Insurance apply much as they would for a regular member of staff. When a contract is outside IR35, you are treated as genuinely in business on your own account, and you can pay yourself in the more flexible way that many company directors use, often through a mix of salary and dividends.
The key point is that IR35 status depends on the actual working relationship, not on what the contract says on paper or what either side would prefer. HMRC looks at how the work is really carried out.
Inside versus outside, and what drives the decision
There is no single test that settles IR35. Instead, status depends on the whole picture of how you work. Several factors carry particular weight.
- Control. Does the client direct how, when and where you do the work, or do you decide that yourself? More client control points towards inside.
- Substitution. Could you genuinely send someone else to do the work in your place, or must you do it personally? A real right to substitute points towards outside.
- Mutuality of obligation. Is the client obliged to offer you work and are you obliged to accept it, as an employee would be, or is each engagement separate?
Other clues matter too, such as whether you take financial risk, provide your own equipment, work for several clients, and are part and parcel of the client's organisation. Because so much depends on the facts, two contractors doing similar work can end up with different conclusions. Where the position is finely balanced, it is sensible to take advice rather than guess, and our accountants for contractors deal with these questions regularly.
Who decides status since April 2021
This is where many contractors trip up, because the rules changed and the answer now depends on the size of the client.
Since April 2021, for medium and large clients in the private sector, the client decides the IR35 status, not the contractor. The client must take reasonable care, give you a status determination statement, and the responsibility for getting it right sits with them. The public sector has worked this way for even longer.
For small clients, the position is different. The contractor's own company decides the status and accounts for the tax if the engagement is inside. This is why knowing whether your client is small matters so much. A client is generally considered small where it falls below the relevant thresholds for turnover, balance sheet total and employee numbers.
If your engagement is inside IR35 and you are a small client, the way you draw money from your company changes, and it is worth reading our guide on how directors pay themselves to understand the knock on effects.
The CEST tool
HMRC provides a free online tool called CEST, which stands for Check Employment Status for Tax, to help work out whether an engagement is inside or outside IR35. You answer questions about how the work is carried out, covering control, substitution, equipment and the other factors that matter, and the tool gives an indication of status.
CEST is useful as a starting point and HMRC says it will stand behind the result where the information given is accurate and the tool reaches a clear answer. However, it does not always return a definite outcome, and it is only as good as the facts you feed into it. A determination based on how you wish you worked, rather than how you actually work, is worth very little. Keep a record of the answers and the date you ran it.
A worked example
Priya compares inside and outside
Priya is an IT consultant who bills GBP 500 a day through her own limited company on a contract worth GBP 100,000 over a year. Outside IR35, her company receives the income, pays a modest salary and corporation tax on the profit, and Priya draws the rest as dividends. After tax at company and personal level she keeps a healthy proportion of the fee and has flexibility over timing.
If the same contract is judged inside IR35, the income is taxed broadly like employment. Income tax and National Insurance apply much as they would to an employee earning a similar amount, so the dividend route is largely closed off for that work. The headline fee is the same, but Priya's take home is noticeably lower because employment style taxes bite harder than the salary plus dividend mix she could use outside the rules.
The exact figures depend on Priya's salary level, her other income, expenses and the tax bands that apply, so treat this as an illustration of the direction of travel rather than a precise calculation. The lesson is simple. The same day rate is worth less inside IR35, which is why status, and negotiating a rate that reflects it, matters so much.
Common mistakes
Contractors often go wrong in predictable ways.
- Assuming the contract wording settles it. A well drafted contract helps, but if the day to day reality looks like employment, the paperwork will not save the position.
- Forgetting who decides. With a medium or large client the decision is theirs, and disagreeing with their determination does not change where the tax responsibility sits.
- Running CEST once and never again. If the way you work changes, or you move to a new engagement, the status needs revisiting.
- Ignoring the small client rules. If your client is small, the responsibility comes back to your company, and that is easy to overlook.
What you should do
Start by establishing whether each client is small, or medium and large, because that tells you who is responsible for the decision. Review how you actually work against the control, substitution and mutuality factors, and run CEST keeping a dated record of your answers. If a determination places you inside IR35, factor the lower take home into your rate negotiations and your personal budgeting.
Where the position is genuinely unclear, get it checked rather than hoping for the best. The cost of advice is small against the cost of a status challenge years later. If you would like a clear view of your IR35 position and how to structure your pay around it, start your quote and we will take it from there.
IR35 decides whether a contractor working through their own company is really like an employee for tax, and being inside the rules can change your take home pay significantly.
Frequently asked questions
Does IR35 apply to every contractor?
No. IR35 only applies where you work through an intermediary such as your own limited company and the engagement looks like employment. A genuinely self employed sole trader, or a contractor running a real business with several clients and proper substitution, may sit outside the rules. It always depends on the facts of how you work.
Who decides my IR35 status?
Since April 2021, for medium and large private sector clients the client decides and issues a status determination statement. For small clients, your own company decides and accounts for any tax if the engagement is inside. The public sector has used the client decides approach for longer.
What does being inside IR35 mean for my take home pay?
Inside IR35 the work is taxed broadly like employment, so income tax and National Insurance apply much as they would for an employee. That usually means a lower take home than an equivalent outside engagement, where you can use a mix of salary and dividends. The exact difference depends on your figures.
Can I rely on the CEST tool result?
CEST is a helpful starting point and HMRC will generally stand behind a clear result where the information is accurate. It does not always give a definite answer, and it is only as reliable as the facts you enter. Keep a dated copy of your answers and the outcome.
Can a contract be partly inside and partly outside IR35?
Each engagement is assessed on its own facts, so you can hold one contract that is inside and another that is outside at the same time. A single engagement, though, is judged as a whole, so you cannot split one contract into inside and outside portions.