IR35 is one of the most misunderstood rules in UK tax. It decides whether a contractor who works through their own limited company should be taxed as an employee — and getting it wrong can mean a large tax bill, plus interest and penalties.
This guide is IR35 explained in plain English: what inside and outside IR35 mean, who decides a contractor’s status and what a Status Determination Statement is.
What Is IR35 and Off-Payroll Working?
IR35 is the name of the tax rules that apply when a worker provides their services through an intermediary — usually their own limited company. The rules ask a simple question: if the worker had been engaged directly by the client, would they have been an employee?
If the answer is yes, the engagement is inside IR35, and tax and National Insurance must be deducted as if the worker were employed. If the answer is no, the engagement is outside IR35, and the contractor’s company is paid gross, with the contractor managing their own tax through salary and dividends. IR35 explained in this way shows why getting the status right matters.
Inside vs Outside IR35 Explained in Plain English
The status decision comes down to how the work is actually done, not what the contract says. The three most important factors are control, substitution and mutuality of obligation — and no single factor decides the outcome, the whole picture counts.
Control
How much control does the client have over what the worker does and how they do it? If the client directs the work day by day, that points towards employment. If the contractor decides how the work is done, that points away from it.
Substitution
Can the contractor send a substitute to do the work? A genuine right to substitute points towards being outside IR35. If only the individual contractor can do the work, that points the other way.
Mutuality of Obligation
Is the client obliged to offer work, and is the worker obliged to accept it? In a genuine contracting arrangement, each assignment is separate. An ongoing obligation points towards employment.
Who Decides the Status?
Who decides depends on the size of the client. Medium and large clients must decide the status of each engagement themselves, and tell the worker and the fee-payer what they decided. Small clients are exempt, so for engagements with a small client, the contractor’s own company remains responsible for deciding whether IR35 applies.
A client is small if it meets two of three conditions: annual turnover of £10.2 million or less, a balance sheet total of £5.1 million or less, and 50 employees or fewer. Contractors choosing between structures should also see this guide to sole trader vs limited company tax.
Status Determination Statements
When a medium or large client decides a contractor’s status, it must issue a Status Determination Statement (SDS). The SDS states the decision — inside or outside IR35 — and the reasons for it, and it must be passed to the worker and to the fee-payer, the organisation that pays the contractor’s company.
The client must take reasonable care when making the decision. A blanket decision covering all contractors is not taking reasonable care — and the tax liability can pass to the client if it gets the decision wrong.
HMRC’s CEST Tool
HMRC provides an online tool called Check Employment Status for Tax (CEST), which asks questions about the engagement and gives an indication of the likely status. Many clients use it as part of their assessment, but it is not a substitute for judgement: it does not cover every factor, and its result is only as good as the answers put into it.
The 45-Day Disagreement Process
If the worker or the fee-payer disagrees with the client’s status decision, they can raise a disagreement. The client must consider it and respond within 45 days, either confirming the original decision with reasons, or changing it and issuing a new Status Determination Statement. IR35 explained: the disagreement process lets you challenge a decision you think is wrong.
Fee-Payer Responsibilities
The fee-payer is the organisation that pays the contractor’s company — usually the client itself, or an agency in the chain. When an engagement is inside IR35, the fee-payer must deduct Income Tax and employee National Insurance, pay employer’s National Insurance on top, and report the payment through payroll. If it fails, the liability can pass up the chain to the client.
Umbrella Companies
Some contractors work through umbrella companies instead of their own limited company. The contractor becomes an employee of the umbrella company, which runs payroll and deducts tax and National Insurance. Umbrella arrangements remove the IR35 decision, but they also remove the flexibility of running your own company, and umbrella fees apply.
Risks of Getting It Wrong
If an engagement is treated as outside IR35 when it should be inside, HMRC can demand the unpaid tax and National Insurance, plus interest and penalties. The bill can cover several years, and the amounts are often large — for clients, a liability on engagements they assessed incorrectly; for contractors, a personal tax bill. Having IR35 explained correctly before an engagement starts is the best protection.
Practical Steps
- Assess each engagement separately. Status depends on the facts of each role.
- Keep the evidence. Save the contract, the SDS, any CEST result and notes of how the work is actually done.
- Review when things change. If the working arrangements change, reassess the status.
- Take advice early. If an engagement is borderline, get professional advice before it starts, not after HMRC enquires.
Frequently Asked Questions
Does IR35 apply to small clients?
For small clients, the contractor’s own company remains responsible for deciding whether IR35 applies — the decision duty falls on medium and large clients. IR35 explained for small clients: the responsibility stays with the contractor’s own company.
What is a Status Determination Statement?
It is the written statement a medium or large client must issue when deciding a contractor’s status, stating whether the engagement is inside or outside IR35 and the reasons, and it must be passed to the worker and the fee-payer.
Can I disagree with a status decision?
Yes. The worker or the fee-payer can raise a disagreement with the client, which must consider it and respond within 45 days, either confirming or changing the decision.
Is working through an umbrella company a way around IR35?
Working through an umbrella company removes the IR35 decision, because the worker is employed by the umbrella. But umbrella fees apply and the flexibility of running your own company is lost, so it is a trade-off rather than a way around the rules.
How We Can Help
IR35 decisions affect how you are paid and how much tax you pay. Financial Accounting Firm helps contractors and businesses assess status, review contracts and set up their affairs correctly — whether you work through your own company or are thinking about hiring an accountant for a UK limited company. If you have just set up a limited company, read our guide to Self Assessment tax return deadlines in the UK. Find out more about our tax and accounting services or contact us for advice. Get IR35 explained by our team before your next engagement starts.
This article is general information only and should not be taken as personal tax or financial advice. Tax rules can change, and your position will depend on your own circumstances.
