What Is IR35?
IR35 is HMRC’s legislation targeting “disguised employment” — situations where a worker provides services through a limited company (a Personal Service Company, or PSC) but would be an employee if engaged directly.
The principle is straightforward: if you’d be an employee without the intermediary company, you should pay broadly the same tax and National Insurance as an employee.
Inside vs Outside IR35
Your IR35 status determines how your income is taxed:
| Outside IR35 | Inside IR35 | |
|---|---|---|
| Tax treatment | Company receives fees; you extract via salary + dividends | Deemed employment; PAYE + NI at source |
| Who determines status | You (for small clients) | The client (for medium/large organisations) |
| NI liability | Employer NI on salary only; no NI on dividends | Employee NI + employer NI on deemed payment |
| Dividend tax | Available — taxed at 8.75%/33.75%/39.35% | Not available — all taxed as employment income |
| Expenses | Company can claim legitimate business expenses | Limited to 5% flat-rate deduction |
Since April 2021, medium and large private sector clients are responsible for determining your IR35 status and deducting tax accordingly. Small clients (turnover under £10.2m, fewer than 50 employees, balance sheet under £5.1m meeting two of three tests) leave the determination to you.
The Financial Impact
The difference in take-home pay between inside and outside IR35 is substantial. Here’s a comparison for a contractor billing £500/day, working 220 days per year (£110,000 gross):
Outside IR35
| Item | Amount |
|---|---|
| Company revenue | £110,000 |
| Allowable expenses | −£5,000 |
| Salary (optimal: £12,570) | −£12,570 |
| Employer NI on salary | −£1,045 |
| Corporation tax (19% on ~£91,385) | −£17,363 |
| Available for dividends | ~£74,022 |
| Dividend tax (£2,000 at 0%, rest at 33.75%) | −£24,308 |
| Annual take-home | ~£62,284 |
Inside IR35
| Item | Amount |
|---|---|
| Gross deemed payment | £110,000 |
| Less 5% flat-rate deduction | −£5,500 |
| Employer NI (15% above £5,000) | −£14,925 |
| Deemed payment for PAYE | ~£89,575 |
| Income tax (personal allowance + bands) | −£24,615 |
| Employee NI (8% on £12,570–£50,270, 2% above) | −£3,802 |
| Annual take-home | ~£61,158 |
Difference: ~£1,126/year at this rate level. But the gap widens significantly at higher day rates because outside IR35 allows more tax-efficient extraction through dividends.
At £600/day (£132,000/year)
| Status | Approximate take-home |
|---|---|
| Outside IR35 | ~£73,500 |
| Inside IR35 | ~£70,800 |
| Difference | ~£2,700/year |
At £800/day (£176,000/year)
| Status | Approximate take-home |
|---|---|
| Outside IR35 | ~£95,000 |
| Inside IR35 | ~£88,500 |
| Difference | ~£6,500/year |
How Status Is Determined
Three key factors underpin IR35 status — often called the “holy trinity”:
1. Control
Does the client dictate how, when, and where you do the work? Employees are typically subject to control; genuine contractors have autonomy over their methods and working patterns.
Inside indicators: Fixed hours, mandatory office attendance, client-directed tasks Outside indicators: Flexible schedule, remote working, you decide how to deliver the project
2. Substitution
Could you send a qualified substitute to do the work in your place? A genuine right of substitution — where you can send someone else and the client must accept them — is a strong indicator of self-employment.
Inside indicators: Client expects you personally, no substitution clause Outside indicators: Contractual right to substitute, you’ve actually sent substitutes
3. Mutuality of obligation (MOO)
Is the client obliged to offer work and are you obliged to accept it? In employment, there’s a mutual commitment. Genuine contractors can turn down engagements.
Inside indicators: Rolling contracts, expectation of ongoing work, penalties for declining Outside indicators: Project-based engagements, gaps between contracts, no obligation beyond current scope
HMRC’s CEST Tool
HMRC provides the Check Employment Status for Tax (CEST) tool to help determine IR35 status. While it’s free and HMRC states they’ll stand by the result (if information is accurate), be aware:
- CEST has been criticised for producing inconclusive results in borderline cases
- It doesn’t fully consider mutuality of obligation
- Independent status determination services may provide more nuanced assessments
What to Do If You’re Inside IR35
If your engagement is determined to be inside IR35, you have several options:
- Umbrella company: An umbrella employs you and handles PAYE/NI. Simple but you lose limited company tax benefits.
- Negotiate status: Review your working practices and contract. Changes to control, substitution, or project scope may shift the determination.
- Accept and continue: Some contractors stay inside IR35 through their PSC, accepting the higher tax cost for other benefits (limited liability, professional indemnity through the company).
- Seek alternative clients: Some contractors only take outside-IR35 engagements.
Key Takeaway
IR35 status can cost contractors anywhere from £1,000 to £10,000+ per year in additional tax, depending on your day rate. If you operate through a limited company, understanding your status — and structuring contracts and working practices accordingly — is essential. Don’t rely solely on CEST; consider professional advice for high-value contracts.
Use the IR35 calculator to model your take-home pay inside and outside IR35, and the contractor comparison calculator to compare umbrella, PSC, and permanent options.