The IR35 legislation has long been a complex and often misunderstood part of UK tax law. Whether you’re a self-employed contractor, a limited company director, or a business that hires off-payroll workers, understanding IR35 is crucial for staying compliant and avoiding unexpected tax liabilities.
In this post, we explain what IR35 is, who it applies to, how employment status is determined, and what steps both contractors and employers should take to stay on the right side of the rules in the 2025/26 tax year.
What Is IR35?
IR35 formally known as the Intermediaries Legislation is a set of tax rules designed to prevent disguised employment. It aims to identify individuals who supply services to clients through an intermediary (such as a limited company) but who would be considered employees if the intermediary wasn’t used.
Introduced in 2000, IR35 ensures that these workers pay broadly the same Income Tax and National Insurance as employees.
The legislation is enforced by HMRC and applies across both the public and private sectors.
Why IR35 Matters
IR35 officially known as the off-payroll working rules exists to stop disguised employment. HMRC estimates that non-compliance with IR35 costs the Treasury hundreds of millions of pounds in lost tax revenue every year.
When contractors work like employees in practice but invoice through a limited company (known as a personal service company, or PSC), HMRC can treat them as inside IR35. This means they should pay broadly the same Income Tax and National Insurance (NICs) as regular employees.
For businesses, recruitment agencies, and contractors alike, misunderstanding or ignoring IR35 can be costly. If HMRC decides IR35 applies, it can lead to:
- Backdated Income Tax and NICs for up to six years, depending on the situation
- Additional penalties and interest charges on top of the unpaid tax
- Reputational damage both for the contractor and the end client or agency
- Lost contracts or reduced earnings if clients avoid using contractors altogether due to perceived risks
Understanding whether IR35 applies and what to do if it does is vital.
IR35 applies to anyone working through an intermediary usually a personal service company (PSC) who would otherwise be an employee if that intermediary didn’t exist.
In practice, IR35 can apply to:
- Contractors and freelancers who operate through their own limited company or PSC.
- Clients (end-users) who hire workers through intermediaries, such as PSCs.
- Agencies and recruiters who supply contractors to end clients.
Key point: The rules are different depending on the size of the end client and whether they are in the public or private sector.
- Public sector and medium or large private sector clients must decide whether IR35 applies to each contract. If it does, they must deduct Income Tax and NICs at source just like for employees.
- If the client is a small private company, the responsibility for deciding IR35 status and paying any tax remains with the contractor’s PSC.
Tip: Many contractors wrongly assume IR35 doesn’t apply if they’re hired through an agency but if the working relationship is really one of employment, the rules still apply.
For full details on how IR35 applies in different sectors and who is responsible for tax, see GOV.UK: Off-payroll working rules.
Key Rule: Employment Status
At the core of IR35 is one simple but crucial question:
“Would this contractor be an employee if they were working directly for the client without their limited company or intermediary in place?”
If the answer is yes, then the contract is inside IR35. This means employment taxes income Tax and National Insurance must be paid as if the worker were directly employed.
If the answer is no, then the contract is outside IR35. The contractor can be paid gross and retain the tax benefits of working through their own limited company, such as drawing dividends and claiming business expenses.
Key point: HMRC will look beyond your contract and assess the actual working relationship. A contract that looks “outside IR35” on paper may be deemed “inside” if, in practice, you work under similar terms to an employee.
Inside vs Outside IR35: What’s the Difference?
Understanding the difference between inside IR35 and outside IR35 is essential for any contractor, agency, or client working with off-payroll labour.
Here’s how it breaks down:
| Status | Description | Tax Implication |
| Inside IR35 | The contractor is deemed to be working as an employee for tax purposes. | Income Tax and National Insurance are deducted at source by the client or fee-payer, just like for a normal employee. |
| Outside IR35 | The contractor is genuinely self-employed, running their own business and taking on business risk. | The contractor is paid gross and manages their own tax through Self Assessment, keeping tax efficiencies like dividends and allowable expenses. |
Key point: If you’re inside IR35, you can’t simply pay yourself in dividends to reduce your tax the tax treatment should mirror employment.
For contractors, this can mean a significant reduction in take-home pay if your contract is found to be inside IR35.
For more details, see GOV.UK: Off-payroll working (IR35).
Who Determines IR35 Status?
Since 6 April 2021, the rules for deciding IR35 status in the private sector have changed. The responsibility now depends on the size of the client organisation.
- Medium and large businesses must determine whether a contract is inside or outside IR35 and ensure the correct tax is deducted and paid to HMRC.
- Small businesses are exempt from this requirement in these cases, the contractor’s limited company (PSC) remains responsible for assessing IR35 status and paying any tax due.
A business is classed as small if it meets two out of these three conditions:
- Annual turnover of £15million (previously £10.2 million) or less
- Balance sheet total of Up to £7.5 million (previously £5.1 million)
- 50 employees or fewer
This means if you’re a contractor working with a small private company, you remain in charge of your own IR35 compliance just as you did before the rules changed.
