What is IR35?
IR35 is UK tax legislation that targets disguised employment — situations where a contractor works through their own limited company but, in reality, is working like an employee of the company they contract for.
The name comes from the Inland Revenue press release that announced it: IR35, published in 1999. It came into force in April 2000 and has been controversial ever since.
The legislation exists because working through a limited company is more tax-efficient than being an employee. A contractor outside IR35 can pay themselves a low salary and take the rest of their income as dividends — dividends aren't subject to National Insurance and are taxed at lower rates than salary. HMRC estimated this was costing billions of pounds a year in lost tax, which is why IR35 was introduced.
If you work through your own limited company but you're effectively an employee of your client, HMRC wants you to pay the same income tax and National Insurance as an actual employee.
Inside vs Outside IR35: What Does It Mean?
Every contractor who works through a limited company is either inside IR35 or outside IR35 on each contract they hold. It's the single most important factor in how much tax you pay.
Outside IR35
You are genuinely in business for yourself. You can take the income through your limited company, pay yourself a small salary, and take the rest as dividends. This is significantly more tax-efficient.
Inside IR35
HMRC (or your client) considers you to be a deemed employee. Your contract income must be paid to you subject to income tax and employee's National Insurance — as if you were on the payroll. You also lose employer's NI from your gross rate, which you'd otherwise keep. You still don't get employment rights like holiday pay or sick pay.
Being inside IR35 means you pay employee tax and NI without getting employment benefits. Many contractors inside IR35 effectively earn less than an equivalent permanent employee, once you account for no employer pension contributions, no sick pay, no redundancy rights, and no holiday pay on top of the tax hit.
How Much Does IR35 Cost You?
The take-home pay difference between inside and outside IR35 is substantial — typically £10,000 to £20,000 per year at common contractor day rates, depending on how efficiently your limited company is run.
| Day Rate | Outside IR35 (est. take-home) | Inside IR35 (est. take-home) | Annual Difference |
|---|---|---|---|
| £300/day | ~£43,500 | ~£34,000 | ~£9,500 |
| £400/day | ~£56,500 | ~£43,500 | ~£13,000 |
| £500/day | ~£68,500 | ~£52,500 | ~£16,000 |
| £600/day | ~£79,500 | ~£61,000 | ~£18,500 |
| £700/day | ~£91,000 | ~£68,500 | ~£22,500 |
Estimates based on 220 working days, 2025/26 tax rates, optimal salary/dividend split for outside IR35. Use the IR35 calculator for your exact numbers.
How is IR35 Status Determined?
IR35 status is determined by looking at the real-world working relationship between you and your client — not the wording of your contract alone (though the contract matters). HMRC and the courts use several tests, but three dominate every assessment.
🔄 Substitution
Can you send a substitute to do the work if you're unavailable, without the client's approval? A genuine contractor can. An employee cannot.
Outside if: genuine substitution right exists🎛️ Control
Does the client control how, when, and where you work? Or do they only specify what outcome they want? Employees are controlled; genuine contractors are not.
Outside if: output-based, not hours-based🤝 Mutuality of Obligation
Is the client obliged to offer you work, and are you obliged to accept it? True contractors have no ongoing obligation either way once a contract ends.
Outside if: no obligation after contract ends💼 In Business for Yourself
Do you have multiple clients, bear financial risk, provide your own equipment, and operate with a business-like structure? These support outside IR35.
Outside if: genuine business indicators presentHMRC's Check Employment Status for Tax (CEST) tool returns "undetermined" for around 1 in 5 assessments and completely ignores Mutuality of Obligation — the most-litigated test in IR35 case law. Use CEST as a starting point only. A professional IR35 contract review from a specialist costs £100–£300 and is money well spent. See our guide: Why HMRC's CEST Tool Gets IR35 Wrong →
Who Decides Your IR35 Status?
This is where many contractors get confused. The answer depends on the size of the company you're contracting for.
| Client Type | Who Assesses IR35? | Legal Framework |
|---|---|---|
| Public sector (NHS, councils, government, etc.) | The client (end engager) | Off-payroll working rules (Chapter 10, ITEPA 2003) — since April 2017 |
| Medium or large private sector company | The client (end engager) | Off-payroll working rules (Chapter 10, ITEPA 2003) — since April 2021 |
| Small private sector company | You, the contractor | Original IR35 rules (Chapter 8, ITEPA 2003) |
What counts as a "small" company?
A company qualifies as small if it meets at least two of these three criteria:
- Annual turnover of £10.2 million or less (rising to £15 million from 6 April 2026)
- Balance sheet total of £5.1 million or less (rising to £7.5 million from 6 April 2026)
- Fewer than 50 employees
When contracting for a small company, you are responsible for self-assessing your IR35 status and paying any additional tax owed if you are inside IR35. You can ask your client to confirm their size in writing — they have 45 days to respond under ESM10011A.
From 6 April 2026, the turnover threshold rises from £10.2m to £15m and the balance sheet threshold rises from £5.1m to £7.5m. HMRC estimates around 14,000 companies will reclassify as small — meaning IR35 responsibility reverts back to the contractor for those engagements. This is potentially good news for contractors who are genuinely outside IR35 and have been caught by blanket inside determinations from medium-sized clients. Full guide to the April 2026 changes →
A Brief History of IR35
Understanding how IR35 evolved helps make sense of the current rules.
Does IR35 Apply to Sole Traders?
No. IR35 only applies to contractors who work through an intermediary — most commonly a personal service company (PSC) or limited company. If you are a sole trader, you pay income tax and National Insurance through Self Assessment directly on your profits. There is no intermediary structure for HMRC to challenge, so IR35 is irrelevant to you.
However, sole traders lose the ability to take income as dividends, claim limited company expenses, or benefit from the corporation tax rate on retained profits. Many contractors who are genuinely in business for themselves still prefer the limited company structure for these tax efficiencies — as long as they are outside IR35.
What Should I Do?
Your action checklist depends on your situation:
- Find out whether your client is small, medium or large — ask for written confirmation of their size if in doubt
- If they're medium/large (or public sector), get their Status Determination Statement (SDS) in writing before you start
- Have your contract reviewed by an IR35 specialist — not just HMRC's CEST tool
- Ensure your working practices reflect your contract (don't say "right to substitute" in the contract if you'd never actually use it)
- Consider IR35 insurance (Tax Enquiry and IR35 insurance covers investigation costs and any tax owed)
- IR35 responsibility reverts to you — you will need to self-assess your status for the new tax year
- Your client is no longer legally required to issue an SDS, but it's still good practice to discuss status with them
- If you believe you are outside IR35, get a professional contract review to document your reasoning
- If you've been inside IR35 under their previous determination and genuinely believe you're outside, this is your opportunity — but get the working practices right, not just the contract wording
Use the IR35Guide.co.uk calculator to see exactly what inside vs outside IR35 means for your specific day rate — including the 2026/27 tax year and the April 2026 changes. For a more detailed breakdown, freelanceratecalculator.net shows you what day rate you need to match a permanent salary.