IR35 meaning: off-payroll working explained
The off-payroll working rules, widely known as IR35, generated an estimated £4.2 billion in additional tax revenue between October 2019 and March 2023, and roughly 120,000 workers were affected by the April 2021 reform alone [1]. Behind those figures sits a single principle: a worker who behaves like an employee should pay broadly the same tax as an employee, whatever legal structure sits between them and the business paying for the work.
IR35 matters to three groups: contractors who supply their services through a limited company, the businesses that engage them, and the agencies that sit in the middle. Getting a status decision wrong can move the entire tax and National Insurance liability from the contractor to the engager, so the meaning of the rules is worth understanding precisely.
This article sets out what IR35 actually is, why it exists, who is responsible for deciding whether it applies, and what happens to payroll once a contract is caught by the rules.
Key takeaways
- IR35 makes sure a worker supplying services through an intermediary pays broadly the same Income Tax and National Insurance as a direct employee would [2].
- The rules apply on a contract-by-contract basis, so one worker can have some engagements inside and others outside the rules [2].
- In most cases the client decides the worker's status, but for a small private-sector client the worker's own intermediary decides [2].
- When a contract is inside IR35, the deemed employer deducts PAYE and employee National Insurance and pays employer National Insurance on top [3].
- Student and postgraduate loan repayments are never deducted by the deemed employer for an off-payroll worker [2].
What the off-payroll working rules mean
The off-payroll working rules make sure that a worker, sometimes called a contractor, pays broadly the same Income Tax and National Insurance as an employee would [2]. They apply when a worker provides services to a client through their own intermediary, and would have been an employee if they had been engaged directly [2].
The rules are assessed contract by contract. A worker can hold several engagements at once, some inside the rules and some outside, and each is judged on its own facts [2]. A contract for this purpose can be written, verbal or implied [3].
Why the rules exist
Without IR35, a person could leave a permanent job on a Friday and return to the same desk on a Monday through a limited company, doing identical work while paying materially less tax. The rules close that gap by testing whether the underlying relationship is one of employment [2]. HMRC has stated that, outside the public sector, only around one in ten people who should have been paying tax under the rules were doing so correctly before the reform, which is why the responsibility for deciding status was moved to larger engagers [1].
What a personal service company is
Most off-payroll workers supply their services through a personal service company, usually shortened to PSC. HMRC does not define a PSC in law, but describes it as a limited company that a worker controls and has an interest in, through which the worker provides services [2]. A worker can also provide services through a partnership or another individual, and the rules still apply [2]. Businesses running their own HMRC-recognised payroll software alongside a mix of employees and contractors need to keep the two populations clearly separated, because only one of them flows through ordinary PAYE.
Who decides employment status
The party responsible for deciding whether IR35 applies depends on the client. In the public sector, and for medium or large private-sector clients, the client decides the worker's status and issues a status determination statement, or SDS, explaining the reasons [2]. Where there is a labour supply chain, the client passes the SDS down until it reaches the party immediately above the worker's intermediary, known as the fee-payer [3].
The check employment status for tax (CEST) tool is HMRC's free service for reaching that decision, and HMRC stands by its result provided the information entered is accurate [4]. Agencies of any size carry responsibilities where the rules apply, particularly where the agency is itself the deemed employer [5]. Accountants managing this decision across several client schemes typically rely on a multi-client payroll dashboard to keep determinations, statements and deductions consistent.
The small company exemption
When a worker supplies services to a small client outside the public sector, responsibility flips: the worker's own intermediary decides whether the rules apply [2]. A client is medium or large-sized if it exceeds the Companies Act size thresholds for two consecutive financial years [6]. From 6 April 2025 two of the three thresholds increased, so a company is medium or large-sized where it meets the values in the table below [6].
| Companies Act condition | Threshold for medium or large-sized status |
|---|---|
| Annual turnover | More than £15 million |
| Balance sheet total | More than £7.5 million |
| Average number of employees | More than 50 |
The 50-employee limit was left unchanged when the financial thresholds rose [6]. A transitional provision applies the new thresholds to a previous financial year, which means the earliest tax year the change affects a typical company is 2027 to 2028 [6].
Inside IR35 versus outside IR35
The phrase "inside IR35" means a contract is caught by the rules and must be taxed like employment. "Outside IR35" means the engagement is genuine self-employment and the worker keeps the usual freedom to draw a mix of salary and dividends from their company. The table below sets out the practical difference.
| Feature | Inside IR35 | Outside IR35 |
|---|---|---|
| Tax treatment of fee | PAYE and employee National Insurance deducted at source | Company income, taxed through the company |
| Who deducts tax | The deemed employer [[3]](https://www.gov.uk/guidance/fee-payer-responsibilities-under-the-off-payroll-working-rules) | The worker's own company |
| Employer National Insurance | Paid by the deemed employer on top of the fee [[3]](https://www.gov.uk/guidance/fee-payer-responsibilities-under-the-off-payroll-working-rules) | Not applicable |
| Employment rights from the client | None [[3]](https://www.gov.uk/guidance/fee-payer-responsibilities-under-the-off-payroll-working-rules) | None |
Working through an umbrella company changes the picture again: IR35 is unlikely to apply because the worker is employed by the umbrella and taxed through its payroll [2].
What changes on payroll when IR35 applies
Once a contract is inside the rules, the deemed employer must deduct Income Tax and employee National Insurance from the fee paid to the worker's intermediary, and pay employer National Insurance and the Apprenticeship Levy where relevant [3]. Those deductions are reported to HMRC through Real Time Information, with the off-payroll worker flagged using the dedicated indicator in the Full Payment Submission [3]. Payroll that holds the HMRC Recognised badge submits this automatically and carries the correct indicator, which matters because these workers are reported alongside, but distinctly from, ordinary employees.
Two points catch engagers out. First, Employment Allowance cannot be set against payments to deemed employees [3]. Second, the deemed employer does not deduct student or postgraduate loan repayments; the worker settles those through Self Assessment instead, a point covered in the guide to student loan deductions [2]. Off-payroll workers are also not entitled to statutory payments or automatic pension enrolment from the deemed employer, because their employment sits with their own intermediary [3]. Platforms embedding UK payroll through an HMRC-recognised payroll API can apply the off-payroll indicator programmatically, so the compliance detail is handled without a separate manual process.
Conclusion
IR35 is less a single tax and more a status test with tax consequences. The meaning that matters in practice is this: the label on the contract does not decide the treatment, the reality of the working relationship does, and the party best placed to judge that reality now carries the responsibility for getting it right. For a small engager, that party is the contractor's own company. For everyone larger, it is the client.
The direction of travel is towards clearer determinations and better tooling, with HMRC continuing to refine both its guidance and the CEST service. For any business that engages contractors alongside a conventional workforce, the sensible response is to treat status determination as a standing payroll process, not a one-off decision, and to keep the two worker populations cleanly separated in the payroll system that reports them.
Frequently asked questions
Does IR35 apply to sole traders?
No. IR35 applies where a worker provides services through an intermediary such as a personal service company, a partnership or another individual [2]. A genuine sole trader has no intermediary, so a different employment status test applies to them directly. Businesses engaging sole traders still need to check that the person is genuinely self-employed, but that is a separate question from the off-payroll working rules.
Who is responsible for deciding IR35 status?
For public-sector clients and medium or large private-sector clients, the client decides and issues a status determination statement [2]. For a small client outside the public sector, the worker's own intermediary decides [2]. A client counts as small until it exceeds the Companies Act size thresholds for two consecutive financial years [6].
What does inside IR35 mean for take-home pay?
Inside IR35 means the fee is treated as employment income, so PAYE and employee National Insurance are deducted before the worker's company receives it [3]. This usually reduces net income compared with an outside-IR35 engagement, where the worker draws a mix of salary and dividends. The deemed employer also pays employer National Insurance on top of the fee, which cannot be deducted from the worker [3].
Can HMRC challenge an IR35 status decision?
Yes. Both the worker and a deemed employer who is not the client can challenge a determination they believe is wrong, and the client must respond within 45 days [3]. HMRC can also review determinations, and will stand behind a CEST result only where the information provided was accurate and matched its guidance [4]. Keeping the reasoning and evidence behind each determination on file is the best protection.
