IR35 in the private sector: the rules explained

Up to 60,000 private and voluntary sector organisations came within the reformed off-payroll working rules when they were extended beyond the public sector on 6 April 2021, and HMRC estimates the reform generated around £1.8 billion in additional tax while affecting roughly 130,000 workers ^[1]. The rules, commonly called IR35, decide whether a contractor working through their own company is treated as an employee for tax ^[2].

This guide explains what IR35 means in the private sector, which clients have to operate the rules, how the small company exemption works after the size thresholds changed, and who is responsible for deducting the tax once a worker is found to be inside the rules.

Key takeaways

• IR35 applies where a contractor working through an intermediary would be an employee if engaged directly by the client ^[2].
• Medium and large private sector clients must determine each worker's status and issue a status determination statement ^[3].
• Small clients are exempt, and responsibility stays with the worker's own intermediary ^[3].
• The size thresholds rose for accounting periods beginning on or after 6 April 2025, moving more clients out of scope ^[4].
• Where a worker is inside the rules, the deemed employer deducts Income Tax and employee National Insurance and pays employer National Insurance to HMRC ^[5].

What IR35 means in the private sector

IR35 was introduced in April 2000 to make sure a worker providing services through their own company pays broadly the same Income Tax and National Insurance as an employee would ^[1]. The rules bite where a worker supplies services to a client through an intermediary, usually a personal service company, and would have been an employee had the engagement been direct ^[2]. A personal service company is not defined in statute, but in practice it is a limited company that the worker controls and holds an interest in ^[2].

The 2021 reform did not change what IR35 is. It changed who applies it. Since 6 April 2021, medium and large clients in the private and voluntary sectors carry the responsibility that previously sat with the worker's own company ^[1]. Clients running large contingent workforces often centralise these engagements on an enterprise payroll so status decisions and deductions sit in one system.

Inside and outside IR35

A worker is inside IR35 when the client determines that, stripped of the intermediary, the working arrangement would be employment for tax ^[2]. An inside determination makes the worker a deemed employee, and PAYE applies to the remuneration for that engagement ^[2]. A worker is outside IR35 when the client determines the engagement would be self-employment, in which case the fee is paid gross to the intermediary and the intermediary handles its own tax ^[2].

The label is not a matter of preference. It follows from the facts of control, personal service and financial risk in the actual working arrangement, and the client must reach the conclusion on those facts rather than on the wording of the contract alone ^[6]. The mechanics of running the check are covered in the guide to the CEST tool for employment status.

Who the rules apply to

Three parties usually sit in a private sector off-payroll chain: the client that receives the work, the worker who performs it, and the intermediary the worker supplies through ^[2]. Where an agency stands between the client and the intermediary, it forms part of the chain too ^[5]. The rules make sure the tax outcome follows the substance of the relationship rather than its legal packaging ^[2].

For the contractor, an inside determination changes how income reaches them but does not by itself make them an employee for wider employment rights ^[7]. The wider background to the regime is set out in the overview of what IR35 means.

Which clients must operate the rules

The single most important question for a private sector business is whether it is large enough to be caught. Only medium and large clients have to operate IR35; small clients are exempt and the duty reverts to the worker's intermediary ^[3].

The small company exemption

If a private sector client qualifies as small, it does not have to determine the employment status of workers it engages through their own intermediaries, and that responsibility stays with the intermediary ^[3]. The test draws on the Companies Act 2006 definition of a small company, applied to the client rather than to the contractor ^[8]. A client that is not small, and to which the simplified test and group rules do not otherwise apply, is treated as medium or large and must operate the rules ^[3].

Accountants often confirm a client's size before advising on any engagement, because the answer decides who carries the compliance duty for every contractor on the books. A multi-client payroll dashboard lets a bureau track that status determination across many clients at once.

The size thresholds from 6 April 2025

For accounting periods beginning on or after 6 April 2025, the thresholds that define a small company rose, moving many more businesses out of the scope of the off-payroll rules ^[4]. A company is small when it meets two or more of the three conditions in the table below ^[4].

Balance sheet total means the aggregate of the amounts shown as assets before deducting liabilities, and the employee figure is the average number employed under contracts of service across the financial year ^[8]. A business that crosses from small to medium takes on the determination duty for the following period, which is why finance teams watch these thresholds as turnover grows.

Wholly overseas clients

The off-payroll rules do not apply where a medium or large non-public sector client is based wholly overseas with no UK connection immediately before the start of the tax year, meaning it is neither UK resident nor has a UK permanent establishment ^[9]. In that situation, the worker's intermediary must consider whether the original intermediaries legislation at Chapter 8 of Part 2 ITEPA 2003 applies instead ^[9].

A UK connection can exist even for an overseas parent. Where the client has a UK office or permanent establishment immediately before the tax year, it is within the scope of the rules despite being based abroad ^[9]. The distinction matters for international groups placing contractors into UK operations ^[8].

The client's obligations

A medium or large client that engages a contractor through an intermediary has two active duties: reach a determination and stand behind it through a dispute process.

The status determination statement

The client must issue a status determination statement, or SDS, to both the worker and the party it contracts with, and it must take reasonable care in reaching the conclusion ^[6]. A valid SDS states the conclusion and the reasons for it, drawn from the employment status principles rather than a bare assertion ^[6]. If the client reaches a conclusion but fails to take reasonable care, the SDS is not valid and the liability for deducting tax and National Insurance rests with the client itself ^[6].

Reasonable care is not discharged by outsourcing the decision. A client that subcontracts the determination or the production of the SDS remains responsible for its accuracy and for passing it down the chain ^[6]. Platforms that embed UK payroll into their own contractor workflows can trigger the resulting deductions through an HMRC-recognised payroll API once a status is set.

The client-led disagreement process

A worker or deemed employer who disagrees with an SDS can challenge it, and the client must operate a disagreement process with a fixed deadline ^[10]. The client has 45 calendar days to consider a valid disagreement and respond, and a valid disagreement must set out the reasons in relation to the employment status indicators ^[10].

The deadline has teeth. A client that fails to respond within 45 calendar days becomes the deemed employer for PAYE purposes and is responsible for any tax, National Insurance and Apprenticeship Levy due until it does respond ^[10]. Keeping the determination, the reasons and the correspondence on file is what evidences reasonable care if HMRC later reviews the engagement ^[6].

Who deducts the tax

Reaching a determination is only half of compliance. Once a worker is inside the rules, someone in the chain has to operate PAYE on the payment to the intermediary.

The fee-payer and deemed employer

The party immediately above the worker's intermediary in the chain is the fee-payer, and where the client passes a valid SDS down the chain, responsibility for deducting tax moves to that fee-payer as deemed employer rather than staying with the client ^[5]. The deemed employer deducts Income Tax and employee National Insurance from the fee, and separately pays employer National Insurance, charged at 15% above the Secondary Threshold from 6 April 2026, together with the Apprenticeship Levy where it applies ^[5][11].

Those deductions are reported through Real Time Information with the off-payroll worker indicator set, which is why the payroll running them must hold the HMRC Recognised badge ^[5]. Businesses that would rather run this in-house move to HMRC-recognised payroll software that applies the indicator automatically.

The deemed direct payment

The amount that the off-payroll rules treat as earnings is the deemed direct payment ^[12]. It is worked out from the value of the payment to the intermediary after removing any VAT, then deducting the direct cost of materials used in providing the services, and any expenses the intermediary met that would have been deductible from taxable earnings had the worker been employed ^[12]. The figure that remains is the deemed direct payment on which the deemed employer operates PAYE ^[12].

The size of that deduction is what makes an inside determination material to a contractor's net income, and the arithmetic is set out in the guide to how an IR35 calculator works. Getting the calculation right, and reporting it correctly, is the point at which a status decision becomes an actual tax payment ^[5].

Conclusion

IR35 in the private sector turns on two questions asked in order: is the client large enough to carry the duty, and if so, would the worker be an employee stripped of the intermediary. The first is answered by the size thresholds, which rose for accounting periods beginning on or after 6 April 2025 and pushed a further tranche of businesses out of scope. The second is answered by the facts of the working arrangement, evidenced in a status determination statement made with reasonable care.

The reform moved the compliance burden onto the businesses that control the engagement, and it attached real consequences to inaction: an invalid SDS or a missed 45-day deadline lands the liability back on the client. The direction of travel across the whole off-payroll regime is the same, responsibility flowing towards whoever sits closest to the money, which makes accurate determination and accurate payroll two halves of the same obligation rather than separate tasks.

Frequently asked questions

Does a small private sector company have to operate IR35?

No. A client that qualifies as small under the Companies Act size test does not have to determine the status of workers it engages through their intermediaries, and that responsibility stays with the worker's own company ^[3]. For accounting periods beginning on or after 6 April 2025 the thresholds rose to turnover of £15 million and a balance sheet total of £7.5 million, so more companies now fall outside the rules ^[4].

What happens if a client does not respond to an IR35 disagreement in time?

A client must respond to a valid status disagreement within 45 calendar days ^[10]. If it fails to do so, it becomes the deemed employer for PAYE purposes and is responsible for the tax, National Insurance and Apprenticeship Levy due until it responds ^[10].

Who pays the tax when a contractor is inside IR35 in the private sector?

The deemed employer, usually the fee-payer immediately above the worker's intermediary, deducts Income Tax and employee National Insurance from the fee and pays employer National Insurance and any Apprenticeship Levy to HMRC ^[5]. The deductions are reported through Real Time Information with the off-payroll worker indicator set ^[5].

Do the off-payroll rules apply to an overseas client?

They do not apply where a medium or large client is based wholly overseas with no UK connection, meaning it is neither UK resident nor has a UK permanent establishment before the tax year begins ^[9]. If the overseas client has a UK office or permanent establishment, it does have a UK connection and is within scope of the rules ^[9].