Off-payroll working rules (IR35) explained
The off-payroll working rules apply where a worker supplies services through their own company but would be an employee if they were engaged directly [1]. Since 6 April 2021, the client receiving the services, not the worker, is responsible for deciding employment status in the public sector and in medium or large private-sector organisations [2]. That single shift moved the tax risk from the contractor to the business that hires them.
These rules, commonly called IR35, sit alongside the older intermediaries legislation and turn an employment-status question into a payroll obligation. When the rules apply, the fee payer must deduct Income Tax and National Insurance through PAYE before paying the worker's company [3].
This article sets out who the rules cover, who decides status and how, the small-company exemption, the status determination statement and the disagreement process, the PAYE and National Insurance consequences of getting it wrong, and the penalty position HMRC applies.
Key takeaways
- The client, not the contractor, decides employment status for medium and large private-sector engagements and all public-sector ones.
- A client is small, and therefore exempt, if it fails to exceed at least two of three thresholds: turnover over £15 million, balance sheet over £7.5 million, and more than 50 employees.
- Every determination must be issued as a status determination statement with reasons, and the client has 45 calendar days to answer a disagreement.
- When the rules apply, the fee payer operates PAYE on a deemed direct payment and accounts for employer National Insurance at 15%.
- HMRC will not charge a penalty where the client took reasonable care, but blanket determinations fail that test.
What the off-payroll working rules cover
The rules apply to a worker who provides services to a client through an intermediary, most often their own limited company [1]. The intermediary can also be a partnership or another individual, but the personal service company is the typical structure. The central test is whether the worker would be regarded as an employee of the client for tax if the intermediary were removed from the chain [2].
An engagement that meets that test is described as inside the rules. An engagement that does not is outside the rules, and the worker's company continues to be paid gross [15]. The distinction decides whether PAYE runs on the payment or not, so it carries real financial weight for both parties.
The status tests that decide the outcome
Employment status for tax is not a matter of job title or contract label. HMRC weighs the same factors the courts use, set out across its Employment Status Manual [12]. Three factors carry the most weight.
Mutuality of obligation asks whether the client must offer work and the worker must accept it. Without a minimum of mutual obligation there is no contract of employment at all [13]. Personal service, and specifically the right of substitution, asks whether the worker must do the job themselves or can send a genuine replacement; an unrestricted right to substitute points away from employment [14]. Control asks how far the client directs what is done, and how, when and where.
The following table summarises how each factor typically points.
| Status factor | Points towards employment (inside) | Points towards self-employment (outside) |
|---|---|---|
| Mutuality of obligation | Client must offer work, worker must accept | No obligation to offer or accept further work |
| Personal service | Worker must perform the work personally | Genuine, unrestricted right to send a substitute |
| Control | Client directs how, when and where | Worker decides method and manages own work |
Who decides employment status
For public-sector clients and for medium or large private-sector clients, the client makes the determination [2]. Where the worker supplies a small private-sector client, responsibility stays with the worker's own intermediary, which must apply the older intermediaries legislation to itself [1].
The client is expected to reach its decision using HMRC's Check Employment Status for Tax tool, known as CEST, or by applying the status principles directly [8]. HMRC stands by a CEST result provided the information entered is accurate and matches the actual working arrangements, and it recommends running the tool again whenever the arrangement materially changes [7].
The small-company exemption
A private-sector client is exempt from making determinations if it qualifies as small under the Companies Act 2006 regime. From financial years beginning on or after 6 April 2025, a company is medium or large-sized only if it exceeds at least two of three thresholds across two consecutive financial years [4]. The table below sets out the current figures.
| Threshold | Small company limit | Medium or large if it exceeds |
|---|---|---|
| Annual turnover | £15 million | More than £15 million |
| Balance sheet total | £7.5 million | More than £7.5 million |
| Average employees | 50 | More than 50 |
A client that stays within at least two of these limits is small, and the responsibility for status returns to the worker's company [4]. Because the assessment runs over two consecutive years and includes a transitional provision tied to the last filed accounts, a change in size does not usually take effect for off-payroll purposes until a later tax year [4].
The status determination statement
When the client is responsible, it must give a status determination statement, or SDS, to the worker and to the party it contracts with [5]. A valid SDS states the conclusion, whether the engagement is inside or outside the rules, and gives the reasons for that conclusion [11]. Until the client passes the statement down the chain, it remains the deemed employer and carries the PAYE obligation itself [5].
Reasonable care is a legal requirement, not a courtesy. HMRC expects a client to act as a prudent and reasonable person in its position would, complete a thorough determination and keep records showing how the decision was reached [9]. A blanket determination, applying one outcome to a group of workers on different terms without considering each situation, does not meet the standard [9]. Businesses that run this process across many contractors often rely on HMRC-recognised payroll software to record determinations consistently and hold the audit trail.
The client-led disagreement process
A worker or deemed employer who disputes the outcome can challenge it, and the client must operate a disagreement process. The client has 45 calendar days from receiving the disagreement to consider the representations, keep the tax treatment unchanged while it does so, and respond with its decision [6]. A client that misses the 45-day deadline becomes the deemed employer and takes on the PAYE liability until it responds [6].
What happens when the rules apply
Where an engagement is inside the rules, the fee payer, the party that pays the worker's intermediary, calculates a deemed direct payment and operates PAYE on it [3]. The fee payer deducts the worker's Income Tax and employee National Insurance and also accounts for employer National Insurance and, where relevant, the Apprenticeship Levy on top [3]. Employer National Insurance is charged at 15% for the 2026-27 tax year on earnings above the Secondary Threshold, which changes the true cost of an inside-rules engagement. Accountants and bureaux managing this across a client base often use a payroll bureau platform to keep each engagement compliant.
Deductions run through Real Time Information in the same way as for any employee, so the fee payer reports the deemed payment on a Full Payment Submission. Payroll systems that hold the HMRC Recognised badge submit the FPS automatically and reflect the deemed employment figures without manual workarounds. For platforms that build payroll into their own products, an HMRC-recognised payroll API can run the deemed-payment calculation and the RTI submission as a single call.
The cost of getting a determination wrong
If HMRC finds that an engagement treated as outside the rules was in fact inside them, the deemed employer becomes liable for the unpaid Income Tax and National Insurance [10]. From 6 April 2024, HMRC can set off tax and National Insurance already paid by the worker and their intermediary against that PAYE liability, which reduces the risk of the same income being taxed twice [10]. The set-off applies to deemed direct payments from 6 April 2017 in open and future cases [10].
A penalty is charged only where the inaccuracy resulted from a failure to take reasonable care, and HMRC will not penalise a client that applied the rules carefully but still reached the wrong answer [9]. Contractors working outside the rules keep their obligations under self-assessment, including any student-loan repayments, rather than through the client's payroll [15]. The mechanics of the older intermediaries legislation are covered in more detail in the Moonworkers guide to the personal service company.
Conclusion
The off-payroll working rules turned employment status from a question the contractor answered on their own tax return into a compliance duty the hiring business must discharge on every engagement. The client decides status, issues a reasoned statement, runs a disagreement process to a fixed deadline, and, where the rules bite, operates PAYE on a deemed payment at the same employer National Insurance rate it pays for its own staff.
The direction of travel is towards tighter record-keeping and away from broad-brush decisions. As HMRC continues to test reasonable care and refine the CEST tool, the businesses best placed to stay compliant are those that treat each determination as an individual assessment and keep the evidence to prove it. The related question of what a personal service company is, and how the intermediaries legislation taxes one, is the natural next step for any contractor weighing up how to operate.
Frequently asked questions
Who is responsible for deciding IR35 status, the contractor or the client?
For public-sector clients and for medium or large private-sector clients, the client decides and must issue a status determination statement with reasons [2]. Only where the client is a small private-sector organisation does responsibility stay with the worker's own company [1]. This is the reverse of the position before 6 April 2021, when contractors assessed themselves.
What counts as a small company for the off-payroll working exemption?
A private-sector client is small if it does not exceed at least two of three thresholds: annual turnover of £15 million, a balance sheet total of £7.5 million, and 50 employees [4]. The turnover and balance-sheet limits rose for financial years beginning on or after 6 April 2025, while the 50-employee limit was unchanged. A small client leaves the status decision with the contractor's intermediary.
How long does a client have to respond to an IR35 status disagreement?
A client must respond within 45 calendar days of receiving a disagreement about a status determination [6]. During that period it must consider the worker's representations and keep the tax treatment unchanged. A client that fails to reply in time becomes the deemed employer and takes on the PAYE liability until it does.
Does HMRC always charge a penalty when an IR35 determination is wrong?
No. HMRC will not charge a penalty where the client took reasonable care to apply the rules correctly but still made a mistake [9]. Penalties arise where reasonable care was absent, for example where a client issued blanket determinations without assessing individual circumstances. The unpaid tax and National Insurance remain due regardless of whether a penalty applies.
<!-- image_prompt: Documentary-style wide shot, a UK contractor and a hiring manager reviewing a printed contract across a desk in a converted warehouse office, soft daylight from a north-facing window, late morning, muted earthy palette of warm grey, oak, paper white, central London brick office building visible in the background through a window, off-centre composition with the subjects in the right third, shot on a Leica Q3 at 28mm f/2.8, photojournalism, 35mm film grain, no AI artefacts, no warped hands, no warped text, landscape orientation 16:9. -->
