What is IR35? Off-payroll working rules explained
IR35 was introduced in April 2000 to make sure a worker supplying services through their own company pays broadly the same Income Tax and National Insurance as an employee would [1]. Reforms in 2017 and 2021 then moved the job of deciding status from the worker's company to the organisation engaging them, except where the client is a small business outside the public sector [2].
IR35, more formally the off-payroll working rules, sits at the boundary between self-employment and employment for tax. It targets the "disguised employee": a worker who looks, in practice, like a member of staff but is paid through a personal service company to reduce the tax due [3]. Getting the judgment wrong is expensive, because the unpaid tax, National Insurance and any penalty can fall on the engager.
This guide explains what IR35 does, who is responsible for the status decision, how that status is judged, and what happens to payroll when a worker is found to be inside the rules. It addresses employers, accountants and the contractors they work with, and reflects the position for the 2026-27 tax year.
Key takeaways
- IR35 ensures a contractor working like an employee pays broadly the same Income Tax and National Insurance as an employee [1].
- Since 6 April 2021, medium and large private-sector clients decide a contractor's status and issue a Status Determination Statement [6].
- Small clients outside the public sector are exempt, leaving the decision with the contractor's own company [2].
- Status turns on control, the right of substitution, and mutuality of obligation, tested case by case [1].
- When a worker is inside IR35, the deemed employer deducts PAYE tax and National Insurance from the fee before paying the contractor's company [5].
What IR35 is and the problem it targets
The off-payroll working rules apply where a worker provides services to a client through an intermediary, usually a personal service company, and would have been an employee if engaged directly [1]. Without the rules, the same work could be taxed very differently depending only on whether a limited company sits in the middle [3].
The concept at the centre of IR35 is "deemed employment". If the worker is treated as employed for tax purposes, the engagement is inside IR35, and the fees must be taxed broadly like a salary [1]. The rules apply on a contract-by-contract basis, so a single contractor can hold one engagement inside IR35 and another outside it at the same time [2]. Businesses that engage contractors alongside employees often run both through one HMRC-recognised payroll engine so the deemed-employment deductions sit in the same compliant flow as ordinary pay.
Who decides status, and how the rules shifted
For its first 17 years, IR35 placed the status decision on the contractor's own company. That changed in two stages. From April 2017 the responsibility moved to public-sector clients, and from 6 April 2021 it moved to medium and large clients in the private and voluntary sectors [6].
The shift matters because legal accountability for the decision now rests with the engager, not the worker [5]. A client can take advice, but it cannot pass the responsibility back to the contractor. Accountants advising several engagers on this typically manage the determinations and the resulting payroll through a multi-client payroll platform.
The client's Status Determination Statement
Where the rules apply, the client must decide the worker's employment status for tax and produce a Status Determination Statement, setting out the conclusion and the reasons for it [2]. The statement has to be passed to the worker and to the next party in the contractual chain [5].
The determination cannot be a blanket label applied to every contractor. Each engagement is assessed on its own terms, because the same worker may be inside the rules on one contract and outside on another [1]. A client that fails to take reasonable care over the statement can become liable for the tax itself [3].
The small company exemption
Small clients outside the public sector are exempt from the 2021 reform. Where the exemption applies, responsibility for deciding whether IR35 applies stays with the contractor's own intermediary rather than the engager [2]. The test uses the Companies Act 2006 definition of a small company, where a business must breach no more than one of three thresholds [1].
The thresholds that define a small client for the off-payroll rules are set out below, on the higher figures in force from 6 April 2026.
| Companies Act size test | Small company threshold |
|---|---|
| Annual turnover | Not more than £15 million |
| Balance sheet total | Not more than £7.5 million |
| Average number of employees | Not more than 50 |
A client is small if it meets at least two of the three limits, in which case the contractor keeps the status decision [2]. A small business that runs its own books through SME payroll software still has to keep its own size data current to know when the duty would transfer. Once a client grows past the limits, the responsibility transfers to the engager from the following tax year [6].
Inside or outside IR35: how status is judged
There is no single rule that decides employment status. The determination weighs the whole working relationship against tests developed in case law over decades [1], a theme explored further in this guide to the off-payroll working rules. Three factors carry the most weight.
Control, substitution and mutuality of obligation
Control asks how much say the client has over what the worker does, and how, when and where they do it [3]. The greater the client's control, the more the engagement looks like employment.
The right of substitution asks whether the worker must do the job personally or can send a qualified replacement [1]. A genuine, unfettered right to substitute points strongly towards self-employment. Mutuality of obligation asks whether the client is obliged to offer work and the worker obliged to accept it, which is a hallmark of an employment relationship [3].
The CEST tool and its limits
HMRC publishes a free online tool, Check Employment Status for Tax, to help clients and workers reach a determination [4]. The tool asks a series of questions about the engagement and returns a view on whether the off-payroll rules apply [4].
HMRC stands behind a CEST result provided the answers are accurate and the engagement reflects them [2]. The tool does not always return a determination, however, and where it cannot, the client must reach a reasoned decision from the underlying status tests instead [1].
What happens when a worker is inside IR35
If an engagement is inside the off-payroll rules, the fee-payer, often the client or an agency in the chain, becomes the deemed employer for tax [5]. The fee-payer must deduct Income Tax and employee National Insurance from the payment to the worker's intermediary and account for them to HMRC [1].
The deemed employer's payroll obligations
The deemed employer reports the deemed direct payment through Real Time Information, on a Full Payment Submission, in the same way as ordinary pay [8]. It also pays employer National Insurance at 15% on the relevant earnings above the secondary threshold, a cost that sits with the fee-payer rather than the contractor [9].
This is where IR35 stops being a tax-status question and becomes a payroll task. The deemed employer needs to calculate PAYE, both classes of National Insurance and any apprenticeship levy on these payments, and submit them on time [8]. Platforms that engage contractors at scale usually embed these calculations through a REST API for UK payroll so that deemed payments and salaried pay run through one compliant pipeline. Larger engagers managing many contracts often consolidate this in an enterprise payroll view.
The set-off rule and double taxation
A long-standing flaw in the rules allowed the same income to be taxed twice when an engagement was wrongly assessed as outside IR35: the deemed employer paid the PAYE liability on assessment, while the worker had already paid tax through their own company [7]. From 6 April 2024, a set-off rule lets HMRC offset tax and National Insurance already paid by the worker or intermediary against the deemed employer's liability [7].
The change reduces, but does not eliminate, the deemed employer's exposure, and a set-off is not guaranteed in every case [7]. It reinforces the value of getting the status determination right at the outset, since the cleanest way to avoid a liability is an accurate decision supported by clear evidence [2].
Conclusion
IR35 is less a single tax than a test of substance over form. It asks whether a contractor, stripped of the company in the middle, would be an employee, and taxes the engagement accordingly. The 2021 reform turned that question into a compliance duty for medium and large engagers, complete with a Status Determination Statement, a small company exemption, and a deemed-employment payroll obligation when a worker is found inside the rules.
For an engager, the practical lesson is that a status decision is the start of a payroll process, not the end of a legal one. An inside-IR35 finding feeds directly into Real Time Information, employer National Insurance and the set-off mechanism, so the determination and the payroll have to work as one system. As more platforms engage flexible workers alongside employees, the businesses that handle IR35 cleanly will be those that treat the status decision and the payroll deduction as two halves of the same compliant flow.
Frequently asked questions
What is the difference between inside and outside IR35?
Inside IR35 means the engagement is treated as employment for tax, so Income Tax and National Insurance are deducted from the fee before the worker's company is paid [1]. Outside IR35 means the worker is genuinely in business on their own account, and their company is paid gross, with the worker handling their own tax [3].
Who is responsible for deciding IR35 status?
For medium and large clients, the engager decides status and issues a Status Determination Statement, a responsibility that cannot be passed to the contractor [5]. Where the client is a small business outside the public sector, the contractor's own intermediary keeps the decision [2].
What counts as a small company for the IR35 exemption?
The exemption uses the Companies Act 2006 size test, under which a client is small if it stays within at least two of three limits: turnover of not more than £15 million, a balance sheet total of not more than £7.5 million, and not more than 50 employees on average, on the figures from 6 April 2026 [1]. A small client outside the public sector is exempt from the 2021 reform [2].
How does an inside-IR35 engagement affect payroll?
The fee-payer becomes the deemed employer and must deduct PAYE tax and employee National Insurance from the payment, then report it through a Full Payment Submission like ordinary pay [5]. The deemed employer also pays employer National Insurance at 15% on the relevant earnings, a cost it cannot recover from the contractor [9].
