If you’re a contractor, freelancer operating via a limited company (PSC) or business engaging contractors, understanding IR35 and recognising whether IR35 applies to you is essential. Misclassifying employment status can lead to significant tax implications and fines.
What is IR35 and Who Does it Apply To?
IR35 which was introduced in 2000, is a piece of UK legislation designed to assess whether a contractor is genuinely self-employed or essentially working as an employee for a client. There had been a huge increase in employees leaving their permanent job and then returning as a contractor to perform their old role whilst avoiding paying tax and National Insurance at the higher rates. The sole aim of IR35 was to prevent disguised employment through an intermediary such as a ltd company.
- Inside IR35: You are considered an employee for tax purposes. Your income is subject to PAYE (Pay As You Earn) and National Insurance contributions.
- Outside IR35: You are genuinely self-employed and can operate through your limited company or as a freelancer, paying taxes accordingly.
Understanding where you fall can protect you from unexpected tax bills and penalties.
Who is responsible for determining IR35 status?
The responsibility for determining IR35 status now depends on whether you as the contractor/freelancer are working in the private or public sector.
Originally all contractors operating through personal service company’s (PSCs) were responsible for determining their own status. This led to widespread non-compliance with HMRC losing millions in unpaid taxes and National Insurance contributions due to relying heavily on a subjective assessment from the contractor. With the prize being contractors paying less tax and NI this was of course favourable. Many clients opted to also use this approach since they were not legally responsible in determining the status, it meant no penalty risk and they benefitted from a reduction to their own employer costs and administrative burden that would usually come with employing someone.
Regardless of who is legally responsible in determining the status as revealed below contractors should always still check their own status to ensure the status determination is accurate. Misclassification can lead to HMRC investigations, unpaid tax liabilities, and penalties.
- Public Sector
In 2017 the responsibility shifted to clients within the public sector. Should they determine that the contractor were deemed to be inside IR35 they would need to deduct tax and National Insurance appropriately via PAYE. - Private Sector (medium and large businesses)
In 2021 the responsibility shifted again to clients within the private sector, putting the onus on the client rather than the contractor. However only companies who are classed as medium and large as defined by the Companies Act 2006 are subject to these rules. If a contractor is inside IR35, the fee-payer (usually the client or agency) deducts tax and National Insurance before paying the contractor.* A Status Determination Statement is required in writing confirming whether a contractor is inside or outside IR35 for each particular engagement by public sector clients since 2017 and medium/large private sector clients since 2021. It must be provided prior to the contractor starting work and can be challenged by the contractor. It should clearly explain the decision for determining the status, the reasoning behind it, and who made it. - Small Private Companies
If the client qualifies as a small company (based on turnover, balance sheet, and employee count as defined by the Companies Act 2007), the contractor themselves are responsible for determining IR35 status and paying taxes if inside IR35.
Key Factors in Determining IR35 Status
IR35 status is based on multiple factors relating to your working relationship with your client. HMRC considers the following:
- Supervision, Director and Control
The contract between the client must clearly confirm that the contractor is in control of where, when, what and how the services are carried out. If the contract stipulate times and days of work, or requiring them to be in the office then they would fall inside IR35.
It should go without saying but clients should not be telling contractors how complete any services, timescales can be pre-agreed but the contractor must remain completely free to work … Contractors would not need to seek permission or need a sick note to take time off, they would not be involved in any appraisals or disciplinary hearings or told when to take breaks.
In the contract ensure there is a comprehensive scope of works or expected deliverables outlining, what is to be provided, where and potentially how many hours expected to be provided. - Substitution
If a contractor is unable to carry out the work for any reason, the contract should allow them to send a substitute to complete the services. Remember, a limited company itself cannot “get sick,” so having the ability to provide a substitute demonstrates genuine independence and that a personal service is not being offered.
When a contractor can realistically provide a substitute and occasionally does so, this is a strong indicator that the contract may be outside IR35. It’s important that every contract, whether you are a client or a contractor, includes a right of substitution clause.
Conversely, if the client only considers the suitability or skills of a specific individual and no substitute can be offered or accepted—especially if the contract explicitly limits substitution—this usually indicates the contractor is working more like an employee rather than a self-employed service provider. - Mutuality of Obligation (MOO)
Mutuality of obligation is another key factor in determining IR35 status. It refers to the obligation of a client to provide work and the obligation of the sub-contractor to accept it which of course is typical in standard employee-employer relationships.
For genuine contractors operating outside IR35, there should be no expectation of ongoing work or guaranteed assignments. Contractors should be engaged on a contract for services basis only, or working on a specific project or task. Once that project is complete, the contractor may move on or may be offered a new project, but there is no automatic continuation.
A compliant contract should allow the contractor to- Refuse work if they choose,
- Work for other clients, and
- Operate on a project-by-project basis.
If a contract specifies exclusivity, requires the contractor to work a set number of hours per week at a fixed rate, and obliges them to take any work the client provides, this strongly indicates an inside IR35 arrangement.
A contract that is more likely to be deemed outside IR35 would include the following:- Clearly stating that the client has no obligation to offer further project work or work on a regular continuing basis,
- Specify that the contract ends when the project is complete, and any new projects should be agreed under a separate contract.
- Company involvement
Contractors should not become part of the company furniture so to speak. They should not be on organisation charts or wall rotas, on the company website, have business cards or a work email address and they certainly shouldn’t be answerable to anyone whilst performing their obligations.
Even having a security pass to the client’s building, or keys, or knowing the passcodes for different areas can indicate a risk to falling inside ir35. A contractor should be completely independent using his or her own laptop, tools, mobile phone and their own insurance to ensure the separate contractual relationship.
Steps to Take to Confirm Your Status
- Use HMRC’s CEST Tool:
The Check Employment Status for Tax (CEST) tool can give a preliminary indication of your IR35 status. Whilst this is a good starting point, it has been highly criticised in the past. - Review Your Contract:
Ensure any contracts reflect reality, setting the standards and the working practices at the very beginning of any client/contractor relationship is an absolute must. The working practices of the relationship will need to reflect the actual written terms of the contract. Should there be a HMRC investigation and the contract between the parties, bear no resemblance to the actual working practices, the written contract would most likely be ignored by HMRC. However, it is the first thing they will look at. This is another example of why templated documents really do not accurately protect a business agreement and is super important to get your contracts tailored to you. - Seek Professional Advice:
An accountant or legal advisor specialising in contractor IR35 compliance can provide clarity. BEB Contract and Legal Services provide a specialist IR35 contract review service designed to give you more clarity with regard to the IR35 status of your contracts, ensuring compliance and providing you with peace of mind.
Why Getting IR35 Status Right Matters
Understanding and correctly determining your IR35 status is not just a necessary exercise—it can have serious financial, legal, and professional consequences if you get it wrong.
The most immediate risk of misclassifying IR35 status is tax-related. If a contractor is deemed inside IR35, HMRC expects income tax and National Insurance contributions to be paid and backdated as if the contractor were actually an employee. Therefore taxes that were previously minimised through dividends and expenses suddenly become due via PAYE deductions, potentially resulting in tens of thousands of pounds owed.
For businesses hiring contractors, incorrectly treating someone as outside IR35 could result in joint liability for the unpaid taxes if the client should have been responsible under Off-Payroll rules.
IR35 is one of HMRC’s priority areas for compliance enforcement. Errors in classification can trigger audits or investigations, which are time-consuming, stressful, and costly. A correct IR35 assessment provides peace of mind and significantly lowers the risk of disputes with HMRC.
Conclusion
Getting IR35 status right is more than a legal necessity it is a strategic decision that affects tax, finances, reputation, and long-term business viability. Getting it wrong can be costly, stressful, and disruptive, but with careful assessment, transparent contracts, and professional guidance, contractors and clients alike can operate confidently and compliantly.
IR35 compliance is complex, but a structured approach can help you determine your status and act accordingly.