YF AccountingLast updated: 23 July 2026
8 min read
IR35 — officially the off-payroll working rules — is tax legislation that decides whether a contractor working through their own limited company is, in substance, an employee of their client. If you are inside IR35, your contract income is taxed like a salary, with PAYE and National Insurance deducted. If you are outside IR35, your company is taxed as a genuine business. The difference is worth thousands of pounds a year, which is precisely why HMRC cares — and why you should too.
What is IR35?
IR35 is HMRC’s unimaginative, scary-sounding name (it comes from the 1999 press release number) for rules targeting “disguised employment”: arrangements where someone works through an intermediary — usually their own limited company — on an engagement that would be plain employment in any other circumstance, largely because the tax outcome is better for everyone except HMRC.
The rules do not ask what your contract calls you. They ask what the working relationship actually looks like. A genuinely independent business selling services can be outside IR35; a permanent employee in all but name cannot, however carefully the paperwork is drafted.
Who decides my IR35 status?
Since April 2021, it depends on the size of your end client:
- Public sector, and medium or large private clients: the client decides your status and must give you a Status Determination Statement (SDS) with reasons. If you are inside, the fee-payer deducts tax and NI before paying your company.
- Small private clients: the responsibility stays with you and your company — the original IR35 rules apply, and you carry the risk of getting it wrong.
A client is “small” if it meets two of three thresholds — and those thresholds rose in April 2025:
| Test | Before April 2025 | From April 2025 |
|---|---|---|
| Annual turnover | £10.2m or less | £15m or less |
| Balance sheet total | £5.1m or less | £7.5m or less |
| Employees | 50 or fewer | 50 or fewer |
This matters more than it looks: thousands of clients will reclassify as “small”, handing the status decision (and the risk) back to their contractors. Because company size is tested against past financial years, the change feeds through with a lag — in practice, most contractors will not see engagements move back to the old rules until around April 2027. If your client is near the thresholds, ask them where they stand.
Am I inside or outside IR35?
Status turns on a picture built from case law, but three factors carry most of the weight:
- Supervision, direction and control — how much say the client has over how, when and where you work. Set hours and close management point to employment.
- Substitution — could you send a suitably qualified replacement to do the work, at your cost? A genuine right of substitution is strong evidence you are outside; a personal-service-only arrangement points inside.
- Mutuality of obligation (MOO) — is the client obliged to offer work, and are you obliged to accept it? An ongoing expectation of work flowing both ways looks like employment.
HMRC and the courts also weigh the supporting cast: whether you use your own equipment, carry financial risk (fixing errors at your own cost, professional indemnity insurance), get paid per project rather than per hour, work for multiple clients, and whether you are “part and parcel” of the client’s organisation — a company email address, people reporting to you, an invite to the Christmas party. None is decisive alone; together they paint the picture.
What is the tax difference between inside and outside IR35?
Here is a realistic 2026/27 comparison for a contractor billing £400 a day, 220 days a year — £88,000 in fees:
| Outside IR35 (own Ltd) | Inside IR35 (umbrella) | |
|---|---|---|
| Contract income | £88,000 | £88,000 |
| How it is taxed | £12,570 salary + dividends after 19–25% corporation tax | Employer NI comes off the assignment rate, then PAYE on the rest |
| Approximate take-home | £59,500 | £55,300 |
Assumptions: minimal expenses, no pension contributions, all profit extracted, and the umbrella figure ignores the margin and apprenticeship levy — so the real inside figure is slightly lower. The gap here is roughly £4,000–£5,000 a year. Worth having, but notably narrower than it used to be: the dividend tax rises of 6 April 2026 (basic rate up to 10.75%, higher to 35.75%) took a bite out of the outside-IR35 advantage. The full extraction maths is in my salary vs dividends guide.
One thing outside-IR35 contractors should remember: the gap widens significantly with pension contributions, expenses and flexible profit extraction — the table above is close to the worst case for the limited company.
What is CEST and should I rely on it?
HMRC’s free Check Employment Status for Tax (CEST) tool asks questions about the engagement and gives a determination. HMRC says it will stand by a CEST result — provided the answers were accurate and the arrangement does not change. Use it as a starting point and keep a copy of the output, but treat a borderline result with caution: CEST has a well-earned reputation for returning “unable to determine” exactly when you need it most. For anything marginal or high-value, get a professional review of the contract and the actual working practices.
Umbrella company vs your own limited company
If a contract is inside IR35, running it through your own company loses most of its point — the income is taxed as employment either way. Most inside-IR35 contractors therefore use an umbrella company: the umbrella employs you, runs PAYE, and you get employment rights such as holiday pay and a workplace pension. Check your assignment rate properly — employer’s NI and holiday pay come out of the rate the agency quotes, and that should be transparent, not a surprise on your first payslip.
Keeping your limited company alongside umbrella work can still make sense if you have a mix of inside and outside contracts, or expect to return to outside work. That is a conversation worth having before you close anything down — my contractor accountant service deals with exactly this.
What changed for umbrella companies in April 2026?
From 6 April 2026, new joint and several liability (JSL) rules came into force for the umbrella market. If an umbrella company fails to pay the PAYE and NI it deducted, HMRC can now recover the full amount from the recruitment agency in the supply chain — and where there is no agency, from the end client. There is no “reasonable care” defence: the liability sticks even if the agency did its checks.
Contractors are not directly liable under JSL, but you are not unaffected. The rules were designed to kill off dodgy umbrellas — the ones promoting 85% take-home schemes — and agencies are now aggressively pruning their approved umbrella lists. Expect to be moved to a compliant (and possibly less generous-looking) umbrella, and treat any umbrella promising unusually high returns as the liability magnet it now is. If your umbrella fails, you face missed payments and retrospective tidying-up even without a personal tax bill.
What should I do practically?
- Get a status view on every engagement — from your client’s SDS, CEST, or a professional review — and keep the evidence.
- If you are outside, make sure the contract and the day-to-day reality support it: real substitution rights, your own equipment, project-based deliverables, multiple clients where possible.
- If you are inside, use a reputable, accredited umbrella and scrutinise the first payslip.
- If your client is near the new small-company thresholds, ask now — the decision (and risk) may be coming back to you from 2027.
- If HMRC opens an enquiry, take advice before responding. Inside determinations mean back taxes, NI and interest — the numbers get big quickly.
Frequently asked questions
What does inside IR35 mean?
Inside IR35 means your engagement is, for tax purposes, treated as employment. Income tax and National Insurance are deducted from your fees through PAYE — by the fee-payer or an umbrella company — rather than your company receiving gross income and paying corporation tax. You are taxed like an employee, though without automatically gaining employment rights from the end client.
Am I inside or outside IR35?
It depends on the reality of the engagement, not the label. Broadly: if the client controls how and when you work, you must do the work personally, and there is an ongoing obligation to offer and accept work, you are likely inside. If you control your work, could send a substitute, carry financial risk and operate as a genuine business, you are likely outside. CEST or a professional review will give you a defensible answer.
Does IR35 apply to sole traders?
No. IR35 only applies where there is an intermediary — usually a limited company — between the worker and the client. Sole traders are covered by ordinary employment status rules instead, where the risk of misclassification sits mainly with the engager. The status tests (control, substitution, mutuality) are essentially the same; the legislation and who carries the liability differ.
Can I still use my limited company if I am inside IR35?
Yes, but there is usually little advantage: the fee-payer deducts tax and NI before paying your company, so the money arrives already taxed. Most inside-IR35 contractors switch to an umbrella for simplicity and employment rights. Keeping the company can still be worthwhile if you have outside-IR35 contracts too, or plan to return to them.
Who pays the tax if HMRC decides I was inside IR35?
It depends who was responsible for the status decision. Where a medium or large client made the determination, the liability generally sits in the supply chain. Where your client was small and the decision was yours, HMRC pursues your company for the income tax and NI that should have been paid, plus interest — and potentially penalties if reasonable care was not taken.
Did IR35 change in April 2026?
The status rules themselves did not change, but the surrounding landscape did. From 6 April 2026, recruitment agencies became jointly and severally liable for PAYE that a non-compliant umbrella company fails to pay, and the higher small-company thresholds set in April 2025 (£15m turnover, £7.5m balance sheet) are working their way through, shifting status responsibility back to contractors at newly “small” clients from around 2027.
Need a hand with IR35?
I act for contractors on both sides of the IR35 line — status reviews, limited company accounts, and the umbrella-or-Ltd decision. Fixed fees with no hourly billing: sole traders from £35 a month, limited companies from £50 a month, and you deal with me throughout. My limited company accounting guide is a good place to start if you are weighing up the structure.
Get in touch or call 0161 531 0959 for a free, no-obligation chat about your contract.
This article is general information, not personal tax advice. Figures and rules correct at July 2026.
Founder of YF Accounting — a fixed-fee, fully digital accountancy practice in Manchester serving SMEs, sole traders and landlords across the UK. One point of contact, unlimited support, no surprise bills.
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