What Is IR35?
IR35 is HMRC’s legislation targeting “disguised employment” — situations where a worker provides services through a limited company (a Personal Service Company, or PSC) but would be an employee if engaged directly.
The principle is straightforward: if you’d be an employee without the intermediary company, you should pay broadly the same tax and National Insurance as an employee.
Inside vs Outside IR35
Your IR35 status determines how your income is taxed:
| Outside IR35 | Inside IR35 | |
|---|---|---|
| Tax treatment | Company receives fees; you extract via salary + dividends | Deemed employment; PAYE + NI at source |
| Who determines status | You (for small clients) | The client (for medium/large organisations) |
| NI liability | Employer NI on salary only; no NI on dividends | Employee NI + employer NI on deemed payment |
| Dividend tax | Available — taxed at 10.75%/35.75%/39.35% | Not available — all taxed as employment income |
| Expenses | Company can claim legitimate business expenses | Limited to 5% flat-rate deduction |
Since April 2021, medium and large private sector clients are responsible for determining your IR35 status and deducting tax accordingly. Small clients leave the determination to you — from 6 April 2026 the Companies Act “small company” thresholds used for this test rose to turnover under £15m and balance sheet under £7.5m (employee count stays under 50; meeting two of the three tests qualifies as small). Because size is judged against a client’s previous financial year, the higher thresholds only start reclassifying clients from small businesses in practice around the 2027-28 tax year.
The Financial Impact
The difference in take-home pay between inside and outside IR35 is substantial. Here’s a comparison for a contractor billing £500/day, working 220 days per year (£110,000 gross):
Outside IR35
| Item | Amount |
|---|---|
| Company revenue | £110,000 |
| Allowable expenses | −£5,000 |
| Salary (optimal: £12,570) | −£12,570 |
| Employer NI on salary (15% above £5,000 secondary threshold) | −£1,136 |
| Company profit | ~£91,295 |
| Corporation tax (marginal relief band, ~22.4% effective on this profit) | −£20,443 |
| Available for dividends | ~£70,851 |
| Dividend tax (£500 at 0%, £37,200 at 10.75%, rest at 35.75%) | −£15,851 |
| Annual take-home | ~£67,571 |
Inside IR35
| Item | Amount |
|---|---|
| Gross deemed payment | £110,000 |
| Less 5% flat-rate deduction | −£5,500 |
| Employer NI (15% above £5,000, grossed down out of the pot) | −£12,978 |
| Deemed payment for PAYE | ~£91,522 |
| Income tax (personal allowance + bands) | −£24,041 |
| Employee NI (8% on £12,570–£50,270, 2% above) | −£3,841 |
| Annual take-home | ~£63,640 |
Outside IR35 keeps a meaningful advantage even after the April 2026 dividend rate rise (basic 8.75% → 10.75%, higher 33.75% → 35.75%) — around £3,931 a year more take-home on a £110,000 contract, because the corporation-tax-then-dividend route still beats PAYE-on-the-full-deemed-payment even with dividends taxed 2pp higher. The gap widens up to around £600/day and then narrows again. Two effects pull against each other: a larger share of company profit clears corporation tax at the marginal-relief rate before dividend tax applies, which favours the outside route, but once salary plus dividends passes £100,000 the Personal Allowance tapers away — costing the outside route its shelter on the director’s salary and pushing dividends into the higher band — while the inside-IR35 deemed salary is climbing through the 40%/45% bands. Above roughly £600/day the taper wins.
At £600/day (£132,000/year)
| Status | Approximate take-home |
|---|---|
| Outside IR35 | ~£77,960 |
| Inside IR35 | ~£72,242 |
| Difference | ~£5,718/year |
At £800/day (£176,000/year)
| Status | Approximate take-home |
|---|---|
| Outside IR35 | ~£92,838 |
| Inside IR35 | ~£89,189 |
| Difference | ~£3,648/year |
How Status Is Determined
Three key factors underpin IR35 status — often called the “holy trinity”:
1. Control
Does the client dictate how, when, and where you do the work? Employees are typically subject to control; genuine contractors have autonomy over their methods and working patterns.
Inside indicators: Fixed hours, mandatory office attendance, client-directed tasks Outside indicators: Flexible schedule, remote working, you decide how to deliver the project
2. Substitution
Could you send a qualified substitute to do the work in your place? A genuine right of substitution — where you can send someone else and the client must accept them — is a strong indicator of self-employment.
Inside indicators: Client expects you personally, no substitution clause Outside indicators: Contractual right to substitute, you’ve actually sent substitutes
3. Mutuality of obligation (MOO)
Is the client obliged to offer work and are you obliged to accept it? In employment, there’s a mutual commitment. Genuine contractors can turn down engagements.
Inside indicators: Rolling contracts, expectation of ongoing work, penalties for declining Outside indicators: Project-based engagements, gaps between contracts, no obligation beyond current scope
HMRC’s CEST Tool
HMRC provides the Check Employment Status for Tax (CEST) tool to help determine IR35 status. While it’s free and HMRC states they’ll stand by the result (if information is accurate), be aware:
- CEST has been criticised for producing inconclusive results in borderline cases
- It doesn’t fully consider mutuality of obligation
- Independent status determination services may provide more nuanced assessments
What to Do If You’re Inside IR35
If your engagement is determined to be inside IR35, you have several options:
- Umbrella company: An umbrella employs you and handles PAYE/NI. Simple but you lose limited company tax benefits.
- Negotiate status: Review your working practices and contract. Changes to control, substitution, or project scope may shift the determination.
- Accept and continue: Some contractors stay inside IR35 through their PSC, accepting the higher tax cost for other benefits (limited liability, professional indemnity through the company).
- Seek alternative clients: Some contractors only take outside-IR35 engagements.
Key Takeaway
IR35 status can cost contractors several thousand pounds a year in additional tax — roughly £5,000 to £6,600 per year at the day rates modelled above — peaking around £700/day rather than rising indefinitely, because the £100,000 Personal Allowance taper starts eating into the outside-IR35 advantage. If you operate through a limited company, understanding your status — and structuring contracts and working practices accordingly — is essential. Don’t rely solely on CEST; consider professional advice for high-value contracts.
Use the IR35 calculator to model your take-home pay inside and outside IR35, and the contractor comparison calculator to compare umbrella, PSC, and permanent options.