IR35 rules are designed to tackle tax avoidance by off‑payroll workers, but getting them wrong can trigger significant tax liabilities, penalties, and legal risks; understanding how IR35 applies to contractors and making accurate status determinations is essential for compliance and protecting the business.
IR35 has changed how contractors and companies work together in the UK, affecting thousands of businesses each year, and staying compliant requires clarity on responsibilities under current legislation. From April 2025, higher small‑company thresholds will move some clients into the small category, with IR35 responsibility reverting to contractors for those engagements from the earliest applicable tax year, so both contractors and hiring companies must know who makes determinations and how to document decisions.
We’ll cover what IR35 is, who makes status determinations, and how key tests (control, substitution, mutuality) apply, plus the April 2025 threshold increases that push some clients into the small category and shift IR35 responsibility back to contractors from the earliest applicable tax year. We’ll also outline practical compliance steps, common mistakes, penalties, and how contractors and hiring companies should document decisions to stay compliant.
What Is IR35?
In simple terms, IR35 is the common name for off-payroll working rules. These tax rules determine whether contractors should pay tax like employees.
The legislation targets “disguised employees” who work through limited companies. IR35 rules were introduced to combat tax avoidance via the use of personal service companies’ but provide services similar to permanent staff.
HMRC introduced these rules to ensure fair taxation. Contractors working inside IR35 pay income tax and National Insurance like employees.
How IR35 Works?
The rules apply when contractors provide services through intermediaries. Most commonly, this means working through a personal service company (PSC).
Three main parties are involved in IR35 assessments:
- The contractor (intermediary)
- The end client (hiring company)
- The fee-payer (often an agency)
The person responsible for determining whether the worker is employed for tax purposes, depends on if the client is large or small under current legislation.
Status Determination Process
Large companies must decide if contractors fall inside or outside IR35. They create a IR35 status determination guide for each engagement.
HMRC expects all businesses engaging off-payroll workers to consider IR35 and introduce comprehensive compliance programmes to avoid penalties.
Small companies are exempt from making these determinations. Contractors working for small companies decide their own IR35 status.
Also Read: Company Secretarial Services UK – Daniels Wolfson & Co
IR35 Changes in 2025-2026
Recent changes have affected how IR35 operates. As of April 6, 2025, additional clarifications and enforcement measures have been introduced to strengthen compliance and improve transparency.
A key update relates to the small company exemption. From this date, two of the thresholds used to determine whether a company remains “small” for IR35 purposes have increased:
- Turnover threshold has risen to more than £15 million (previously £10.2 million).
- Balance sheet total threshold has risen to more than £7.5 million (previously £5.1 million).
- The third criterion – an average of 50 employees – remains unchanged.
Meeting any two of these three conditions reclassifies a business as medium or large, removing the exemption. Conversely, these changes will also reclassify around 14,000 companies as small, shifting IR35 compliance obligations back to contractors by 2026.
Another important development is that contractors now have the right to request confirmation of a client’s size. The client must respond within 45 days of receiving such a request. These changes give contractors more clarity about their working arrangements and allow them to challenge status determinations more effectively through formal processes.
Company Size Classifications
Understanding company size is crucial for IR35 compliance. The rules differ significantly between large and small companies.
Large Company Criteria
As of financial years beginning on or after 6 April 2025 (i.e., for 2025–26 accounts), the size thresholds are:
- Annual turnover exceeds £15.0 million
- Balance sheet total exceeds £7.5 million
- More than 50 employees on average
Previously, a company was considered large if it met two of these conditions:
- Annual turnover exceeds £10.2 million
- Balance sheet total exceeds £5.1 million
- More than 50 employees on average
Small Company Rules
Small companies have fewer IR35 obligations. Contractors working for small companies determine their own employment status.
This creates different compliance requirements depending on client size. Many contractors prefer working with small companies for this reason.
Also Read: Business Advisory & Consultant Services – Daniel Wolfson & Co
IR35 Assessment Factors
Several factors determine whether work falls inside or outside IR35. These tests help establish the true nature of working relationships.
| Factor | Working Inside IR35 | Working Outside IR35 |
|---|---|---|
| Control | Client controls how, when, where work is done | Contractor has autonomy over delivery |
| Substitution | Cannot send substitute | Can send qualified substitute |
| Mutuality of Obligation | Ongoing obligation to provide/accept work | Project-based, no ongoing obligation |
| Financial Risk | No financial risk, guaranteed payment | Bears financial risk, potential for loss |
| Equipment | Client provides all equipment | Uses own equipment and tools |
| Integration | Integral part of client’s business | Separate business providing services |
The Three Key Tests
- Control Test: Examines who decides how work gets completed. High client control suggests employment status.
- Substitution Test: Looks at whether contractors can send replacements. True substitution rights indicate genuine contracting.
- Mutuality of Obligation: Considers ongoing obligations between parties. Continuous work obligations suggest employment relationships.
Responsibilities Under IR35
Different parties have specific obligations under off-payroll working rules. Understanding these responsibilities prevents compliance issues.
Client Responsibilities
Large clients must complete status determinations for each contractor. They need to provide Status Determination Statements within 45 days.
Clients must also maintain proper records of their decisions. Documentation should include reasoning behind each status determination.
They’re responsible for applying appropriate tax treatment. This includes ensuring correct deductions when contractors fall inside IR35.
Contractor Obligations
IR35 rules for contractors are that they must provide accurate information for status assessments. They need to be honest about their working arrangements and circumstances.
When working for small companies, contractors determine their own status. They must assess their arrangements against IR35 tests carefully.
Contractors can challenge incorrect status determinations. They have rights to request reviews and provide additional evidence.
Agency Duties
Agencies acting as fee-payers have specific responsibilities. They must apply correct tax treatment based on client determinations.
Agencies need to operate PAYE when contractors fall inside IR35. This includes deducting income tax and National Insurance contributions.
They must also pass Status Determination Statements to contractors. Clear communication prevents confusion about employment status.
Also Read: Payroll services UK – Daniel Wolfson & Co
IR35 Compliance Flowchart
Start: Are you providing services through an intermediary?
↓ (Yes)
Is the end client a small company?
↓ (No – Large Company)
Client determines IR35 status
↓
Status Determination Statement issued
↓
Inside IR35? → Yes → PAYE applied by fee-payer
↓
Outside IR35→ No → Normal PSC taxation applies
Financial Impact of IR35
IR35 status significantly affects take-home pay. Contractors inside IR35 face higher tax bills due to employment taxation.
Net Income Comparison: Inside vs. Outside
| Annual Contract Value | Outside IR35 (Net) | Inside IR35 (Net) | Difference |
|---|---|---|---|
| £50,000 | £38,250 | £32,400 | −£5,850 |
| £75,000 | £58,125 | £49,050 | −£9,075 |
| £100,000 | £78,000 | £65,700 | −£12,300 |
Figures are approximate and exclude expenses, pension contributions, and other variables
The financial difference motivates many contractors to ensure compliant outside IR35 arrangements. Proper structuring can maintain tax efficiency while meeting legal requirements.
Also Read: Personal Tax Returns Accountant & Self Assessment Tax Return Services
Common IR35 Mistakes
Many contractors and companies make similar errors with IR35 compliance. Understanding these mistakes helps prevent costly problems.
1. Contractor Mistakes
- Poor Contract Terms: Using employment-style contracts that suggest control and integration. Contracts should reflect genuine commercial relationships.
- Lack of Substitution Rights: Failing to include meaningful substitution clauses. These rights must be genuine and exercisable in practice.
- No Financial Risk: Accepting guaranteed payments without business risk. True contractors should face potential losses from poor performance.
2. Client Mistakes
- Inadequate Assessments: Rushing status determinations without proper analysis. Thorough assessments reduce challenge risks and penalty exposure.
- Treating Contractors Like Employees: Managing contractors identically to permanent staff. Different treatment reflects different legal relationships.
- Poor Documentation: Failing to record decision-making processes adequately. Good records support status determinations during HMRC investigations.
Also Read: Limited Company Accounting Services / Bookkeeping Services
HMRC Penalties and Enforcement
HMRC actively enforces IR35 rules through investigations and penalties. 70% of the unpaid tax if the investigation finds you knew you had made a mistake in determining the status as inside IR35 but chose not to act.
The most severe penalties apply to deliberate non-compliance. 100% of the unpaid tax if the investigation finds you actively tried to conceal the employment status of off-payroll workers to underpay tax.
Penalty Structure
| Behaviour | Penalty Rate | Additional Consequences |
|---|---|---|
| Careless error | 0–30% | Interest on unpaid tax |
| Deliberate error | 20–70% | Interest plus penalties |
| Deliberate concealment | 30–100% | Interest, penalties, potential prosecution |
Regular compliance reviews help avoid these penalties. Many companies now use specialist advisers to ensure correct status determinations.
Best Practices for Compliance
Successful IR35 compliance requires systematic approaches from all parties. Following established best practices reduces risks significantly.
How IR35 affects Contractors in the UK?
Review Working Practices: Regularly assess actual working arrangements against contract terms. Ensure behaviour matches contractual intentions.
Maintain Business Substance: Operate as genuine businesses with multiple clients. Single-client arrangements face greater IR35 scrutiny.
Document Business Activities: Keep records of business decisions, client relationships, and commercial activities. Good documentation supports outside IR35 positions.
IR35 Compliance for Companies
Implement Robust Processes: Develop systematic approaches to status determination. Consistent processes improve decision quality and reduce legal risks.
Train Decision Makers: Ensure staff understand IR35 principles and assessment methods. Proper training improves determination accuracy.
Regular Review Cycles: Periodically reassess contractor relationships and status determinations. Circumstances change, requiring updated assessments.
Future of IR35
The off-payroll working rules continue evolving. Government reviews and industry feedback influence future changes.
Recent data from the IPSE IR35 Spotlight 2025 survey highlights the growing impact of IR35 reforms on the UK contracting market. As of 2025, 26% of contractors are not currently working, a notable rise from 21% in 2024. Of those out of work, 56% directly attribute their unemployment to IR35-related changes, up from 50% the previous year.
Additionally, demand for contract work has weakened, with 43% of contractors reporting a decline in available roles following the Autumn Budget. The number of roles offered outside IR35 has also decreased, from 80% in both 2023 and 2024 to just 70% in 2025. Reflecting this trend, 67% of contractors express low confidence in securing outside-IR35 engagements over the coming year. These findings underscore the sustained and intensifying disruption IR35 continues to cause across the freelance and contracting landscape.
Industry bodies continue lobbying for reforms. They argue current rules damage UK competitiveness and reduce flexible working opportunities.
Technology solutions are emerging to help with compliance. Digital tools can streamline status assessments and improve documentation processes.
Getting Professional Help
IR35 complexity often requires professional guidance. Specialist advisers help contractors and companies navigate the rules effectively.
Professional services include status reviews, contract analysis, and compliance audits. Many firms offer IR35 insurance to protect against determination challenges.
Legal and tax advisers provide different perspectives on IR35 arrangements. Combined expertise often produces better compliance outcomes.
Conclusion
IR35 remains a complex but essential consideration for UK contractors and companies. The rules continue evolving, requiring ongoing attention to compliance requirements.
Successful navigation requires understanding assessment factors, maintaining proper documentation, and seeking appropriate professional guidance when needed.
Both contractors and companies benefit from proactive approaches to IR35 compliance. Early attention to these issues prevents costly problems later.
The key to success lies in honest assessment of working relationships. Arrangements should reflect genuine commercial realities rather than artificial structures designed solely for tax purposes.
Frequently Asked Questions
What happens if HMRC disagrees with an IR35 decision?
HMRC can investigate and challenge status determinations. They may impose additional tax, interest, and penalties if they find non-compliance.
Taxpayers can appeal HMRC decisions through established procedures. First-tier and upper-tier tribunals hear IR35 disputes.
Can contractors challenge client status determinations?
Yes, contractors have formal rights to challenge determinations. They can request reviews and provide additional evidence supporting their position.
For example, a request made on 20th February 2025 must be answered by 6th April 2025 (the start of the new tax year) for size confirmation requests.
Do IR35 rules apply to overseas clients?
IR35 rules apply to UK tax residents providing services to UK clients. Overseas arrangements may have different tax implications.
Unless the end client is a small business or based wholly overseas, the contractor is no longer responsible for determining employment status for tax purposes.
How often should IR35 status be reviewed?
Status should be reviewed when circumstances change significantly. This includes new contracts, changed working arrangements, or updated legislation.
Annual reviews are good practice even without changes. Regular assessment helps identify potential compliance issues early.
What documentation is needed for IR35 compliance?
Essential documents include contracts, Status Determination Statements, and records of actual working practices. Email correspondence and project records also support compliance.
Companies should maintain decision-making records and evidence supporting their determinations. Contractors need business records demonstrating commercial operation.
Can umbrella companies help with IR35?
Umbrella companies can provide employment arrangements for contractors inside IR35. They handle PAYE obligations and reduce administrative burden.
However, umbrella arrangements don’t change underlying IR35 status. Contractors still need proper status assessments from end clients.
What’s the difference between IR35 and employment law?
IR35 determines tax treatment, while employment law governs working rights. Someone can be inside IR35 but not an employee for other purposes.
Employment rights like holiday pay and unfair dismissal protection require separate legal analysis. Tax status doesn’t automatically confer employment rights.
How do agencies fit into IR35 arrangements?
Agencies often act as fee-payers responsible for applying correct tax treatment. They must operate PAYE when contractors fall inside IR35.
Agencies need clear processes for handling Status Determination Statements. They should ensure proper tax treatment based on client decisions.
What were the changes in 2017 and 2021?
2017 (public sector): Responsibility for IR35 status moved from the worker to the public sector client, with the upstream payer becoming the “deemed employer” (fee‑payer) responsible for PAYE, employee and employer Class 1 NICs, and the Apprenticeship Levy where the engagement is inside IR35; determinations had to be communicated with reasons and a dispute process, and this applied regardless of organisation size, with the fee‑payer being either the client (direct hire) or the paying agency.
2021 (private/third sector): The same off‑payroll framework extended to medium and large private and third‑sector clients, while a statutory small business exemption kept contractors responsible where the client is “small” under Companies Act tests; wholly overseas clients with no UK connection remained out of scope so contractors retained responsibility, and across both years the pillars remained: client makes and communicates the status determination with a dispute route; the fee‑payer operates PAYE/NICs and the Apprenticeship Levy on inside‑IR35 payments; contractor responsibility persists only where exemptions or out‑of‑scope conditions apply.
What were the changes in 2017 and 2021?
They shift decision- and tax-liability: clients (or the fee‑payer/agency) must assess IR35, issue SDS, and run PAYE for Income Tax, NICs and the Apprenticeship Levy on inside‑IR35 roles—reducing contractor take‑home, adding compliance costs for businesses, and process/liability exposure for agencies.
Misclassification risk and penalties largely move onto clients/fee‑payers, so accurate assessments, clear SDS communication, and dispute handling are critical; contractors face net pay and engagement‑model changes, businesses may adjust rates and workflows, and agencies often act as deemed employers in the chain.
What were the changes in 2022?
In the 23 Sep 2022 mini‑Budget, the government said it would repeal the 2017 and 2021 off‑payroll (IR35) reforms from 6 Apr 2023, putting status decisions back on the worker in all cases.
Less than a month later, on 17 Oct 2022, this repeal was cancelled, so the reforms stayed in force and clients/fee‑payers remain responsible where applicable.
What were the changes in 2023?
There were no rule changes in 2023; the 2022 plan to repeal the 2017/2021 reforms was quickly reversed, so the existing off‑payroll framework stayed in place.
However, the government consulted on a tax “set‑off” so HMRC can credit taxes already paid by the worker when calculating PAYE due from the fee‑payer in non‑compliance cases, aiming to reduce over‑collection; this was expected to proceed, with indications it could apply from 6 April 2024 in defined circumstances.
How the changes affect contractors
What the contractor should do:
If the client is not small or wholly overseas, the client/fee‑payer decides IR35 status; confirm who makes the decision with the client or agency, and if it’s the worker (small or wholly overseas client), assess status as before the reforms and keep evidence.
Prioritise compliance: maintain accurate contracts and working practices, and note HMRC case outcomes vary despite some contractor wins (e.g., Stuart Barnes, Adrian Chiles), so robust documentation and reviews remain essential.
Tax implications:
Inside IR35: treated as an employee for tax; PAYE deducts Income Tax and Class 1 NICs from gross pay; a PSC can still be used but is less tax‑efficient.
Outside IR35: paid gross to the PSC with typical contractor tax efficiencies applying, provided actual working practices match the contract and status assessment.
How does the responsibility of issuing a Status Determination Statement (SDS) affect end clients under IR35?
Responsibilities: End clients must determine IR35 status, issue a Status Determination Statement (SDS) with reasons to the contractor and any agency, and ensure the fee‑payer runs PAYE for Income Tax, NICs, and the Apprenticeship Levy on inside‑IR35 engagements.
Impact on contractor use: Some organisations reduced contractor hiring or shifted to umbrellas due to compliance burden and liability; where contractors are retained, day rates are often uplifted to offset reduced take‑home under inside‑IR35 taxation.
Parul is a dedicated writer and expert in the accounting industry, known for her insightful and well researched content. Her writing covers a wide range of topics, including tax regulations, financial reporting standards, and best practices for compliance. She is committed to producing content that not only informs but also empowers readers to make informed decisions.
