IR35 applies when a contractor working through a limited company would be classified as an employee. Getting it wrong means a large tax bill. Here is what you need to know.
IR35 β officially the Intermediaries Legislation β is a set of tax rules that apply when a contractor or freelancer provides services through a limited company (a Personal Service Company or PSC) but would be classed as an employee if they worked directly for the client.
If HMRC determines that IR35 applies to a contract, the contractor pays income tax and National Insurance contributions as though they were an employee β losing the tax advantages of contracting through a limited company.
HMRC assesses IR35 status using three core factors β drawn from case law stretching back to the 1968 Ready Mixed Concrete case:
Does the client control how, when, and where you work? High control indicates employment. A genuine contractor sets their own working methods, chooses their hours, and decides how to deliver the output β the client cares about the result, not the process.
Can you send a qualified substitute to do the work without the client's approval? A genuine right of substitution is a strong indicator of self-employment. The right must be genuine β it must exist in the contract and in practice. A clause that says "with client approval only" is weaker.
Is the client obliged to offer work, and are you obliged to accept it? In a genuine contracting relationship, there is no obligation on either side beyond the current project. If the client expects you to be available and you expect to be offered ongoing work, mutuality of obligation points towards employment.
Medium and large clients must issue a written Status Determination Statement before or at the start of the engagement. The SDS must state whether IR35 applies and give reasons. Contractors can dispute a determination β the client must respond within 45 days.
HMRC's Check Employment Status for Tax (CEST) tool is available online at gov.uk. It produces a result that HMRC will stand by if the information provided is accurate and honest. However, CEST has been criticised for not adequately reflecting mutuality of obligation, and a "cannot determine" result from CEST means the contract needs professional review.
The written contract is not the whole picture β IR35 status depends on working practices in reality, not just what the contract says. However, a contract that contradicts outside-IR35 indicators is damaging. Your contract should:
Where IR35 applies and has not been correctly applied, HMRC can recover the unpaid tax and National Insurance, plus interest and penalties of up to 100% of the unpaid amount. Under the off-payroll rules the fee-payer (often the agency, or the client if there is no agency) is liable; where the client is small, the contractor’s own company is liable.
For private sector engagements with medium or large clients, the client issues a Status Determination Statement. For small clients (under Companies Act thresholds), the contractor determines their own status.
Control: does the client control how, when and where you work? Substitution: can you send a substitute? Mutuality of obligation: are you required to accept work offered? No single test is decisive: HMRC and the courts look at the whole picture of the working relationship.
Your contract should include a substitution clause, confirm you control your working methods, state there is no obligation to offer or accept future work, and reflect financial risk (you fix errors at your own cost).