IR35 Explained: Are Your Contractors Really Contractors?

If your business engages contractors who work through their own limited companies – or if you are a contractor operating that way yourself – IR35 is something you cannot afford to get wrong.

The rules have been around since 2000 but significant changes in 2021 shifted who is responsible for making the assessment. Since then, HMRC has stepped up its enforcement activity and the consequences of getting it wrong can be substantial – backdated tax, National Insurance, interest and penalties, all landing at the door of whoever failed to apply the rules correctly.

Here is what you need to know.

What Is IR35 and Why Does It Exist?

IR35 is the shorthand name for the off-payroll working rules – UK tax legislation designed to tackle what HMRC calls “disguised employment.”

The scenario it targets is this: an individual who, if engaged directly by a business, would clearly be an employee (subject to PAYE, National Insurance, employment rights) instead sets up a limited company and provides their services through that intermediary. By doing so, they can take income as dividends rather than salary, paying significantly less tax and NI in the process.

IR35 aims to level the playing field. If the reality of how someone works looks like employment, HMRC’s position is that it should be taxed like employment, regardless of what structure sits in the middle.

Who Is Responsible for Making the Assessment?

This is where things changed significantly in April 2021.

Before that date, the responsibility for determining IR35 status sat with the contractor’s own limited company. Unsurprisingly, many contractors concluded their own engagements fell outside the rules.

Since April 2021, for medium and large private sector businesses – and for all public sector organisations – the responsibility has shifted to the end client. It is now the business engaging the contractor that must assess whether the rules apply and issue a Status Determination Statement (SDS) setting out its decision.

Small companies remain exempt. If the end client qualifies as small under the Companies Act 2006 – meaning it meets at least two of the conditions: turnover of £10.2 million or less, balance sheet total of £5.1 million or less, and 50 or fewer employees – the assessment responsibility stays with the contractor’s limited company.

For everyone else, the obligation – and the potential liability – sits with you as the engager.

How Is IR35 Status Actually Determined?

There is no single test. IR35 status is assessed by looking at the overall picture of how the engagement actually works in practice, not just what the contract says on paper. The key factors are:

Substitution  Can the contractor genuinely send someone else to do the work in their place, without the client’s approval? A genuine, unrestricted right of substitution is one of the strongest indicators of self-employment. If the client expects that specific person and would not accept a substitute, that points toward employment.

Control Who decides how the work is done, when it is done, and where? The more control the client exercises over the day-to-day working arrangements, the more the engagement resembles employment.

Mutuality of obligation Is the client obliged to keep offering work, and is the contractor obliged to keep accepting it? An ongoing, open-ended arrangement where work is simply expected to continue is a hallmark of employment rather than a series of discrete contracts.

Financial risk Does the contractor bear genuine financial risk? Do they invest in their own equipment, quote for fixed-price projects, or risk not being paid if work is unsatisfactory? True contractors have skin in the game. Those who simply turn up and get paid an hourly rate do not.

Integration Is the contractor genuinely operating as an outside supplier, or are they indistinguishable from the permanent workforce? Do they have a company email address, attend staff meetings, appear on the org chart? The more embedded they are, the more HMRC will view the arrangement as employment.

Each engagement must be assessed individually – what is true for one contractor on one project may not be true for another. HMRC’s Check Employment Status for Tax (CEST) tool can be used to help assess employment status for tax purposes for any engagement, including where IR35 may be relevant. HMRC states that it will stand by the result produced by the tool, provided the information entered is accurate, remains accurate, and the tool is used in accordance with HMRC guidance. You can access the tool here: https://www.gov.uk/guidance/check-employment-status-for-tax

What Happens When IR35 Applies?

If an engagement is assessed as falling inside IR35, the contractor’s fees are subject to PAYE income tax and National Insurance – deducted at source by the fee payer, which is usually the end client or the recruitment agency in the chain.

The contractor’s limited company receives the net amount after deductions and the tax treatment mirrors employment income for that assignment.

The critical point on liability: If the responsible party gets this wrong, HMRC may seek to recover unpaid Income Tax and NICs, together with interest and, in some cases, penalties. If the end client fails to take reasonable care when making the status determination, responsibility for deducting and paying those amounts can rest with the client, even where PAYE would otherwise have been operated by an agency or fee-payer further down the chain. Blanket determinations, such as treating all contractors as inside IR35 without properly considering the facts of each engagement, are unlikely to amount to reasonable care.

Why Getting This Right Matters

HMRC has invested significantly in IR35 compliance activity. High-profile cases – many involving household names – have resulted in substantial settlements and considerable reputational damage.

For businesses, the risk is not just a tax bill. It is the disruption of having to review and renegotiate contractor arrangements, the management time involved in an HMRC investigation, and the potential impact on working relationships with contractors who feel they have been incorrectly assessed.

For contractors, an incorrect inside determination can significantly affect their take-home pay and their ability to operate efficiently through their limited company.

Getting the assessment right (documented carefully, reviewed regularly, and applied consistently) protects everyone involved.

How We Can Help

IR35 assessments require a careful look at the real-world working arrangements, not just the contract wording. We work with both businesses and contractors to review engagements, support status assessments and ensure compliance obligations are being met correctly.

If you are unsure whether your contractor arrangements are properly assessed, or you are a contractor who wants clarity on your own position, get in touch with us today.