If you are thinking of working as a freelancer or a contractor via your own limited company, you need to get a basic understanding of the IR35 rules very quickly.
The tax avoidance debate in the UK often centres on the alleged misdeeds of certain wealthy individuals and large multinational corporations. But away from the national press, there is another tax avoidance battle going on between HMRC and the UK’s professional contractors.
The crux of the argument is a piece of legislation called IR35. IR35 “protects hundreds of millions in tax revenue”, HMRC claims.
However, the UK’s contracting population contends that IR35 is a millstone around their necks, and which puts disproportionately high compliance costs on one-person businesses.
The term “IR35” is now used interchangeably to refer to two sets of rules:
- Chapter 8 of ITEPA 2003 – the original IR35 rules, where the contractor decides their own status
- Chapter 10 – the newer Off-Payroll Working rules, which shift responsibility to the end-client or agency
This overlap can cause confusion, but both regimes aim to determine whether you’re genuinely ‘in business on your own account’ rather than a ‘disguised employee’, and apply PAYE if you’re not.
So, what are the IR35 rules that you need to know about if you are new to contracting?
Contents
- What is IR35?
- Why IR35 matters
- What changed in 2017 and 2021?
- The small company exemption
- Why clients avoid PSCs
- How IR35 status is determined
- What happens if you’re caught by IR35?
- How to protect yourself
- IR35 insurance and contract reviews
- FAQs
What is IR35?
IR35, also known as the intermediaries legislation, is a set of tax rules introduced in April 2000 to target disguised employment. This is where individuals supply their services through a limited company, but in practice work like regular employees.
HMRC believes this can lead to lower tax and National Insurance liabilities, and created IR35 to close the gap. If you were considered to be an employee without your limited company in place, you may be caught by IR35.
In tax law, IR35 technically refers to Chapter 8 of the Income Tax (Earnings and Pensions) Act 2003. The more recent Off-Payroll Rules, now codified in Chapter 10, apply in parallel, but only change who is responsible for determining the IR35 status. In both cases, the core question remains the same: would you be an employee if the limited company didn’t exist?
Why IR35 matters
If your contract is found to be inside IR35, you lose the tax advantages of working through a company. You will pay full PAYE taxes, including employer and employee NICs, and cannot use dividends or claim many business expenses.
If HMRC decides that you have incorrectly assessed your status, it can demand years of backdated tax, interest, and penalties. In short, IR35 affects your take-home pay, audit risk and flexibility.
What changed in 2017 and 2021? (The Off Payroll Rules)
Before 2017, contractors were responsible for determining their own IR35 status. But HMRC believed too many were wrongly declaring themselves outside IR35. As a result, the government introduced new off-payroll working rules.
- From April 2017, public sector clients became responsible for determining IR35 status.
- From April 2021, these rules extended to medium and large private sector organisations.
Under these rules, the client must provide a Status Determination Statement (SDS) to explain whether a contract falls within or outside IR35.
If the client gets it wrong, they or the agency that pays you could be liable for the tax. These rules are explained in detail on GOV.UK.
The small company exemption
If you contract for a small private sector client, the off-payroll rules don’t apply. You remain responsible for assessing your own IR35 status. A company is considered small if it meets at least two of the following:
- Annual turnover under £10.2 million
- Balance sheet total under £5.1 million
- Fewer than 50 employees
This exemption is outlined in the Companies Act 2006 and confirmed by HMRC guidance. Clients must verify their size in writing if asked.
Why clients avoid PSCs
Since the off-payroll reforms, many clients now avoid hiring limited company contractors altogether. This is especially common in finance, healthcare, and government sectors. Why? Because the risks of getting IR35 wrong are high.
If HMRC finds a client has made incorrect determinations, they can be held liable for unpaid tax and NICs. To avoid this, many businesses have adopted blanket approaches:
- Refusing to work with PSCs at all
- Deeming all contracts inside IR35 regardless of individual circumstances
- Only engaging workers via umbrella companies
This is one of the most significant impacts of the IR35 reform. It’s not about you, but about how clients manage their tax exposure. If you’re pushed into an umbrella role, it’s usually to shift PAYE responsibility to a third party.
How IR35 status is determined
IR35 status is based on how you work in practice, not just what’s written in your contract. Key factors include:
- Mutuality of Obligation – Is the client obliged to offer work, and are you obliged to accept it?
- Right of Substitution – Can you send someone else to do the work?
- Control – Who decides how, when and where you work?
Other indicators include whether you provide your own equipment, take financial risk, or work with multiple clients.
These are derived from case law such as Ready Mixed Concrete (1968) and HMRC’s interpretation on CEST, although that tool has been criticised by experts.
What happens if you’re caught by IR35?
If a contract is inside IR35, the fee-payer must deduct tax and NICs at source. You cannot take income as dividends, and travel or subsistence expenses may not be claimable. If you incorrectly operated outside IR35, HMRC can pursue:
- PAYE and NICs on income earned
- Late payment interest
- Penalties for careless or deliberate non-compliance
This applies even if the contract ended years ago. HMRC can go back up to six years — or more if fraud is suspected.
How to protect yourself
There’s no guaranteed way to stay outside IR35, but you can strengthen your position:
- Get your contracts professionally reviewed
- Ensure your working practices reflect your contract
- Avoid employee-like behaviour or client control
- Use business insurance and your own equipment
- Document any use of substitute workers
If your client provides an SDS, you can dispute it if you believe it’s incorrect. They are legally required to consider your objection and respond.
IR35 insurance and contract reviews
Several specialist providers offer IR35 reviews and insurance. This can give you peace of mind and financial protection in case of an HMRC enquiry. Common options include:
- Investigation-only cover – covers legal fees for defence
- Tax liability cover – includes backdated tax and NICs
Qdos Contractor is one of the leading providers. Their policies cover both individual contractors and agencies, and they also offer SDS tools and support for appeals.
Frequently asked questions
Does IR35 apply if I only have one client?
Having one client doesn’t automatically place you inside IR35, but it raises the risk. HMRC will also consider other factors, such as substitution and control.
Can a client refuse to work with my limited company?
Yes. Many clients now insist on using umbrella companies to avoid the risk of being liable for incorrect status determinations.
What if I disagree with a client’s SDS?
You can raise a formal dispute. The client must respond within 45 days, providing an explanation for their decision or indicating a change.
What’s the difference between inside and outside IR35?
Inside means your contract is treated as employment for tax purposes. Being outside means you’re operating as a genuine business and can draw income through dividends and claim expenses.
Am I safe if I use IR35 insurance?
Insurance can protect you financially if you’re challenged, but it doesn’t make you exempt. You still need strong contracts and working practices.
Do I need to get every contract reviewed for IR35?
Ideally, yes. IR35 status is assessed on a contract-by-contract basis. Just because one engagement is outside IR35 doesn’t mean the next one will be — even if it’s with the same client.
Can I switch from umbrella to limited company mid-contract?
Not usually. Most clients won’t allow a mid-assignment switch, especially under the off-payroll rules. You can change structure between contracts, but not halfway through one.
Is it easier to stay outside IR35 if I work remotely?
Not necessarily. Working from home might give you more control over how you do your job, but it won’t override other factors like substitution or mutuality of obligation.
Can I ask the client why they’ve put me inside IR35?
Absolutely. Clients must give you reasons in the SDS. You can also formally challenge the determination, and they’re required by law to respond within 45 days.
What if the client never gives me a Status Determination Statement?
That’s a breach of the off-payroll rules. If your client is a medium or large organisation, they’re legally required to issue one before the contract begins. If they don’t, they may become liable for the tax.
Can I just stop using my company and go self-employed?
It’s possible, but risky. If the client treats you like an employee, working as a sole trader won’t protect you from HMRC scrutiny, and it removes your liability shield. Also, it’s very unusual to provide professional services as a sole trader. Almost all clients want an intermediary in place – either a limited or umbrella company.