IR35 rules are designed to tackle tax avoidance by off-payroll workers, but for businesses, getting IR35 wrong can lead to significant tax liabilities, penalties, and legal risks. Understanding how IR35 applies to your contractors and making the right status determinations is essential for compliance and protecting your business.
In this article, you’ll get a clear, practical guide to IR35 in employment law, including how the rules work, who they affect, and what steps your business needs to take. If you need expert support assessing your contractor arrangements or reducing your IR35 risk, our employment law solicitors are here to help.
Here we’re explaining:
- What is the aim of IR35 legislation?
- What is the IR35 rule?
- When does IR35 apply?
- What if the contract says that IR35 does not apply?
- Does IR35 apply to sole traders?
- Does IR35 apply to office holders?
- What are the Managed Service Company (MSC) rules?
- What does it mean to be outside IR35?
- IR35 in the private sector
- Are there circumstances when the rules don’t apply?
- What if IR35 does apply?
What is the aim of IR35 legislation?
The IR35 legislation aims to prevent avoidance of income tax and National Insurance Contributions (NICs) using an intermediary between a worker and a client, such as a personal services company (PSC), partnership, or managed service company (MSC), when in reality, it is an employment relationship. This is known as ‘disguised employment’.
The IR35 legislation comprises of the Social Security Contributions (Intermediaries) Regulations 2000 (the Regulations), which deals with NICs and the Income Tax (Earnings and Pensions) Act 2003 (ITEPA), which deals with income tax. This legislation aims to deal with what HMRC sees as tax avoidance by individuals choosing to pay NICs, dividends and corporate tax of partnerships or limited companies, which are significantly lower than employee income tax and NICs, by supplying their services through an intermediary and paying themselves dividends rather than a salary.
Put simply, IR35 is designed to determine whether contractors working usually through a third party to supply services to a client, would in fact be employees of the client, were it not for the existence of the intermediary.
A PSC has historically been the preferred intermediate entity. The structure of a PSC is not defined in law, but it is typically a limited company controlled by the individual worker, who has a majority interest in it, and is usually a director. In practice, a PSC can also be referred to as a ‘contracting company’ or ‘professional services company’.
What is the IR35 rule?
If an individual falls within the IR35 legislation (ie they would have been classed as an employee of the end client but for the use of a PSC), whatever their contract with the client says and whether an individual holds an office with the client, income tax and NICs are due on the fees paid to the individual, as if they were employed by the client. From 6 April 2021, it became the responsibility of the ‘fee payer’ (i.e. person or business paying the PSC, typically the end client) to determine whether the IR35 applies, and account for income tax, NIC’s and the Apprenticeship levy, (which, if relevant, must be accounted for alongside IR35 compliance), to HMRC.
When does IR35 apply?
Whilst for tax purposes, an individual worker can be either employed or self-employed, from an employment law perspective, there are three recognised types of employment status. An individual can be an employee, a worker or genuinely self-employed (which, in short, means that they are engaged in business on their own account). There is a significant overlap between the status tests for taxation purposes and for determining employment rights; they are not entirely the same. For IR35 purposes, if an individual would have been an employee but for the intermediary, then the relationship is sufficient to trigger IR35. We have prepared a separate employer's guide on employment status and self-employed contractors. However, it is important that you understand the following factors when assessing whether your individual worker falls inside the scope of IR35 or outside. It will allow your business to evaluate the relationship between the individual worker and your business. (If you are reading around this subject, your business may be referred to as the client, the end user, or even the fee payer, respectively).
The factors that are considered include (but are not limited to):
- Mutual intention – if both parties clearly state an intention for the relationship to be one of contractor (the individual engaged to carry out the work) and client (your business), this can assist. If this is evidenced in written communication and set out in the contract, this will support the argument. However, your intentions must also be borne out in the reality of the situation.
- Control – what degree of control does your business have over the details of the relationship? How much influence do you have over the contractor’s work? Who dictates what, how, when and where the worker completes the work? The more control your business has over the worker, the more likely the arrangement looks like an employer and employee relationship, and it follows that IR35 is likely to apply. It is the right to control, rather than the actual levels of control exercised, which is key, but clearly, if a great deal of control is being exercised, this will point towards the individual being an employee. Clearly, ‘what’ is to be delivered is something that your business will want to have a say in. You will be contracting the individual because you have a need for something to be done in a certain way. However, for a true contractor/client relationship, this should be collaborative. The mode of working is very important and could be the deciding factor when assessing where the control lies.
So, with this in mind, if the intention is for the relationship to fall outside of IR35, your business may wish to avoid retaining control over the working timetable. Start and finish times, specific days of work, length of breaks, if and when holidays are taken by the worker, and even uniform requirements, should be discussed on a collaborative basis rather than dictated by your business. - Substitution – is personal service of an individual worker required, or is there the right for the worker to send a substitute who does not regularly provide the services for your business, in their place? If there is a clause in the contract between your business and the intermediary allowing for a replacement if the named individual cannot or is unwilling to perform the work, this points towards the worker not being an employee, particularly if your permission is not required. The contract may also allow for the worker to bring a helper to assist (at their expense). The absence of these types of clauses does not automatically mean that there is an employer and employee relationship if the right of substitution has been exercised in practice, and it can be evidence as such. This is just as important
- Mutuality of obligation – in an employer and employee relationship there is a reciprocal obligation for both parties to perform their respective duties. The employer has an obligation to offer work to the employee, and pay them for it, and the employee has an obligation to accept and perform that work. If your business has engaged a truly contracted individual, that individual is not obliged to make their services available, and the client is not obliged to provide ongoing work.
Notice periods can often suggest that there might be mutuality of obligation between the parties. Typically, in a contractor engagement, both the individual and the client have the right to terminate the relationship at short notice. If there is a longer notice period, this is more likely to point towards an employer-employee relationship. Equally, an open-ended relationship is more likely to point to an employer/employee relationship than a shorter fixed term might do. - Financial risk and reward – if a worker is an employee, they have no financial risk because the employer assumes this risk. If an individual can prove that they have the opportunity to profit from how they organise their work, and have financial risks like other directors operating similar companies, this is more akin to a contractor engagement. Examples of relevant financial risks include (but are not limited to) the failure of clients to pay, the imposition of potential consequential penalties or the obligation to carry out additional work, for no extra reward where it falls below client standards, or over-runs beyond a fixed fee quoted. Purchasing assets for the company, or paying significant sums for training or insurance are further examples of risk. If a contractor is regularly receiving a consistent sum of money from your business, like a wage, and not a sum for completion of a project, this would point more towards an employer and employee relationship, whereby IR35 might be applicable.
- Equipment used at work – an employee would always expect an employer to provide any equipment required to carry out work under an employment contract or at least be reimbursed for it if they have purchased it themself, whereas a contractor should be taking the financial risk of purchasing without reimbursement and using their equipment which should be an asset of their business. Where this is not the case, it is more likely that the relationship will fall within the principles of IR35.
- Becoming part and the parcel of an organisation – if a client supervises and integrates the individual into the organisation such that the individual becomes part of the organisation, (providing a workplace station, and/or email address, subjecting the worker to its own internal policies and inviting them to staff socials etc), this looks more like an employment relationship that would be caught by IR35.
- Employee benefits – it may seem obvious, but a self-employed contractor who is a company director of a limited company, must not receive any employee benefits of any kind (including holiday pay, sick pay, membership of a firm's pension scheme, right to a car parking space and canteen facilities, free training courses or equipment training, or any other benefit that would put the contractor in a similar position to one of their employees) otherwise this could indicate an employer and employee relationship caught by IR35. The government has introduced a CEST tool, which is a good starting point when looking at status determination of workers. MHRC has also published an Employment Status Manual, which explains the CEST tool and how it works.
What if the contract says that IR35 does not apply?
The contract or label agreed between the parties isn’t conclusive. It’s a starting point, but what really matters is how the relationship operates in practice — that’s what ultimately determines the true nature of the arrangement.
There are typically two contracts to consider when assessing IR35: one between the client and the intermediary company, and another between the intermediary and the individual providing the services.
For the contract between the intermediary and the individual, it’s important to establish an actual employment relationship — the individual should be genuinely employed by the intermediary. This helps reduce the risk of IR35 applying.
While the main contract between the intermediary and the client often includes a warranty confirming the individual is employed by the intermediary, this must also reflect reality. In practice, the intermediary should control how and when the individual works for clients, and the individual should be paid a salary and receive benefits at the intermediary’s discretion. HMRC is less likely to investigate if the pay and benefits package is competitive for the market the individual operates in.
Overall, it’s generally safer for the individual to be subject to the intermediary’s rules rather than the client’s, to avoid any suggestion that the client has control — a key factor in IR35 assessments.
Does IR35 apply to sole traders?
No, IR35 does not apply to sole traders, but there are 'status' rules. If you are unsure, our employment law solicitors would be happy to assist you with your concerns.
Does IR35 apply to office holders?
Under the Finance Act 2013 two new tests were introduced so that income tax and NICs could be chargeable, and an office holder providing services via an intermediary could be deemed to fall within IR35.
- If the arrangements had been directly between the individual and the client, the individual would have been regarded as an ‘office holder’.
- Where the worker is an office-holder under the client and provides services to the client relating to the office, even when they provide other services (for example, as a consultant) which relate to the office.
What are the Managed Service Company (MSC) rules?
A Managed Service Company (MSC) is a type of intermediary that promotes and facilitates the use of limited companies to supply individual workers’ services to end clients. What sets an MSC apart is that it typically takes on the administrative responsibilities of running the company, including calculating PAYE, handling dividends, and managing reporting and compliance requirements with Companies House and HMRC.
This all-in-one service contrasts with a Personal Service Company (PSC), where the individual worker retains full responsibility for running their own company and managing its obligations.
These rules require MSCs to automatically operate PAYE and NICs on sums paid to workers irrespective of whether, ignoring the intermediate company, an employment relationship might exist between the worker and client. The introduction of specific anti avoidance legislation applying to MSCs means they are now less commonly used as an intermediary.
There are specific tests to confirm whether an entity constitutes an MSC. If your business engages with an MSC and you would like to know more, of if you have any questions about the accounting and reporting obligations of an MSC and how it might impact your business, our specialist employment law solicitors would be happy to assist you.
What does it mean to be outside IR35?
For tax purposes, this means that an individual is truly self-employed and not regarded as an employee of the client and does not have to pay income tax and NICs on fees received from the client, as an employee would. If the individual is genuinely self-employed, then for employment law purposes, the implications of not being an employee of the client are more wide-ranging than this, for example, as self-employed contractors do not receive certain employee benefits such as sick pay or holiday pay or the right to join the employer’s pension scheme.
IR35 in the private sector
Initially, when the IR35 rules were introduced in 2000, compliance obligations were firmly placed at the door of the PSC. Reforms in 2017 and 2021 shifted the obligation away from the PSC and towards public authorities and medium and large entities. Changes were made in 2017 to ensure that where the client recipient of a worker via an intermediary was a public authority, the public authority would be responsible for determining whether the arrangement fell inside or outside IR35. Where IR35 did apply, it became the responsibility of the public authority to comply with the obligations and make the necessary reports and deductions (under the off-payroll regime). In 2021, those off-payroll working rules were extended to large and medium-sized companies within the private sector with a UK connection. Companies were deemed to be relevant medium or large size entities if they met two or more of three requirements (see below).
The three requirements have recently been amended, narrowing the definition of medium and large entities. Accordingly, from 6 April 2025, a company which meets two or more of the following requirements is required to follow the large or public client off-payroll regime:
- an annual turnover of more than £15 million,
- a balance sheet total of over £7.5 million, or
- more than 50 employees.
If deemed to be a medium or large entity, your business is responsible for determining whether the worker’s status falls inside or outside the scope of IR35. This requires a ‘status determination statement’ (SDS), with reasons for justifying its conclusion, to be submitted to the worker and to the intermediary with which the worker contracts (usually the PSC). Failing to provide the SDS or take reasonable care in preparing the SDS, could result in the your business incurring liability for the required tax and NICs.
This would be sufficient in a simple supply chain, however sometimes there are multiple companies within the arrangement. An employment agency may also be involved. It is important for a client caught by the large and public off-payroll regime to ensure that the SDS is passed down the labour supply chain as well as to the off-payroll worker. If your business fails to meet these obligations, you could be deemed the fee-payer in the supply chain and therefore responsible for accounting for taxes and NICs to HMRC (even if a different entity is the actual fee payer).
Some workers may be unhappy with the determination. A statutory dispute resolution process applies, meaning a worker or deemed employer can make representations to the end client that the SDS is incorrect, which the client must respond to within 45 days failing which it will become the deemed employer. Consequently, if your business is an end client and a contractor or deemed employer in the supply chain disagrees with your SDS and initiates the statutory dispute resolution process, your business will need to ensure that you respond within 45 days of receiving such a complaint. You may wish to seek advice from one of our employmentlaw solicitors at an early stage if you are changing the status of a contractor.
Where individual contract workers are assessed in a SDS, as employees for IR35 purposes, the 'fee-payer' is responsible for operating PAYE and accounting for tax and employer’s NICs. In the context of IR35, a fee payer is the entity responsible for paying the contractor's PSC for the work performed. This entity is typically the one directly above the PSC in the supply chain, which is usually the end client, but could be an agency, MSC or other form of intermediary. There is also a new legal obligation on the end client to respond to a request for information about its size from the agency or individual worker.
From 6 April 2024, a statutory set off mechanism was introduced to allow end clients and fee-payers to offset tax and NICs liabilities against taxes paid by the intermediary. If you would like guidance on how, as an end client / fee-payer, your business can offset its tax and NICs liability against income or corporate tax paid by the intermediary, contact our specialist employment tax solicitors for further guidance.
Companies that are not deemed to be medium or large entities are classed as small entities. Where a small entity is the recipient of an individual worker via an intermediary, it is for the PSC to determine whether the relationship falls inside IR35 or not. If it falls inside, the small client off-payroll regime must be followed, and the PSC is required to calculate the income tax and Ni liability and account to HMRC. Therefore, under the small client off-payroll regime the risk lies with the PSC. Under the large and public client off-payroll regime, it is the end client that holds the risk.
Are there circumstances when the rules don’t apply?
The IR35 rules do not apply to offshore companies without a UK presence, which will be excluded from the off-payroll rules. However, where an end client uses an agency which is not a UK based employment agency, the end client could be deemed to be the host employer and therefore liable to HMRC under other offshore employment intermediaries legislation.
The rules also do not apply to contracts entered into before 6 April 2021 and new investigations into PSC’s will not be commenced into employment status by HMRC for those arrangements in place before that date unless fraud or criminal behaviour is suspected.
If your business has been caught by the narrowing of the definition of medium and large entities, and you would like support in assessing and updating the change in determination to the relevant parties, our specialist employment tax team would be happy to assist you.
What if IR35 does apply?
In summary, as explained above, if IR35 applies, the sums received by the intermediary for the individual worker’s work for the client, are in effect treated as employment payments to the worker, and it is the responsibility of the ‘fee payer’ to make deductions for tax and NICs and account for these to HMRC.
Whilst the indicators to determine employment status in an Employment Tribunal are largely the same as those used by HMRC for tax purposes, it cannot be assumed that just because an individual is deemed to fall within IR35 (meaning that the intermediary must make the necessary PAYE deductions of an employee) that the individual is an employee of the client. Employment status for employment and tax purposes are two separate things.
It is worth ensuring that you know where you stand in respect of IR35 and seek legal advice from the start of a contract, as a general rule, HMRC can go back at least six years and evaluate past contracts to see if the legislation relating to IR35 applies, which could, where applicable create a liability for arrears of income tax and NICs (and potentially penalties and interest). Our employment law solicitors can advise you further.
If your business has contracted with a worker via an intermediary and you have concerns about your obligations an end client or you are simply confused as to whether your contract with an intermediary will fall under IR35, contact our specialist employment tax team for further guidance.
If you want to avoid the complexities of using Personal Service Companies (PSCs) and navigating IR35, there are alternative ways to structure working relationships for the supply of labour.
These include:
- Hiring the contractor as an employee, bringing them fully onto your payroll
- Engaging the contractor directly on a genuinely self-employed or worker basis, without involving a PSC
- Using a UK-based agency that supplies the individual directly, without an intermediary company in the chain
Each option comes with its own legal and tax implications, but they can offer a simpler route where the off-payroll working rules do not apply.
Should you have any questions about employment status and IR35, please contact our employment law solicitors for advice.
