If you’re a professional contractor working via your own company, you will almost certainly have heard of IR35.
If you are caught by this tax legislation, it can have a significant impact on your take-home pay. So what do “inside” and “outside” IR35 actually mean?
What is IR35?
This legislation, first implemented in 2000, was designed to ensure that workers who operate like employees but supply their services through a company pay broadly the same tax as normal employees.
The rules were aimed mainly at contractors who might leave a permanent role but return to the same organisation the next day, providing the same services via their own limited company.
In these situations, HMRC may view the worker as a disguised employee.
IR35 now operates in two different ways depending on the size of the client organisation.
Where the end client qualifies as a small company, the original IR35 rules still apply (often referred to as Chapter 8). The contractor’s limited company remains responsible for determining whether a contract falls inside or outside IR35.
However, where the client is a medium or large organisation, the newer off-payroll rules (commonly known as Chapter 10) apply. Under these rules, the client is responsible for determining the contractor’s employment status.
So, unless your client qualifies as a small company, they will normally be responsible for deciding whether your engagement falls inside or outside IR35.
What does it mean to be inside IR35?
If your contract falls inside IR35, HMRC considers the engagement to resemble employment for tax purposes. As a result, most of the income from the contract is taxed under PAYE, meaning income tax and National Insurance contributions are deducted in a similar way to an employee’s salary.
It is worth noting that many roles advertised as inside IR35 are actually PAYE engagements operated through an umbrella company.
In these situations, the contractor becomes an employee of the umbrella company rather than operating through their own limited company.
Where a contractor continues to use their own limited company on an inside-IR35 engagement, the income must generally be treated as employment income for tax purposes.
When determining status, HMRC will look at several factors, including:
- The degree of control exercised by the client
- Whether a genuine right of substitution exists
- Who provides equipment and resources
- Whether there is an ongoing mutuality of obligation
- Whether the contractor can take on other clients
What does it mean to be outside IR35?
If your engagement is outside IR35, you are considered to be operating as an independent business. Your company invoices the client for its services and pays Corporation Tax on its profits in the usual way.
Directors typically extract income using a small salary and dividends. This structure is still generally more tax efficient than employment, although the gap has narrowed in recent years due to higher dividend taxes and increased Corporation Tax rates.
Inside IR35 vs outside IR35 – key differences
- Outside IR35: The contractor’s limited company invoices the client and pays Corporation Tax on profits. Income is usually extracted via salary and dividends.
- Inside IR35: Most contract income is treated as employment income and taxed through PAYE.
- Status decision: For most medium and large clients, the client determines IR35 status under the off-payroll rules. For small companies, the contractor’s company remains responsible.
- Working structure: Many inside IR35 roles are paid through umbrella companies rather than a contractor’s limited company.
How to determine your IR35 status
The rules which determine IR35 status are complex. A contractor’s status is determined by both the wording of their contract and the way the work is carried out in practice (often referred to as working practices).
For most contractors today, the end client determines status under the off-payroll rules. Clients may use a variety of tools when making their decision, including third-party assessment tools and the official HMRC CEST service.
What happens if I am inside IR35?
If you are found to be inside IR35, the organisation paying your company (or the fee payer in the supply chain) must deduct PAYE tax and National Insurance contributions before payment. They must also provide a Status Determination Statement explaining the decision.
What happens if I am outside IR35?
If your contract falls outside IR35, your company continues to operate under normal business tax rules. The company pays Corporation Tax on its profits, and you then pay personal tax when extracting income via salary or dividends.
What can you do to remain outside IR35?
- Use online tools to assess your current status and identify potential risks.
- Consider paying for a professional IR35 contract review to ensure both your contract wording and working practices support an outside-IR35 position.
- Negotiate changes with your client or recruiter where necessary.
- Ensure a confirmation of arrangements document is signed where possible.
- Maintain compliant working practices throughout the engagement and keep evidence demonstrating your contractor status.
- Consider taking out IR35 investigation insurance, particularly if your company remains responsible for IR35 status under Chapter 8.
You can also estimate the financial difference between inside and outside IR35 using our IR35 take-home pay calculator.
Finally, keep a clear paper trail showing the steps you have taken to demonstrate that your engagement sits outside IR35. If HMRC ever investigates your company, this documentation can be extremely valuable.
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