The Definitive Guide to IR35 and Contractor Compliance
IR35 has shaped the UK contracting market for more than two decades, yet compliance still causes uncertainty across the labour supply chain.
For contractors, an IR35 determination can change how an engagement is taxed and whether working through a limited company remains financially suitable. For agencies and hiring businesses, the same decision can create responsibilities around status assessments, payroll, and record-keeping. A weak process can also unexpectedly introduce liability into the labour supply chain.
In this guide, we explain how IR35 and the off-payroll working rules operate, how status is assessed, and what contractors, agencies, and hiring businesses can do to manage compliance more effectively.
What is IR35? And what are the off-payroll working rules?
IR35 is the common name for legislation that determines whether someone providing services through an intermediary should be treated as employed or self-employed for tax purposes.
The intermediary is usually the contractor’s personal service company (PSC). The rules ask a hypothetical question: If the contractor provided their services directly to the client, would the relationship resemble employment?
When the answer is yes, the engagement is generally described as being “inside IR35”. The contractor is treated as an employee for tax purposes for that engagement. When the answer is no, the engagement is “outside IR35”, allowing the contractor’s company to receive payment without off-payroll deductions.
The rules apply separately to each contract. A contractor can therefore have one engagement inside IR35 and another outside IR35 at the same time. Written, verbal, and implied agreements can all form part of the contractual relationship considered for these purposes.
IR35 generally applies where a worker provides services through their own intermediary, commonly a personal service company in which they have a material interest. It does not usually apply to someone who is genuinely employed and paid through an umbrella company, although separate PAYE and supply-chain compliance obligations may apply. Sole traders also fall outside the intermediaries legislation, but their employment status must still be assessed under the relevant tax rules.
Who is responsible for deciding IR35 status?
Responsibility depends mainly on the type and size of the end client.
For engagements with public authorities and medium or large private-sector clients, the client receiving the contractor’s services is normally responsible for assessing employment status. The client must communicate its conclusion through a status determination statement, or SDS.
Where the contractor works for a small private or voluntary-sector client, responsibility generally remains with the contractor’s intermediary. Their personal service company must consider IR35 and, where the rules apply, calculate the relevant employment payment. The intermediary may also remain responsible when a client is based wholly overseas and has no UK connection.
How is a small client defined?
According to HMRC, the company-size thresholds increased for financial years beginning on or after 6 April 2025. Under the new thresholds, a corporate client may be classed as medium or large if it exceeds at least two of the following conditions for two consecutive financial years:
- Annual turnover of £15 million
- A balance-sheet total of £7.5 million
- An average of 50 employees
Contractors and agencies should avoid making assumptions based on a client’s profile or headcount alone. A worker or contracting party can ask a private-sector client to confirm its size, and the client must generally respond within 45 days.
How is an IR35 status determined?
An IR35 assessment looks at the relationship that would exist between the contractor and the client if the intermediary were removed. There is no single test that decides status. Instead, the engagement is considered as a whole, using principles developed through case law.
Several factors carry particular weight.
Personal service and substitution
A requirement for the named contractor to perform the work personally can point towards employment. A genuine right to provide a suitable substitute can support self-employment, especially where the contractor chooses and pays that substitute.
What happens in practice matters as much as the wording of the contract. A substitution clause carries little weight if the client would never realistically allow someone else to do the work.
Control
Control considers how much say the client has over what work is done and how it is carried out, including when or where the services are provided.
A client can define the required outcome, set deadlines, and establish necessary standards. The relationship becomes more employment-like when the client can direct the contractor’s methods, move them between tasks, or supervise them in much the same way as an employee.
Mutuality of obligation
This looks at the commitments between the contractor and client. A project with a defined scope and end point may support self-employment. An ongoing expectation that the client will continue providing work and the contractor will continue accepting it can point towards employment.
Financial risk and business independence
Someone operating a genuine business may take on risks an employee normally wouldn’t, such as correcting defective work at their own cost or investing in equipment and insurance.
Other signs of independence can include negotiating fees around a project and marketing services to other clients.
Integration into the client organisation
How the contractor fits into the organisation can also impact IR35 assessment. Access to internal systems or attendance at project meetings may be necessary to deliver the work. But greater integration becomes more significant where the contractor manages employees within the normal hierarchy, appears on organisational charts, or is treated in a similar way to permanent staff.
The assessment ultimately depends on the overall relationship. Contract terms, working practices, and the circumstances of the engagement all need to tell a consistent story.
Do the contract and working practices need to match?
Yes, an IR35 contract should accurately describe how the engagement works in practice.
A carefully drafted substitution clause cannot strengthen the position when the client would never permit substitution. Similarly, a statement of work may promise a defined deliverable while the contractor is used to cover a continuing internal role under close supervision.
HMRC advises organisations to consider both the contractual terms and day-to-day arrangements. Written terms may become unreliable when they conflict with working practices, have been changed verbally, or fail to describe the engagement in sufficient detail.
This is important because the relationship can change after work begins. A six-month project may gradually expand, with the contractor taking on unrelated duties and becoming increasingly embedded in the client’s team. The original determination may then cease to reflect reality.
Can CEST determine whether an engagement is inside IR35?
Contractors, agencies, and hirers can use HMRC’s Check Employment Status for Tax tool, commonly called CEST, to assess an engagement.
The tool asks about the contract, the worker’s responsibilities, and how the work will be performed. It then provides HMRC’s view of the person’s employment status for tax. The result can also be saved and used as evidence when generating an SDS.
Sometimes this tool cannot make a determination, and it will say as much. HMRC will stand by a result only where the information entered is accurate and consistent with its guidance.
How can contractors tell whether a contract is inside or outside IR35?
Contractors should assess the complete engagement before accepting an IR35 conclusion.
An outside-IR35 position may be supported where the contractor:
- Controls how the agreed services are delivered
- Has a genuine right to provide a substitute
- Accepts meaningful financial risk
- Works towards defined deliverables or project outcomes
- Operates independently from the client’s employee structure
- Provides services as part of an established business
An inside-IR35 position becomes more likely where the individual must provide the services personally, works under significant client control, and fills an ongoing role within the business. Payment based entirely on hours worked and an expectation that further work will continually be offered may add to that picture.
These indicators must be considered together. A contractor does not become outside IR35 simply by using their own laptop, working remotely, or serving more than one client.
What changes when a contract is inside IR35?
Where a medium or large client determines that the rules apply, the deemed employer must deduct Income Tax and employee National Insurance contributions from the relevant payment. It must also pay employer National Insurance contributions and the Apprenticeship Levy where applicable.
Employer National Insurance is an obligation of the deemed employer and cannot be deducted from the deemed direct payment made for the contractor’s services. VAT is also removed before the taxable deemed payment is calculated and continues to be handled under the normal VAT rules.
The contractor’s company receives the balance after off-payroll deductions. Because tax and National Insurance have already been applied to that income, the contractor can generally withdraw the corresponding amount from their company without paying those charges again, provided the payment is handled and recorded correctly.
An inside-IR35 determination applies to tax treatment for the relevant engagement. It does not, however, automatically give the contractor employment rights, holiday pay, or pension enrolment from the client or agency.
Contractors should consider the financial impact before accepting an inside-IR35 role. The appropriate day rate, working structure, and company arrangements may all need to be reviewed.
Brookson’s contractor accountancy service can help limited-company contractors understand the accounting and tax implications of their working arrangements.
What happens when the client is small?
Where a private-sector client qualifies as small, the contractor’s intermediary normally retains responsibility for assessing status.
If the engagement falls inside IR35, the contractor’s personal service company must calculate a deemed employment payment and account for the relevant tax and National Insurance. The calculation considers income received from affected engagements as well as salary, pension contributions, and certain allowable expenses.
This area can become technically complex, particularly where a contractor has several engagements or receives a mixture of salary and dividends. Specialist accountancy advice can help ensure that the deemed payment is calculated and reported correctly.
Can a contractor challenge an inside-IR35 determination?
Yes, a contractor can raise a disagreement with the client and explain why they believe the SDS is incorrect.
A useful challenge should address the employment-status factors and include supporting evidence. For instance, the contractor may show that they control the delivery method or carry responsibility for correcting defective work.
The client must consider the representations and respond within 45 calendar days. It must either maintain the original determination and explain why, or withdraw it and issue a new SDS. The original tax treatment continues while the disagreement is under review. If the client fails to respond within the deadline, it can become the deemed employer and assume the related PAYE liabilities until it does respond.
Contractors should keep the SDS, their written challenge, and any evidence supporting the working arrangement. An independent review can help establish whether the challenge has a sound legal basis.
Brookson Legal provides IR35 status assessments and review support for contractors, agencies, and hiring businesses.
What must agencies and hiring businesses do to comply with IR35?
Agencies and hirers need a repeatable process that identifies affected workers, produces defensible determinations, and ensures the correct party operates PAYE.
Understand the labour supply chain
Start by establishing how each worker is engaged and which organisations sit between the worker and the end client.
A contractor may be supplied through an agency, consultancy, or managed service provider, and may work through a personal service company or another structure. The commercial reality matters, so organisations should confirm the arrangement rather than rely on contractual labels alone.
Make a reasoned status determination
For medium and large organisations, the client must assess each relevant engagement and take reasonable care when reaching its decision.
The assessment should involve someone who understands how the work will operate in practice and should consider the circumstances of the individual engagement. Blanket determinations can fail the reasonable-care requirement where contractors performing similar roles have materially different arrangements.
Issue a valid Status Determination Statement
The client must communicate its conclusion through an SDS to the worker and the organisation it contracts with.
A valid SDS needs to state whether the engagement is inside or outside IR35 and explain the reasoning behind that conclusion. Simply applying a status label is not enough.
Where agencies sit within the supply chain, the SDS must also be passed to the next relevant party. Failure to do so can transfer responsibility for the tax deductions.
Confirm who is responsible for PAYE
The fee-payer is usually the organisation directly above the contractor’s intermediary in the contractual chain. Where the off-payroll rules apply, that organisation will generally become the deemed employer.
The deemed employer must operate PAYE on the relevant payment and account for employer National Insurance and any applicable Apprenticeship Levy. Agencies should establish these responsibilities before payments begin rather than waiting until an invoice is due.
Provide a route for disagreements
Contractors and deemed employers can challenge a status determination. Hiring businesses therefore need a clear process for reviewing disagreements, considering new evidence, and communicating the outcome.
The client must respond within 45 days and either confirm its original decision with reasons or issue a new SDS.
Review determinations when circumstances change
An accurate determination can become outdated if the engagement changes.
A significant shift in project scope, responsibilities, reporting arrangements, or working practices may require the status to be reassessed. Regular reviews can also help organisations identify determinations that no longer reflect how contractors are actually working.
How does IR35 interact with wider supply-chain compliance?
IR35 sits within a broader network of obligations covering employment status, PAYE, and the use of employment intermediaries.
This became especially important on 6 April 2026, when new rules introduced joint and several liability for PAYE in labour supply chains involving umbrella companies.
Where an agency has the contract with the end client to supply the worker, that agency is responsible for ensuring the umbrella company operates PAYE correctly. Where the end client contracts directly with the umbrella, the responsibility falls to the end client. HMRC can recover an underpayment from the responsible agency or client when the umbrella fails to pay the correct amount.
These rules apply to payments made to workers on or after 6 April 2026. This includes workers engaged through supply chains that existed before that date. They cover both PAYE Income Tax and the corresponding National Insurance liabilities.
This changes the practical meaning of supply-chain due diligence. An agency can no longer rely solely on the umbrella company’s contractual promise to handle payroll. It needs evidence that workers are employed correctly and that PAYE is being operated on their full taxable pay.
HMRC recommends due diligence across the full supply chain, appropriate contractual protections, and sample payslip checks. Agencies should also examine the umbrella company’s trading history and remain cautious where unusually high take-home pay or non-taxable payment arrangements are promoted.
IR35 and umbrella compliance often meet at the point where a worker’s engagement model is identified. A business must establish whether the worker is operating through a PSC, employed through a genuine umbrella arrangement, or engaged in another way. An incorrect assumption at this stage can lead to the wrong status process and the wrong party accounting for tax.
What are the most common IR35 compliance mistakes?
Getting IR35 wrong can have serious consequences for end hirers and contractors. Many failures begin with ordinary process gaps rather than deliberate non-compliance.
Treating the contract as the full assessment
A contract review is valuable, but the document needs to reflect reality. Hiring managers should confirm how the work will be delivered and raise changes during the engagement.
Using blanket determinations
Placing every contractor inside IR35 may appear cautious, yet it can fail the reasonable-care requirement where individual arrangements differ. It may also make it harder to attract genuine independent contractors.
Allowing the wrong person to complete the assessment
A central tax or HR team may understand the legislation but lack knowledge of the role. A hiring manager may know the working practices but lack status expertise. The strongest process brings these perspectives together.
Completing CEST with generic answers
HMRC stands behind CEST results only where the information supplied is accurate. Answers copied from standard terms without checking the real arrangement weaken the result.
Failing to pass on the SDS
An accurate determination still creates risk when it does not reach the correct parties. Each organisation receiving the SDS should record it and pass it to the next relevant party promptly.
Ignoring changes during the engagement
Extensions, new responsibilities, and changes in control can alter the status picture. Reviews should be triggered by material changes rather than left until the contract ends.
Treating IR35 and umbrella compliance as separate workflows
Both begin with visibility across the workforce and supply chain. A joined-up process allows organisations to identify PSC workers, verify umbrella employment, and allocate tax responsibilities correctly.
What records should be kept for IR35 compliance?
Good records make it easier to explain and defend a decision.
Clients should retain the contracts, status assessments, and SDS documents for each engagement. The file should also contain the information used to answer assessment questions, evidence of working practices, and records of any disagreements.
Where workers are provided through third parties, the client should preserve communications confirming how they are engaged and what checks were performed. The deemed employer should retain payment calculations, payroll records, and supporting evidence for permitted deductions.
A strong record should allow someone who was not involved in the original decision to understand:
- What the contractor was engaged to deliver
- How the work operated in practice
- Which status factors were considered
- Why the conclusion was reached
- When the position was last reviewed
This level of evidence supports consistency and makes responding to HMRC considerably easier.
What happens if HMRC investigates an IR35 determination?
HMRC may examine both individual engagements and the wider process used to manage off-payroll workers. Organisations should be ready to provide contracts, SDS records, payroll information, and evidence of actual working practices.
If HMRC decides an engagement was wrongly treated as outside IR35, the deemed employer may face unpaid PAYE and National Insurance, plus interest and possible penalties. For liabilities assessed from 6 April 2024, certain tax already paid by the worker or intermediary may be set off against the amount due.
Regular internal reviews can help identify weak determinations before HMRC does. Brookson Legal’s mock HMRC investigation service can help organisations test their records and decision-making processes in advance.
How can contractors, agencies, and hirers strengthen IR35 compliance?
Strong IR35 compliance depends on keeping each determination tied to the reality of the engagement.
Contractors should understand who is responsible for their status, review any SDS carefully, and keep evidence of how they work in practice. Agencies and hiring businesses need clear visibility across the supply chain, with responsibilities for assessments, SDSs, and PAYE understood from the outset. Determinations should also be revisited when the role or working arrangement changes.
Where the facts are complex or finely balanced, specialist advice can help organisations test their reasoning and strengthen their compliance process. Brookson Legal provides IR35 assessments and compliance support for contractors, agencies, and end hirers, while its contract review service can help ensure agreements reflect the intended working practices.
Speak to Brookson Legal about building an IR35 compliance process that supports your contractors and protects your supply chain.
FAQs
1. What is the difference between IR35 and the off-payroll working rules?
IR35 is the common name for rules that determine whether someone providing services through an intermediary would be considered employed for tax purposes if engaged directly.
The off-payroll working rules use the same underlying employment-status test but, for public-sector and medium or large private and voluntary sector clients, place responsibility for determining status on the client and can place PAYE responsibilities elsewhere in the supply chain.
2. Does being inside IR35 make a contractor an employee?
No, an inside-IR35 determination means employment taxes apply to income from that engagement. It does not automatically make the contractor an employee of the client or give them employment rights such as holiday pay or pension enrolment.
3. What makes a Status Determination Statement valid?
An SDS must state whether the engagement is inside or outside IR35 and explain the reasons for that conclusion. The client must take reasonable care when making the determination and provide the SDS to the contractor and the organisation it contracts with. A status label without supporting reasons is not sufficient.
4. How often should IR35 status be reviewed?
IR35 status should be reviewed whenever there is a material change to the contract or working practices. Changes to the project scope, responsibilities, reporting arrangements, or the level of client control can affect the original determination.
For longer engagements, periodic reviews can also help ensure the SDS continues to reflect how the contractor is actually working.