IR35 is the shorthand name for the UK's off-payroll working rules — a set of tax regulations designed to ensure that contractors who operate through a limited company (typically called a personal service company, or PSC) pay broadly the same Income Tax and National Insurance as employees, if the reality of their working arrangement looks like employment.

The rules have been around in some form since 2000, but they were substantially reformed in 2017 (for the public sector) and again in 2021 (for medium and large private sector businesses). Those 2021 changes shifted responsibility for determining a contractor's employment status from the contractor themselves to the organisation that engages them — and that shift is where many of the practical compliance challenges arise.

IR35 explained simply: if a contractor would be treated as an employee for tax purposes were it not for the PSC sitting in the middle, the rules apply. Income Tax and National Insurance are then deducted at source, in the same way they would be for a salaried member of staff. This guide walks through who the rules affect, how status is assessed, what the financial consequences look like, how the 2026 umbrella company changes interact with IR35, and — critically — what goes wrong in practice.

IR35 applies where a worker provides their services through an intermediary — most commonly a PSC, but also a partnership or another individual — and where, if they were engaged directly, they would be treated as an employee of the client for tax purposes. The rules apply across both the public and private sectors.

Public sector engagements

For work carried out for a public authority (a government department, NHS trust, local council, and so on), the client has been responsible for determining IR35 status since April 2017. There are no size thresholds — all public sector clients must apply the rules.

Private sector engagements

Since April 2021, the responsibility for determining status in the private sector depends on the size of the client business:

• Medium or large businesses: the client determines the worker's employment status and issues a Status Determination Statement (SDS). If they get it wrong, the PAYE liability falls on them.
• Small businesses: the off-payroll rules do not apply. The contractor's own intermediary remains responsible for assessing and paying the right tax — as was the case for everyone before 2017.

What counts as a small business?

A business qualifies as small for IR35 purposes if it meets at least two of the following three conditions in its most recent financial year: annual turnover no more than £10.2 million; balance sheet total no more than £5.1 million; no more than 50 employees. Note that for accounting periods beginning on or after 6 April 2025, the Companies Act small company thresholds increased (turnover to £15 million, balance sheet to £7.5 million), but HMRC's IR35 threshold criteria are set by specific IR35 legislation rather than Companies Act definitions — confirm with a tax adviser which threshold applies to your specific engagement before relying on the small company exemption.

There is no single statutory test for IR35 status. Determining whether someone sits inside or outside the rules requires a judgment based on the overall picture of the working relationship, drawing on decades of employment law case history. HMRC weighs up several key factors, none of which is individually decisive.

The main tests

• Substitution: can the contractor send a genuine substitute to carry out the work, without the client's approval of the specific individual? A real, unfettered right of substitution points strongly toward outside IR35. A substitution clause that exists only on paper — where the client would reject any substitute in practice — carries very little weight.
• Control: to what extent does the client dictate how, when, and where the work is done? The more control the client exercises, the more the arrangement resembles employment.
• Mutuality of obligation: is the client obliged to offer work, and is the contractor obliged to accept it? A genuine business-to-business contract typically involves no such obligation on either side.
• Financial risk: does the contractor risk their own money — for example, by having to correct defective work at their own cost, or by quoting a fixed price for a deliverable? Employees do not carry that kind of financial risk.
• Part and parcel: is the contractor integrated into the client's organisation in ways that look indistinguishable from permanent employment — attending internal meetings as a matter of routine, managing permanent staff, or using a company email address?

HMRC's CEST tool

HMRC provides a free online tool called Check Employment Status for Tax (CEST), available at gov.uk/guidance/check-employment-status-for-tax. CEST will stand behind CEST results if the information entered is accurate and the tool reaches a definitive conclusion — but it does not cover every scenario, and a significant proportion of real-world engagements return an "unable to determine" result. It is a starting point, not a definitive answer.

If a determination concludes that a contractor sits inside IR35, the practical and financial consequences are significant. The engagement does not simply become employment — the contractor still operates through their PSC — but the tax treatment changes substantially.

The deemed employer deducts at source

The organisation classed as the deemed employer (typically the agency or, if there is no agency, the end client) must deduct Income Tax and employee National Insurance from the fees paid to the contractor's intermediary before they are passed on. The deemed employer also becomes liable for employer's National Insurance and the Apprenticeship Levy on those fees.

This is a significant cost increase for the end client: employer's NI alone adds around 15% to the cost of the engagement on top of the contractor's gross fee (at 2026 rates). In practice, many businesses renegotiate day rates downward to absorb this cost, which is one reason why an inside-IR35 determination materially reduces the contractor's actual take-home.

Contractors lose access to tax-efficient structures

Outside IR35, a contractor operating through a PSC can draw a modest salary and take the majority of their income as dividends — a structure that is more tax-efficient than PAYE employment. Inside IR35, the income is effectively taxed as employment income before it even reaches the PSC, which means much of the tax advantage disappears. The contractor may still have a PSC in place, but there is substantially less net income flowing through it.

The Status Determination Statement

Whenever a medium or large client determines a worker's IR35 status, they are legally required to produce a written Status Determination Statement (SDS) setting out their conclusion and the reasoning behind it. The SDS must be provided to the worker and to the party they have contracted with (typically the agency). Without a valid SDS, the liability for unpaid PAYE sits with the client by default.

A separate but closely related set of rules came into force on 6 April 2026, targeting non-compliance in the umbrella company market. These are not IR35 rules — but they affect the same people and the same supply chains, so it is worth being clear on how the two regimes interact.

What the new rules do

From 6 April 2026, the agency that holds the contract with the end client to supply workers is responsible for ensuring PAYE is operated correctly where an umbrella company employs those workers. If there is no agency in the chain, responsibility falls to the end client directly. Crucially, HMRC can recover any underpaid PAYE from the agency or end client if the umbrella company fails to pay correctly — liability is not limited to the umbrella itself.

The rules apply to all payments made to workers on or after 6 April 2026, regardless of whether the supply chain is a new arrangement or one that was already in place before that date.

Who is not covered

The 2026 umbrella rules do not apply to workers who are engaged through their own PSC and assessed under IR35, managed service companies, salaried members of an LLP, or individuals treated as employed by a staffing agency under existing agency worker rules. IR35 and the umbrella rules sit alongside each other — they address different parts of the non-compliance problem — but for most contractors and hirers, only one set of rules will be relevant to any given engagement.

Why this matters for businesses that use contractors

If your business sources contractors through an umbrella company via a recruitment agency, you now have a direct interest in confirming that the agency is operating PAYE correctly. HMRC's ability to pursue the end client for unpaid tax — even where the end client had no involvement in the failure — is a significant change, and one that warrants a review of any supply chain arrangements put in place before April 2026.

HMRC has made IR35 compliance a sustained enforcement priority, and its annual reports consistently show substantial compliance yield from off-payroll working investigations. Investigations can be triggered by risk-flagging in HMRC's systems, by sector-wide compliance campaigns, or as a by-product of other PAYE or Corporation Tax enquiries.

Where enforcement activity tends to focus

HMRC has run high-profile IR35 investigations in the public sector — the BBC, NHS, and various government departments have all faced significant retrospective PAYE demands — and enforcement in the private sector has intensified since the 2021 reforms. Sectors that make heavy use of contractors (IT and technology, financial services, media and publishing, construction, and professional services) attract proportionally more scrutiny.

Retrospective liability

A critical point that is often underestimated: IR35 liability is not just a future risk. HMRC can open enquiries into past years, and if a determination is found to have been wrong — or if no proper determination was carried out — the resulting PAYE demand can cover multiple tax years, with interest and potentially penalties added on top. For a medium or large business that has been engaging contractors without properly applying the off-payroll rules since April 2021, that retrospective exposure can be very substantial.

The contractor's position

For contractors working for small private sector clients, where the old rules still apply and the contractor's own intermediary determines status, the risk sits with the contractor and their PSC. A poorly reasoned or undocumented status determination — or no determination at all — leaves the contractor exposed if HMRC opens an enquiry. Keeping contemporaneous evidence of the working practices that support an outside-IR35 position is genuinely important, not just a box-ticking exercise.

IR35 does not operate in isolation. Several other pieces of tax legislation interact with the off-payroll rules, and understanding where they overlap — and where they differ — avoids the confusion that frequently arises when contractors or hirers research this area.

IR35 and managed service companies

Managed service company (MSC) rules are a distinct anti-avoidance regime that applies where a third-party provider is substantially involved in setting up and running a contractor's PSC. MSC rules can override IR35 and result in the contractor's income being taxed as employment income regardless of the IR35 status determination. Both regimes are worth understanding if you use a composite contractor solution rather than your own standalone PSC.

IR35 and umbrella employment

If a contractor is employed by an umbrella company — rather than operating through their own PSC — the off-payroll working rules are unlikely to apply, because the contractor is already an employee of the umbrella. Their income goes through PAYE from the outset. This is why umbrella employment is sometimes presented as an IR35 solution; it sidesteps the IR35 question entirely, though it also removes most of the tax-efficiency benefits of PSC contracting. As noted above, the 2026 umbrella rules now add a separate compliance layer for umbrella arrangements.

IR35 and the construction industry scheme (CIS)

Contractors working in the construction sector may also be subject to the Construction Industry Scheme, which operates its own employment status tests and withholding obligations. The two sets of rules can apply independently of each other, and a worker can potentially fall under both. If you operate in construction and engage subcontractors through intermediaries, getting specialist advice on the overlap between CIS and IR35 is worthwhile.

Whether you are a contractor assessing your own position or a business that engages contractors, the following steps reflect what good IR35 compliance actually looks like in practice.

These are the errors that come up most frequently in practice — and the ones that tend to carry the largest financial consequences.