You’ve set up a limited company to work as a contractor, or you’re about to, and you keep hearing about IR35. It’s one of the trickiest areas of UK tax, and the rules have changed several times since they began. Get it wrong, and you could face a large tax bill, plus interest and penalties.
This guide explains the IR35 rules in simple terms. You’ll find out whether they apply to you, who decides your status, and how being inside or outside IR35 affects your take-home pay.
We also explain the latest change. Higher company size thresholds apply from 6 April 2026, so, over time, more of your clients could count as small. When a client is small, deciding your IR35 status becomes your job, not theirs.
Key takeaways
- IR35 is a set of tax rules that treat contractors who work like employees as employees for tax purposes.
- Public sector bodies and medium or large private clients decide your status and must give you a status determination statement.
- When your client is small, your own company decides your IR35 status instead. From 6 April 2026, a client can have up to £15 million turnover and still count as small.
- Inside IR35, you pay tax much like an employee. Outside IR35, you can take a mix of salary and dividends and claim business expenses.
- A limited company doesn’t let you avoid IR35. How you actually work decides your status.
What is IR35?
IR35 is the name for the UK’s tax rules on disguised employment. Disguised employment happens when someone works like an employee but is paid through a company, so they and their client pay less tax.
The company in the middle is called an intermediary. Most often, it’s a personal service company (PSC), a limited company that the contractor owns and runs. You’ll also see the term personal service provider used for the same set-up.
Without IR35, a contractor could pay themselves a small salary and take the rest as dividends. That cuts National Insurance for both the contractor and the client, even when the work looks exactly like employment.
The name comes from the 1999 Inland Revenue press release that announced it. Since then, the IR35 legislation has changed several times:
- April 2000: IR35 began, and contractors decided their own status.
- April 2017: public sector bodies took over responsibility for deciding status.
- April 2021: medium and large private sector clients did the same, after a one-year delay because of COVID-19.
- April 2024: a new offset rule stopped the same income being taxed twice when HMRC corrects a client’s mistake.
- April 2026: higher size thresholds started to apply, so more private sector clients count as small.
IR35 only affects people who provide their services through an intermediary. If you’re unsure where you fit, our guide to contractors, freelancers, and consultants explains the differences.
Who do the off-payroll working rules apply to?
The off-payroll working rules are the newer part of IR35, where the client decides your status. They involve three parties:
- The worker, who personally provides the services.
- The intermediary, usually the worker’s own limited company.
- The client, the organisation that receives the services.
There’s often a recruitment agency between the intermediary and the client, too. Who decides your IR35 status depends on the type of client you work for:
- Public sector clients always decide, whatever their size.
- Medium and large private sector clients decide, and must tell you their decision.
- Small private sector clients don’t have to apply the off-payroll rules, so your own company must decide whether IR35 applies.
The off-payroll rules don’t apply if:
- You’re a sole trader.
- You’re employed directly by the client.
- An umbrella company employs you and runs PAYE on your pay.
If your client is based wholly overseas with no UK connection, the off-payroll rules don’t apply either – but your own company must still decide your status under the original IR35 rules.
Still choosing your structure? Our guide on how to set up a limited company as a contractor walks you through each step.
The small company exemption explained
Small private sector clients don’t have to apply the off-payroll rules. When your client is small, responsibility passes back to your own company. In plain English, there are two sets of rules:
- You decide. The original IR35 rules, in Chapter 8 of the Income Tax (Earnings and Pensions) Act 2003, apply. Your company assesses your status and pays any extra tax.
- Your client decides. The off-payroll rules, in Chapter 10 of the same Act, apply. The client, or the agency that pays you, deducts tax before paying your company.
Only the end client’s size counts – a recruitment agency can’t claim the exemption based on its own size. Size uses the same tests as company accounts, which our guide on how company size affects audit requirements explains. Watch out for groups, though: a company that’s small on its own isn’t treated as small if it’s part of a medium or large group.
What changed for IR35 in April 2026
From 6 April 2026, higher size thresholds mean more private sector clients count as small. If your client becomes small, it stops deciding your IR35 status, and the responsibility moves to your company.
The new limits come from changes to the Companies Act 2006. HMRC has confirmed they apply to IR35, raising the turnover limit to £15 million. A company is small if it meets at least two of these conditions:
| Test | Before | From 6 April 2026 |
|---|---|---|
| Annual turnover | £10.2 million or less | £15 million or less |
| Balance sheet total | £5.1 million or less | £7.5 million or less |
| Average number of employees | 50 or fewer | 50 or fewer (unchanged) |
The change doesn’t happen overnight. The new limits apply to financial years starting on or after 6 April 2025, and a client’s size for each tax year is based on its last set of accounts with a filing deadline before that tax year starts.
A company usually needs to meet the limits for two consecutive years before its size changes. As a result, many clients won’t move out of the off-payroll rules until the 2027/28 tax year or later.
For you, that means some clients may stop issuing status determinations. When they do, you’ll need to assess your own status for those contracts.
New umbrella company rules from April 2026
From 6 April 2026, recruitment agencies – or the end client, if there’s no agency – are responsible for making sure umbrella companies run PAYE correctly. If you’re weighing up an umbrella instead of your own company, our guide explains how they work: What is an umbrella company?
How is your IR35 status decided?
Your IR35 status depends on what your contract says and, more importantly, how you actually work. HMRC and the courts imagine a direct contract between you and the client. If that imagined contract would be employment, you’re inside IR35.
Medium and large clients must record their decision in a status determination statement (SDS), with reasons. They must take reasonable care when making it, and give it to you and to whoever they contract with, like an agency.
Control, substitution, and mutuality of obligation
Three main tests carry the most weight in any IR35 assessment:
- Control: who decides how, when, and where you work? A developer told to work set hours in the client’s office looks like an employee. One who delivers a project to an agreed spec, on their own schedule, looks like a business.
- Substitution: can you send someone else in your place, and would the client genuinely accept that? A consultant who can send a qualified colleague to run a workshop, and pays them, has a real right of substitution.
- Mutuality of obligation: does the client have to offer you work, and do you have to accept it? An employee is expected to take on whatever work they’re given. A contractor agrees to deliver a specific project and can turn down extra work.
Other factors count too, including taking financial risk, using your own equipment, being part of the client’s organisation, and working for several clients. No single test decides the outcome. HMRC and tribunals look at the whole picture.
Using HMRC’s CEST tool
HMRC’s Check Employment Status for Tax (CEST) tool is free to use on GOV.UK. You answer questions about the engagement, and it gives HMRC’s view of whether the off-payroll rules apply.
Anyone can use it, including contractors, clients, and agencies, and it’s anonymous. HMRC will stand by the result, as long as your answers are accurate and you follow its guidance. Save a copy of each result, and run the tool again if your working practices change.
CEST is a useful starting point, but it doesn’t consider every factor a tribunal would, including mutuality of obligation. If it can’t reach a decision, or the stakes are high, ask an IR35 specialist to review your contract.
What to do if you disagree with your status determination
Medium and large clients must give you an SDS that explains their reasons. If you think they’ve got it wrong, you can use their client-led disagreement process:
- Tell the client in writing that you disagree, and explain why.
- Include your evidence, like your contract and examples of how you work in practice.
- The client must respond within 45 days, either confirming its decision with reasons or issuing a new SDS.
If the client doesn’t respond within 45 days, it becomes liable for the Income Tax and National Insurance due on your fees until it does.
If you still disagree after the client responds, you could negotiate changes to your working practices, or ask an accountant to review the contract before you renew.
Inside vs outside IR35: what’s the difference?
Being inside IR35 doesn’t make you an employee. You won’t get holiday pay, sick pay, or employment rights from the client. But you’ll pay tax on that income much like an employee.
When your client decides you’re inside IR35, the fee-payer (the business that pays your company, usually the agency or the client) deducts Income Tax and National Insurance before paying your company. When your own company decides, it works out a deemed payment at the end of the tax year and pays the extra tax itself. In that case, it can deduct a flat 5% allowance for running costs.
Outside IR35, your company is paid in full. You can pay yourself a tax-efficient mix of salary and dividends, and your company can claim legitimate business expenses. Here’s how the two compare:
| Inside IR35 | Outside IR35 | |
|---|---|---|
| How you’re paid | When your client decides, Income Tax and employee National Insurance are deducted before your company receives the money. When your own company decides, it pays the tax itself through a deemed payment | Your company is paid in full, then pays you a salary and dividends |
| Employer National Insurance | 15% on the fee, paid by the fee-payer (or your company if you decide your own status) | Only on any salary above £5,000. A company whose only employee is its director can’t claim the Employment Allowance to offset this |
| Dividends | Not available on income from the contract | Available, taxed at 10.75%, 35.75%, or 39.35% in 2026/27 |
| Expenses | Very limited, with no tax relief for travel to the client’s site | Legitimate business expenses can be claimed |
| Take-home pay | Lower, close to an employee on the same income | Usually higher |
For a closer look at your options outside IR35, see our guide on how to take money out of your limited company.
IR35 and the Construction Industry Scheme
If you work in construction through your own company, the off-payroll rules and the Construction Industry Scheme (CIS) can both apply. Special rules stop the same income being taxed twice.
When your pay falls inside the off-payroll rules, the payer deducts PAYE instead, and doesn’t need to consider CIS for those payments. If the off-payroll rules don’t apply, for example because the client is small, the payer must still check whether CIS deductions are due. And if your own company decides you’re inside IR35, it must account for the deemed payment when operating CIS.
How to stay compliant as a limited company contractor
IR35 compliance comes down to knowing who’s responsible and keeping evidence. Use this checklist for every contract:
- Check your client’s size before you sign, so you know who decides your status.
- Read every SDS carefully, and challenge it promptly if you disagree.
- Assess contracts yourself when your client is small, using CEST or an accountant’s review. Keep a record of your reasoning.
- Make sure your contract reflects reality, with a genuine right of substitution, control over how you work, and no obligation to accept more work.
- Run your company like a business. Work for more than one client where you can, and keep your finances separate with a dedicated business bank account.
- Stay on top of deadlines. Our guide to UK tax year dates and deadlines lists the key dates for your company.
What are the penalties for non-compliance?
If HMRC finds that IR35 applied and too little tax was paid, whoever was responsible for the decision must pay:
- the unpaid Income Tax and National Insurance
- late payment interest on that amount
- a penalty of up to 30% of the unpaid tax for careless errors, 70% for deliberate errors, or 100% for deliberate and concealed errors
If your own company decided your status, the bill falls on your company. If a client failed to take reasonable care, the liability can move to them. Since April 2024, HMRC can also offset tax you and your company already paid against the deemed employer’s bill.
The bottom line on IR35 rules
In 2026, who decides your IR35 status depends on your client. Public sector bodies and medium or large private businesses decide for you. When the client is small, the decision is yours, and the higher thresholds mean that more contractors will find themselves in that position.
The most useful thing you can do is check who’s responsible before every new contract, then keep evidence of how you really work. IR35 is complex, so speak to an accountant about your situation. For specific questions, you can also contact HMRC’s IR35 team.
Starting out as a contractor? A limited company gives you a professional, separate structure for your contracts. Form a company with Rapid Formations today. Then add our Hassle-Free Compliance service to stay on top of your filings and deadlines once you’re trading.
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