IR35 & Off-Payroll Working
A contractor guide.

Inside vs outside IR35: what it means in practice

For contractors and IT consultants, your IR35 status affects how you are paid, who carries the tax risk, and how much you keep.

The key status tests

IR35 status is not determined by job titles or simply holding a limited company. It is determined by case law. HMRC looks past your written contract to examine your working practices across three main tests:

Off-payroll working rules and liability

The mechanism for determining IR35 status changed with the introduction of the Off-Payroll Working rules in the public sector (2017) and the private sector (2021). The responsibility for determining status depends on the size of your end client.

• A
  Medium or large clients If your end client is classed as a medium or large business, they are legally responsible for determining your IR35 status. They must provide you with a Status Determination Statement (SDS). If they incorrectly determine you are Outside IR35, HMRC will generally pursue the fee-payer for the missing tax.
• B
  The small company exemption If your end client is a small business (meeting two of: turnover under £10.2m, balance sheet under £5.1m, fewer than 50 employees), the Off-Payroll rules do not apply. The responsibility and financial liability for determining IR35 status remains with you, the contractor.

Problems with the CEST tool

To assist with status determinations, HMRC provides the Check Employment Status for Tax (CEST) tool. Many end clients use this exclusively to generate Status Determination Statements.

Tax calculations and the financial difference

The difference between Inside and Outside IR35 can be large. An Inside IR35 determination can reduce your net take-home pay by up to 25%. Run the numbers on your day rate with our IR35 take-home calculator to see the day-rate impact and the break-even uplift you would need to negotiate.

• Outside IR35: You draw a planned director's salary up to the National Insurance Primary Threshold. The remaining profit is subject to Corporation Tax, with equipment purchases typically qualifying for the Annual Investment Allowance or Full Expensing. The post-tax profit is then extracted as a mix of dividends and retained reserves. The dividend vs bonus comparison and our Director Pay calculator run through the arithmetic.
• Inside IR35: Your gross invoice (minus VAT) is treated as salary. The fee-payer deducts Income Tax and Employee National Insurance. Furthermore, Employer's National Insurance and Apprenticeship Levy costs are often factored into the offered day rate, suppressing your gross revenue. Concurrent Outside contracts (see the director pay guides) require careful year-end planning to keep the two income streams distinct.

Compliance and how to defend your position

Defence falls into two streams depending on who is responsible for your status determination. If the end client is medium or large, they issue a Status Determination Statement (SDS) and you challenge it through the client-led disagreement process. If you are claiming the Small Company Exemption and self-determining, evidence needs to be prepared before there is a dispute. Both streams need the same thing: a documented, contemporaneous record that your working practices genuinely reflect a business-to-business relationship.

Challenging an SDS: The Client-Led Disagreement Process

Where the end client is medium or large, Chapter 10 ITEPA 2003 gives the worker a statutory right to disagree with the SDS. The client must operate a formal disagreement process and is required to respond within 45 days. The deemed employer (typically the fee-payer) is bound by the original SDS until a revised determination is issued, so deductions continue during the dispute. You are arguing for a change going forward and a potential later repayment, not an immediate switch in how you are paid.

1. Submit a written representation to the end client. State clearly which conclusions in the SDS you disagree with, reference the status tests (substitution, control, mutuality of obligation, financial risk, part and parcel), and attach supporting evidence.
2. The client must consider your representation and issue either a confirmation of the original SDS with reasons, or a new SDS. Failure to respond within 45 days means the client (not the fee-payer) becomes liable for the PAYE shortfall.
3. If the SDS is confirmed, you have no further statutory appeal route against the end client. Your remaining options are: (a) re-open working-practice negotiations to change the facts on the ground and request a fresh determination, or (b) accept the determination and move to recovery via Self Assessment if evidence later supports a refund claim.
4. Never let the fee-payer treat you as Inside without a compliant SDS. If no SDS has been issued, or it has not been passed down the chain to the fee-payer, liability defaults up the chain to the client. This is a negotiating lever.

What belongs in an IR35 evidence pack

An evidence pack is the file you produce if HMRC opens an enquiry, or if you need to substantiate a disagreement. It should be compiled contemporaneously, created during the engagement, not reconstructed afterwards. HMRC enquiries can reach back six years, so the pack must survive staff changes at the client and memory gaps on your side.

A Confirmation of Arrangements document, signed by the end-client manager who supervises the work, is usually the most useful item in the pack. It helps show that the written contract matches the day-to-day arrangement.

Responding to an Inside IR35 Determination

If the SDS lands as Inside and a disagreement is unlikely to shift it, the question becomes operational rather than legal. You have four realistic routes, and the right answer is usually a blend:

• Operate through the fee-payer as a deemed employee. Your PSC continues to exist but the contract income flows through payroll with PAYE and Employee NI deducted. The net is paid into your PSC and can be distributed without further tax, since it has already been taxed at source (a 5% deductible expense allowance historically available to the worker was withdrawn in 2017 for public-sector and 2021 for private-sector contracts, with no further relief applying).
• Switch to an umbrella company for Inside contracts. This eliminates the administrative burden of running a dormant-for-this-contract PSC and gives a cleaner separation between Inside and Outside work. Check the umbrella is on HMRC's list of approved providers and that the take-home calculation is transparent. Disguised-remuneration schemes marketed as "umbrella" are still being pursued under the Loan Charge.
• Renegotiate the day rate. An Inside rate must absorb Employer NI (15.05%) and the Apprenticeship Levy (0.5%) that the fee-payer now has to pay. A rate that made sense Outside is typically 20-25% too low Inside. Walking away from a contract that cannot be re-rated is often the correct commercial answer.
• Change the working practices. If the Inside conclusion is driven by a small number of fixable facts (a fixed desk, a line manager, no right of substitution), a genuine structural change to the engagement, followed by a fresh SDS request, can move the determination. This only works if the facts change; cosmetic edits to the contract alone will fail.