IR35 explained: does it affect your limited company?

IR35 has been a thorn in the side of limited companies that provide professional services since April 2000.

The financial consequences if your work is caught by this tax rule are significant.

In this concise guide, we explain IR35 and how to ensure that your company falls outside its scope.

We also examine the ‘Off-Payroll’ rules, which are separate but related legislation and—confusingly—are also referred to as ‘IR35’.

Why was IR35 implemented?

From the late 1980s onwards, the IT industry saw a boom in the number of professionals opting to work via their own limited companies as ‘contractors’ rather than as payroll employees.

As the numbers increased, HMRC believed that many of these new company directors were, in fact, ‘disguised employees’ rather than bona fide small business people.

Many would work 9-5 for an employer one day, only to return the next day as limited company contractors, performing exactly the same work.

If you work via your own company rather than staying in traditional employment, you will pay less overall tax.

This is mainly because National Insurance Contributions (NICs) are not payable on dividends.

The differential is smaller than in the late 1990s, thanks to the 2016 dividend tax hike and more recent corporation tax rise.

However, it is still beneficial (tax-wise) to be a contractor rather than a traditional employee.

In response to the huge growth in the number of so-called ‘personal services companies,’ the government implemented the Intermediaries Legislation (IR35) on April 6th, 2000.

These rules were created to combat what it saw as widespread avoidance of tax and NICs by disguised employees. The legislation is contained within Chapter 8 of ITEPA 2003.

The term ‘IR35’ originates from the number of the press release which first detailed HMRC’s planned clampdown.

What are the IR35 rules exactly?

In essence, if you undertake a contract role, and the terms of the contract and the way you perform the role are more akin to those of a normal employee than a ‘self-employed’ person, then that particular contract would be subject to IR35.

After allowing a fixed 5% allowance* to meet your company’s running costs, the remaining contract revenue is subject to normal employment taxes (NICs and income tax).

If a contract is deemed to be caught by IR35, its net return could be cut by 25%.

* does not apply in the public sector

2017, 2021 – the ‘Off Payroll’ rules are introduced

In April 2017, following concern that disguised employment was rife in state-run organisations, a new piece of legislation – ‘Off-Payroll’ working – was created.

This legislation is contained within Chapter 10 of ITEPA 2003.

According to the HMRC:

…this measure moves responsibility for deciding if the off-payroll rules for engagements in the public sector apply, from an individual worker’s PSC to the public sector body, agency or third party paying them.

The new rules forced clients to decide whether workers were subject to IR35. Therefore, the onus for determining employment status switched away from workers themselves.

The fee-payer in the employment chain is responsible for deducting employment taxes from the worker’s income.

Following a COVID-related delay, the off-Payroll rules hit the private sector from April 2021 onwards.

This led to a dramatic drop in the number of limited company contractors working for end clients.

The only exemptions from the new rules are ‘small companies’, where the original IR35 rules still apply (i.e. the worker continues to self-assess their IR35 status).

Many risk-averse clients have opted to blanket ban limited company workers due to the heavy penalties associated with non-compliance. Unfortunately, many blanket bans (particularly in the City) remain in place today (2025).

Off-Payroll repealed – and then reinstated – in 2023

Dramatically, on September 23rd 2022, Chancellor Kwasi Kwarteng announced that the Off-Payroll rules would be abolished in April 2023. 

However, new Chancellor Jeremy Hunt cancelled the repeal on October 17th 2022.

So, things remain as they are for now.

How do you know if your work is caught by IR35?

In the event of a tax investigation by HMRC, the terms of your written contract and your working conditions will be examined to provide an overall picture of the true nature of your work.

Some of the main factors considered include:

• Control – to what extent is the contractor under the direct control and supervision of the end-client?
• Substitution – can the contractor provide a substitute if they cannot perform their contract duties?
• Mutuality of Obligation – when the current fixed-term contract period has expired, is there a reasonable expectation of a renewal?

Even if these factors are concisely addressed in the written contract, they must also reflect how you work.

Read more about IR35 on ITContracting.com – lots of in-depth guides.

How can I protect myself against IR35?

This all depends on your contract status.

1) Contracting with a small company client: you determine your IR35 status

If you are a contractor with a small company client(as defined by the Companies Act 2006: fewer than 50 employees, turnover under £10.2 million, or a balance sheet under £5.1 million), you are responsible for determining your IR35 status.

In this case, you should follow these steps to protect yourself:

• Have your contracts reviewed by an IR35 specialist – they will make sure both the wording of the contracts and your working practices match and demonstrate that you are outside IR35.

• Show that you are truly ‘self employed’ – see the ‘control’, ‘mutuality of obligation’ and ‘substitution’ factors listed above.

• Take out IR35 insurance – consider tax investigation insurance, which covers legal and professional fees in the event of an HMRC investigation. Some policies also cover additional tax liabilities if you are found inside IR35.

2) Working outside IR35 for a large company: the client holds the liability

If you contract for a medium or large company, the client determines your IR35 status.

If the client states that your role is outside IR35, you should still take steps to protect yourself:

• Make sure your client provides you with a Status Determination Statement (SDS) – this states your IR35 status, and the reasoning behind it.

• Maintain ‘self employed’ working practices – work independently, avoid employee-like benefits, and ensure the wording of your contract matches your working conditions.

• Monitor the client’s IR35 compliance – clients are notoriously risk-averse regarding IR35, and could reassess roles (even at renewal time).

3) Working inside IR35 via your limited company

If the client allows you to contract via your limited company (on an inside basis), you can take some steps to improve your position.

• Negotiate better contract terms: If possible, negotiate higher rates to offset your increased inside-IR35 tax liability.

• Consider working through an umbrella company. This may be a hassle-free option compared to maintaining your company. You can also keep your company active while working for an umbrella company.

• Make sure the correct deductions are made: Your fee-payer (client or agency) must deduct PAYE tax and National Insurance before paying your company. You will need an IR35-aware accountant to double-check everything.

4) Working as an umbrella employee: IR35 does not apply

You may choose to contract via an umbrella company out of choice. Or – as is often the case – you take on an ‘inside IR35’ role, and the client has a no-limited company policy, so you’re forced to go down the umbrella route.

If you work through an umbrella company, IR35 is not a concern because you are already taxed as an employee through PAYE. However, you should still take steps to protect your earnings and employment rights:

• Choose a reputable umbrella company: Ensure your provider is a UK-based, FCSA-accredited PAYE umbrella company. Avoid offshore or disguised remuneration schemes.

• Understand your deductions: Check what fees and deductions are taken from your pay. Unscrupulous umbrellas have been known to ‘skim’ employees’ pay.

• Check for employment rights: As an umbrella employee, you should receive statutory benefits such as holiday pay, sick pay, and pension contributions.

Is IR35 insurance still necessary?

Tax investigation insurance will cover the cost of professional representation during an HMRC investigation. 

You may also take out a more comprehensive policy, which will cover your company for the costs of any taxes you may be deemed to owe following an HMRC investigation.

Since the introduction of the off-payroll rules, end-clients (aside from small companies) have held the IR35 liability and determined your employment status. So, you won’t need IR35 insurance for those particular contracts.

However, it is recommended in the following scenarios.

• You work for a ‘small company’ client and determine your own employment status.
• You have a mix of ‘inside’ and ‘outside’ IR35 contracts.
• If you’ve worked outside IR35 in the past, HMRC can review your engagements going back up to 6 years.
  
• Insurance can provide retrospective protection if HMRC challenges your past tax arrangements.

The leading provider for contract reviews and IR35 insurance is Qdos.