If you are a contractor who provides services through a personal service company (PSC) or another intermediary, understanding the difference between inside vs outside IR35 is crucial. Your IR35 status can affect how your income is taxed, who determines your status, and how much of your contract income you ultimately receive.
The rules can be complex, particularly because responsibility changes depending on whether you work for a small private-sector client, a medium or large private-sector client, or a public-sector organisation.
This blog explains the difference between inside vs outside IR35, its tax implications, and who determines the IR35 employment status.
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What Is IR35?
Off-payroll working rules, sometimes known as IR35 rules, are designed to determine whether an individual or a contractor pays broadly the same Income Tax and National Insurance (NI) as an employee would.
The off-payroll working rules may apply if the contractor who provides services to a client through their own intermediary would have been an employee if they were providing their services directly to that client.
You need to understand that inside vs outside IR35 is basically a tax status test. You should not confuse it with determining whether someone has employment rights under employment law.
What Is Inside vs Outside IR35?
Your IR35 status determines how the off-payroll working rules apply to a particular engagement. These rules ensure that workers or contractors who would have been employees if engaged directly pay broadly the same Income Tax and NI as employees.
What Is Inside IR35?
If your engagement falls Inside IR35, you are treated as employed for tax purposes for that engagement. Where the inside IR35 rules apply, the fee-payer generally deducts Income Tax and employee NI through Pay As You Earn (PAYE) and pays employer NI. Keep in mind that being inside IR35 does not, by itself, give you employment rights with the client.
What Is Outside IR35?
Outside IR35 means the off-payroll rules do not apply to that engagement. However, your intermediary remains responsible for the relevant tax and reporting obligations.
Look at the table below for a quick comparison of inside vs outside IR35:
| Factor | Inside IR35 | Outside IR35 |
| Off-payroll rules | Apply | Do not apply |
| Tax treatment | Treated as employed for tax purposes. | Off-payroll PAYE rules do not apply; the intermediary handles its normal tax and reporting obligations. |
| Income tax | PAYE is usually operated by the fee payer | Not deducted under off-payroll rules |
| Employee NICs | Usually deducted through PAYE | Not deducted under off-payroll rules |
| Employer NICs | Paid by the deemed employer where applicable | Not paid under the off-payroll rules |
| Employment rights | Not automatically created by IR35 status | Not automatically created by IR35 status |
Disclaimer: This table highlights the off-payroll tax rules. It should not be interpreted as a complete comparison of a contractor’s overall tax position.
What Are Inside vs Outside IR35 Tax Implications?
An engagement inside IR35 is subject to employment-style tax treatment under IR35 rules where those rules apply, normally involving PAYE Income Tax and employee NI deductions by the relevant fee-payer.
An engagement outside IR35 is not subject to the off-payroll rules. Therefore, the intermediary generally remains responsible for its normal Corporation Tax, PAYE, dividend and other tax obligations. Keep in mind that the overall financial outcome depends on the worker’s circumstances and should not be assumed from IR35 status alone.
Who Do the IR35 Rules Apply to?
You may be affected by the off-payroll rules if you are a contractor, client, or an agency or other supplier.
Small Private-Sector Clients
If the client is a small private-sector organisation, they generally do not have to determine the contractor’s IR35 status. The responsibility remains with the contractor’s intermediary, but the client may still need to confirm its size if asked.
Medium and Large Private-Sector Clients
Usually, a medium or large private-sector client is responsible for determining whether the off-payroll rules apply and issuing a Status Determination Statement (SDS).
Public-Sector Clients
Public-sector clients are responsible for deciding the contractor’s status for the off-payroll rules.
How to Determine IR35 Status?
Now that you understand the differences between inside vs outside IR35, it is useful to learn how HMRC determines IR35 status. HMRC considers several factors and the overall working relationship while determining IR35 compliance, and these are considered separately for each contract per client. Some of the key factors are:
Personal Service
If you have a genuine, unrestricted right to provide a substitute, this can point towards self-employment, but the right must be genuine and reflect the actual relationship.
Control
If you have control over who decides what work is done, how, when and where it is carried out, it may indicate self-employment.
Mutuality of Obligation
Another factor HMRC considers in determining inside vs outside IR35 status is mutuality of obligation (MOO). This IR35 assessment considers whether the client is obliged to provide and pay for work and whether the worker is obliged to perform it.
These are important indicators, but IR35 is not determined by a simple three-factor checklist. HMRC considers the overall circumstances of the engagement, including the contractual terms and how the relationship operates in practice.
Keep in mind that for IR35, the assessment is made on a contract-by-contract basis. For a small private-sector client, the worker’s intermediary usually remains responsible for determining whether the off-payroll rules apply.
What Are the Red Flags for IR35?
While discussing Inside vs Outside IR35, it is essential to understand the IR35 risk factors. These risk factors are circumstances that may indicate an engagement is more consistent with employment for tax purposes.
Some of the red flags for IR35 are:
- The client decides your working hours and location.
- You are integrated into the client’s organisation.
- You are closely supervised like an employee.
- You cannot determine how the work is carried out.
How Much is 500 Per Day Inside IR35?
At a £500 daily contract rate inside IR35, your estimated net take-home pay is approximately £290 to £340 per day. However, your take-home pay will be lower because Income Tax and employee NI are deducted through PAYE.
For instance, 220 billable days at £500 gives a contract value of £110,000 before considering the deductions and costs associated with the engagement. The exact amount you receive depends on your working days, fee-payer arrangement, tax code, pension, and other income. So, it is not reliable to declare that every contractor on £500 a day inside IR35 will receive a fixed amount.
Is it Better to Be Inside or Outside IR35?
One of the most frequent questions people ask when discussing inside vs outside IR35 is which option is better. Neither inside IR35 nor outside IR35 is good or bad. The better choice depends on your risk tolerance, financial goals, and how you prefer to run your career.
Outside IR35 is typically more tax-efficient for a genuine business-to-business engagement. This is because the off-payroll rules do not apply and the intermediary handles its own tax obligations.
In contrast, inside IR35 generally results in higher employment-style tax and NIC deductions. However, the contractor may still prefer it depending on the rate, contract, benefits and circumstances.
Who Decides Whether a Contractor Is Inside or Outside IR35?
The table below highlights the inside vs outside IR35 status determination:
| Client type | Who normally determines status? |
| Public sector | Client |
| Medium/large private sector | Client |
| Small private-sector client | Contractor’s intermediary/PSC |
What Is the 2 year Rule for Contractors?
In the UK, the 24-month rule is an HMRC guideline that dictates whether a contractor can claim tax relief on travel and subsistence expenses.
Under this rule, a workplace is not treated as temporary when the contractor spends or is expected to spend 40% or more of their working time there over a period lasting or expected to last more than 24 months. In that case, the workplace is generally treated as a permanent workplace and ordinary commuting costs are not eligible for relief.
Note that the 24-month rule is not an IR35 test. It relates to the tax treatment of travel and subsistence expenses.
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The Bottom Line
The difference between inside vs outside IR35 depends on whether the contractor would be considered an employee for tax purposes if engaged directly by the client. Inside IR35 means the off-payroll rules apply, with PAYE and NI handled by the relevant fee-payer. Outside IR35 means IR35 rules do not apply, and the intermediary remains responsible for their normal tax obligations.
IR35 status depends on the actual working relationship, including working practices and contractual terms. It does not depend solely on the contract wording or company structure.
If you have complex engagements, it is best to consider professional advice. At MicroEntityAccounts, we can help you assess your contract, review your IR35 position, and keep your business compliant with HMRC requirements. Get a quote today!
