For UK contractors, a wrong turn into IR35 rules can significantly reduce take-home pay. But do you really know what IR35 is? Well, IR35 for contractors is a UK tax law designed to catch disguised employees who work like regular staff through their own limited company to pay less tax. IR35 can affect how your income is taxed, who is responsible for determining your employment status, and how much you ultimately take home.
This guide explains the IR35 rules for contractors, who determines your IR35 status and how, the difference between inside IR35 and outside IR35, and the potential tax implications.
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What Is IR35 for Contractors?
IR35 is commonly known as the UK’s off-payroll working rules. These rules make sure that a worker, sometimes known as a contractor, pays broadly the same Income Tax and National Insurance (NI) as employees.
The rules can apply when an individual provides services through an intermediary, such as a Personal Services Company (PSC), but would have been regarded as an employee if they had contracted directly with the client.
Who Decides IR35 Rules for Contractors?
The IR35 rules determine who is responsible for assessing a contractor’s employment status for tax purposes. Generally, the person responsible for determining the employment status depends on the client’s size and sector.
- The public-sector client is responsible for determining whether IR35 for contractors applies.
- A medium or large private- or voluntary-sector client is generally responsible for determining the worker’s employment status for tax purposes.
- A small private- or voluntary-sector client does not have to determine whether the off-payroll working rules apply. The worker’s intermediary generally remains responsible for making the determination.
Where the client is responsible, it must issue a Status Determination Statement (SDS) and explain whether the off-payroll rules apply and the reasons for the decision. So, contractors should check who is responsible for the determination rather than assuming they must make the IR35 decision themselves.
What Is the IR35 Status for Contractors?
To understand IR35 for contractors, it is essential to learn what IR35 status is. Your IR35 status determines whether your engagement falls inside or outside of the UK’s off-payroll working rules.
What Is Inside IR35?
If an engagement is inside IR35, the off-payroll working rules apply, and the worker is treated as employed for tax purposes for that engagement.
When the off-payroll rules apply, the fee-payer is responsible for accounting for Income Tax and employee NI through PAYE, along with applicable employer obligations. They take income tax and NI directly out of your pay before you receive it. Therefore, being inside IR35 can result in a different tax and NI position from an engagement outside the rules.
However, being inside IR35 for contractors does not give them employment rights. The off-payroll rules concern tax and NI and do not by themselves make the contractor an employee for employment-law purposes.
What Is Outside IR35?
If an engagement is outside the off-payroll working rules, the off-payroll rules do not apply to that engagement. The worker’s intermediary remains responsible for its normal tax and reporting obligations, including Corporation Tax where applicable, and the contractor may receive remuneration from the company through salary, dividends or other permitted methods.
The table below gives a quick comparison of inside and outside IR35 for contractors.
| Factor | Inside IR35 | Outside IR35 |
| Employment status for tax | Treated broadly like employment for the engagement. | Not treated as employment under the off-payroll rules |
| Tax treatment | Usually subject to PAYE when off-payroll rules apply. | Normal intermediary tax rules may apply. |
| Contractor’s flexibility | Potentially lower | Potentially higher |
| Assessment | Based on the specific engagement | Based on the specific engagement |
| Limited company planning | More restricted by PAYE treatment. | Greater scope for normal company remuneration planning. |
What Are the Three Rules of IR35?
You need to know that there are no three standard rules of IR35. However, there are important factors used when assessing IR35 for contractors.
Control
This explains who decides what work is done, where, when, and how it is performed. If there is a high degree of client control, it indicates employment, but it does not mean the engagement is inside IR35.
Right of Substitution
A genuine, unrestricted right for the contractor to provide a substitute can indicate self-employment. However, the actual contractual right and how it operates in practice matter.
Mutuality of Obligation
This includes whether the client is obliged to provide work and the worker is obliged to accept it.
These are important employment-status factors, but HMRC considers the overall circumstances of the engagement. No single factor automatically determines whether an engagement is inside or outside IR35.
Does Having a Limited Company Mean You Are Outside IR35?
No, a contractor can operate through a UK limited company and still have an engagement that falls inside IR35 rules. IR35 for contractors focuses on the nature of the relationship between the client and contractor, including what would happen if the intermediary were removed from the arrangement. Therefore, contractors should look beyond the company structure and consider both their actual working practices and their contract.
How Much is 500 Per Day Inside IR35?
A £500 daily rate inside IR35 is not equivalent to receiving £500 as take-home pay. When the off-payroll rules apply, Income Tax and employee NI are usually deducted through PAYE.
For example, a £500 daily rate over 220 billable days would produce £110,000 of gross contract fees before considering VAT, allowable expenses and the tax calculation. If the engagement is inside the off-payroll rules, the relevant deemed employment payment is subject to PAYE and National Insurance. The eventual take-home amount depends on the circumstances of the engagement and the worker.
Is it Worth Contracting Inside IR35?
Contracting inside IR35 for contractors can be worthwhile if they negotiate a higher day rate to make up for employee-level PAYE taxes or if they need immediate income.
Contracting inside IR35 can still be worthwhile, depending on the day rate, availability of work, contract length and your personal circumstances. Although the tax treatment may be less favourable than an outside-IR35 engagement, the contract could still offer attractive earnings or flexibility compared with permanent employment.
What Is the 5% Rule for IR35?
The 5% rule refers to a historic allowance under the IR35/off-payroll rules. It allowed contractors working inside IR35 via a PSC to claim 5% of their gross contract income tax-free to cover general business administration costs, without needing proof of actual expenses.
In 2017, the allowance was removed for the public sector and eliminated for medium and large private sector clients following the April 2021 off-payroll reforms. However, it may still apply only if you contract for a small private-sector company that is exempt from the off-payroll rules.
What Are the Common IR35 Mistakes Contractors Should Avoid?
Here are some of the common mistakes to avoid when it comes to IR35 for contractors:
Assuming a Limited Company Automatically Means Outside IR35
Remember that your company structure alone does not decide your IR35 position.
Relying Only on the Contract
The written contract is a crucial starting point for any IR35 assessment, but it is not the only factor HMRC considers. The actual day-to-day working relationship is important.
Treating an IR35 Decision as Permanent
IR35 status can differ from one engagement to another.
Ignoring Changes to the Engagement
If your responsibilities, contractual terms or working arrangements materially change, your IR35 position may need to be reconsidered.
Comparing Day Rates Without Considering Tax
An inside-IR35 engagement and an outside-IR35 engagement can have different financial consequences.
Accepting a Blanket IR35 Decision
A client should not automatically classify every contractor as inside or outside IR35 without considering the specific engagement. HMRC states that determinations should be based on the circumstances of the particular engagement.
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The Bottom Line
Understanding IR35 for contractors is important to manage contracts and finances. Whether your engagement is inside or outside IR35 depends on your specific contract and working practices. It does not simply depend on the contractor’s job title, day rate or limited company structure.
Factors such as control, substitution and mutuality of obligation can affect the overall circumstances of the engagement. If you are unsure about an IR35 determination, it is best to seek advice from a qualified UK tax or employment-status professional.
At MicroEntityAccounts, we have experienced contractor accountants who can help you assess your IR35 position and review your contract. Get a quote today and contract with confidence!
