What employers need to know about off payroll workers
If you’re an employer working with contractors or freelancers, understanding IR35 is essential. This blog explains everything you need to know about these tax rules in simple terms, helping you stay compliant and avoid unexpected penalties.
What is IR35?
IR35, also called the off-payroll working rules, is tax legislation designed to stop tax avoidance. It applies when contractors provide services through their own limited company (often called a Personal Service Company or PSC), but would actually be considered employees if they weren’t using this company structure.
The rules aim to ensure contractors who work like employees pay similar taxes and National Insurance as regular employees, regardless of how they’re structured.
Why IR35 matters for employers
Since April 2021, medium and large private sector employers have become responsible for determining the IR35 status of their contractors.
A small employer defined by the following criteria does NOT need to assess workers for IR35; the responsibility lies with the worker to notify the engager:
The definition of what is a ‘small business’ is taken from the Companies Act 2006 and will apply to limited companies, LLPs, unregistered companies and overseas companies.
The government has recently updated the eligibility thresholds for the definition of ‘small’ companies in the private sector, and these new thresholds apply from 6 April 2025. However, threshold changes may have no practical impact for off-payroll working until 6 April 2027, because a company’s size is determined by reference to the previous year’s accounts. Companies must be prepared now, however.
The thresholds have increased, so companies that were previously deemed as ‘medium’ may now be classed as small and will not need to determine IR35 status.
The latest eligibility thresholds state that a business will be small if it satisfies two or more of the following requirements:
- It has an annual turnover not exceeding £15m (previously £10.2m)
- It has a balance sheet total not more than £7.5m (previously £5.1m)
- It had an average of no more than 50 employees for the company’s financial year.
Medium and large businesses will need to decide whether to treat contractors as employees for tax purposes.
You might need to deduct tax and National Insurance from their payments, but only from the net invoice figure.
If the worker is VAT registered, tax and NIC are not applied to the VAT element of an invoice.
Getting it wrong can result in hefty financial penalties and back taxes.
If the engager is classified as a ‘small’ company, the responsibility will fall on the worker to assess whether they are caught by IR35. The worker, therefore, must undertake an assessment using HMRC’s CEST tool to assess their status, and if they are deemed to be caught by IR35, they must notify the engager.
The engager then processes the worker as caught by IR35, through the payroll and deducts income tax and National Insurance Contributions.
How to determine IR35 status
HMRC considers several key factors when deciding whether a contract falls inside or outside IR35. These consider whether the ‘contractor’ is actually working like an employer, rather than a supplier.
Control
Consider the extent of your control over the contractor’s work. If you control how, when, and where they work, they’re more likely to be inside IR35.
Ask yourself –
- Do you set their hours?
- Do you tell them exactly how to do their job?
- Do you manage them like your employees?
If the answer is ‘yes’, then IR35 applies.
Substitution
A genuine contractor should be able to send someone else who is qualified to do the work instead of doing it themselves. If your agreement doesn’t allow this, it suggests an employment relationship.
Mutuality of obligation
This refers to whether you are obligated to provide ongoing work and whether the contractor is required to accept it. True business relationships usually involve specific projects with no expectation of continuous work.
Financial risk
Real contractors typically take on financial risks. They might invest in their own equipment, fix unsatisfactory work at their own expense, or potentially lose money on fixed-price contracts.
If they are responsible for something that has gone wrong, are they required to put it right at their own cost? If so, this is a pointer to being outside of IR35
Part and parcel
If a contractor becomes integrated into your organisation, having company business cards, appearing on the staff chart, and attending team events suggests they are more like an employee.
Steps for IR35 compliance
First, identify all your contractors who work through intermediaries and assess their risk level.
Next, create a thorough process for determining their status. You can use HMRC’s Check Employment Status for Tax (CEST) tool as a starting point; however, although Mutuality of Obligation is an integral part of tax case law on employment status, HMRC have not included this in the CEST tool.
I was heavily involved in the testing of CEST with HMRC. At the time, the concern was raised with HMRC, but they chose to ignore the Mutuality of Obligation. In my view, HMRC does not like the simple fact that if there is no obligation for the engager to offer work, and the worker to accept that work, there can be no employment; therefore, IR35 would not apply.
Of course, Mutuality is not the only factor to take into consideration. This is why it is important to get expert advice. Document all your decisions and review them regularly, particularly when contract terms are updated.
For each contractor, provide a Status Determination Statement explaining your decision. Send this to both the contractor and any agency in the supply chain.
You also need a process for handling disagreements. When contractors challenge your determination, you must respond within 45 days, either confirming your original decision with reasons or issuing a new determination.
Make sure your contracts and actual working practices align. HMRC will look at both what’s written and what actually happens day-to-day.
Financial implications
When a contractor is deemed inside IR35, they should be paid through PAYE. Either you or the fee-payer (if working through an agency) will need to deduct income tax and National Insurance contributions. The fee-payer will also need to pay Employers’ National Insurance.
Contractors legitimately outside IR35 can continue operating through their limited company, manage their own tax affairs, and potentially benefit from the tax advantages of company ownership.
Common mistakes to avoid
Many employers make blanket determinations, assessing all contractors uniformly without considering individual circumstances. This approach is often flawed and risky.
Some rely too heavily on the CEST tool without understanding its limitations.
Others focus only on contract terms while ignoring the reality of the working relationship.
Poor documentation is another common issue – failing to keep detailed records of how you made your determinations can cause problems if HMRC investigates.
Treating similar roles differently without a good reason is also problematic and might attract unwanted attention.
I have seen many cases where the engager has taken the worker’s word at face value that they are not working under IR35, because they do similar work elsewhere and are not under IR35 there.
Unless the engager meets the small business criteria above, the engager MUST undertake the assessment. The worker may not like the result; however, the responsibility lies with the engager.
Best practices for managing IR35
Consider IR35 status before engaging contractors. Think about whether the role you’re filling might look like employment to HMRC.
Review all your contractor relationships periodically to ensure ongoing compliance. As projects evolve, working practices might drift into employment territory.
Make sure your managers understand the basics of IR35 so they don’t accidentally create employment relationships through how they manage contractors.
IR35 compliance takes some effort, but with good processes in place, you can still benefit from the flexibility contractors offer. By understanding the rules, implementing solid determination processes, and keeping proper records, you can manage your IR35 risk effectively while still accessing the skilled
contractors your business needs.
Tax rules change over time, so staying informed about updates to IR35 is important for ongoing compliance.
