A guide to IR35 (off-payroll working)

The IR35 off-payroll working rules have significantly changed how businesses engage with contractors in the UK. These regulations, designed to tackle what HMRC calls “disguised employment,” affect both contractors and the organisations that hire them.

It’s a complex area, and this blog breaks down what IR35 means for both public and private sector organisations, helping you navigate compliance and avoid potential penalties.

What is IR35?

Let’s start with the basics.

IR35, also known as the Intermediaries Legislation or Off-Payroll Working Rules, was introduced in 2000 to combat tax avoidance by workers who provide services through an intermediary (typically their own limited company or Personal Service Company) but who would be considered employees if the intermediary weren’t used.

So, for example, an IT professional working within his own limited company, with him as the only employee, and providing a service for a single client that required him to work full time on their business.

The legislation aims to ensure that individuals who work like employees pay similar income tax and National Insurance contributions as employees, regardless of the structure they work through.

The 2017 and 2021 reforms

Public sector reform (April 2017)

In April 2017, the government introduced significant changes to how IR35 was applied in the public sector:

• Responsibility shift: The responsibility for determining IR35 status moved from the contractor to the public sector client.
• Tax liability: The fee-payer (usually the public body or agency) became responsible for deducting tax and NICs before paying the contractor’s PSC if the engagement was deemed inside IR35, effectively an employee, but for the use of the intermediary company

Private sector reform (April 2021)

After delaying implementation due to the COVID-19 pandemic, similar changes were extended to the private sector in April 2021:

• Medium and large businesses became responsible for determining the IR35 status of their contractors.
• Small company exemption: Private sector businesses meeting the “small company” criteria remain exempt, with contractors continuing to determine their own IR35 status.

Who is affected?

Public sector

• All public authorities, including government departments, the NHS, local authorities, police forces, and educational establishments
• Agencies and third parties that supply contractors to the public sector
• Contractors who provide services to public sector clients through their own limited company

Private sector

• Medium and large-sized private sector businesses that meet at least two of these criteria:
  • Annual turnover of more than £15 million
  • Balance sheet total of more than £7.5 million
  • More than 50 employees
• Agencies and third parties supplying contractors to medium/large private businesses
• Contractors providing services to medium/large private sector clients

Small Company Exemption

Private sector organisations qualifying as “small” are exempt from the rules. A business is considered small if it meets at least two of these conditions:

• Annual turnover of £15 million or less
• Balance sheet total of £7.5 million or less
• 50 employees or fewer

For these small businesses, contractors continue to determine their own IR35 status. It is highly recommended that a small company engaging workers that may be caught by IR35, obtain the checks that the contractor has made.

Key responsibilities

Client responsibilities (Public and Medium/Large Private)

1. Status determination: Assess whether each engagement falls inside or outside IR35
2. Status Determination Statement (SDS): Provide a written determination and reasoning to the contractor and any agencies in the supply chain
3. Reasonable care: Take reasonable steps to reach the correct conclusion about status
4. Dispute resolution process: Implement a process to handle disagreements about status determinations
5. Record keeping: Maintain detailed records of determinations and processes

Fee-Payer Responsibilities

If an engagement is deemed inside IR35, the fee-payer (the organisation that pays the contractor’s limited company) must:

1. Calculate and deduct income tax and employee NICs from the contractor’s fee. If the contractor is VAT registered, then the amount on which tax and NIC are calculated is the net invoice amount.
2. Pay Employer NICs (currently 15%)
3. Report and pay these deductions to HMRC through the payroll system
4. Consider the Apprenticeship Levy implications

Determining IR35 status

HMRC looks at several key factors to determine employment status:

Control

• Does the client control what, how, when, and where the contractor completes the work?
• Can the contractor choose their own working hours?
• Is the contractor subject to the same management and supervision as employees?

Substitution

• Can the contractor send someone else to do the work in their place?
• Is personal service required?
• Would the client accept a substitute if one were offered?
• If a substitute is offered, are they suitably qualified, and have the necessary checks been undertaken

Mutuality of Obligation (MOO)

• Is the client obligated to provide ongoing work?
• Is the contractor obligated to accept work offered?
• Does the contractor work on a project-by-project basis?

Other factors

• Financial risk: Does the contractor take financial risks that employees don’t? If work has not been undertaken to a satisfactory standard, does the worker have to repair it at their own cost?
• Equipment: Who provides the equipment needed to complete the work?
• Integration: How integrated is the contractor into the organisation? Things to look out for are email addresses, business cards, mobile phones and vehicles provided by the engager
• Exclusivity: Can the contractor work for other clients simultaneously?

Tools for determining status

CEST Tool

HMRC provides the Check Employment Status for Tax (CEST) tool to help determine IR35 status. While using CEST isn’t mandatory, HMRC will stand by its results if accurate information is provided.

Limitations of CEST

• Criticised for oversimplification
• May not handle complex scenarios well
• Doesn’t adequately address mutuality of obligation
• May provide indeterminate results

Many organisations supplement CEST with independent specialist reviews or other assessment tools.

Compliance and best practices

For public and private sector organisations

1. Document everything: Maintain detailed records of how you reached each determination
2. Consistent process: Implement a standardised assessment process
3. Regular reviews: Reassess contracts periodically and when circumstances change
4. Supply chain due diligence: Ensure agencies understand their obligations
5. Communication: Maintain open communication with contractors about determinations
6. Preparation for disputes: Develop a robust dispute resolution process
7. Consider blanket approaches carefully: Avoid “blanket determinations” that treat all contractors the same

For contractors

1. Review contracts: Ensure contracts reflect the reality of the working relationship
2. Build evidence: Gather evidence supporting outside IR35 status, where applicable
3. Challenge inaccurate determinations: Use the client’s disagreement process
4. Consider operating models: Evaluate whether a limited company remains the best option, both engager and worker may agree that employment is appropriate, which may be particularly beneficial to the worker with the benefit of employment rights etc
5. Specialist advice: Seek professional tax and legal advice

Consequences of non-compliance

Financial penalties

Non-compliance with IR35 regulations can result in severe financial consequences that extend far beyond simple tax adjustments.

Organisations face liability for all unpaid taxes and National Insurance Contributions, along with interest charges applied to late payments that can accumulate significantly over time.

Perhaps most concerning are the penalty provisions, which can reach up to 100% of the tax due in cases where HMRC determines there has been carelessness or deliberate non-compliance, effectively doubling the financial burden.

Beyond the immediate financial impact, IR35 non-compliance also carries substantial reputational risks that can have lasting effects on business operations. HMRC has the power to publicly name non-compliant businesses, creating negative publicity that can damage relationships with clients, suppliers, and stakeholders.

This public scrutiny often makes it more difficult to attract high-quality contractor talent, as skilled professionals may be reluctant to work with organisations that have demonstrated tax compliance issues. Additionally, businesses that fall foul of IR35 regulations frequently find themselves subject to increased scrutiny from HMRC across all their tax matters, leading to more frequent audits

HMRC are keen to make an example of high-profile individuals, as such cases achieve the most publicity. The fact that HMRC have lost many of such cases does not deter them from spending a lot of time and money pursuing individuals who they consider should be within IR35.

An example of how tricky assessing IR35 can be is the case between TV presenter Adrian Chiles and HMRC, which has lasted for eight years. During this time, HMRC initially lost in 2022 but then won on appeal in 2024.

The future of IR35

The off-payroll rules continue to evolve, with possible future developments including:

• Simplification: Potential streamlining of the rules
• Alignment: Greater alignment of tax and employment law
• Enforcement: Increased HMRC compliance activity
• Legal challenges: Ongoing case law development

It is widely accepted that IR35 has not brought into the Exchequer the amounts of tax and NIC first envisaged. There remains a clamour in some circles for IR35 to be abolished. Let’s wait and see what changes, if any, there are in the future.

Navigating IR35 remains challenging for both public and private sector organisations. The key to compliance lies in understanding the rules, implementing robust determination processes, and maintaining detailed records.

By taking a proactive approach, organisations can mitigate risks while still accessing the valuable skills and flexibility that contractors provide. And for contractors, adapting to the new landscape with professional advice will help navigate these complex regulations.

For both sectors, seeking professional legal and tax advice remains essential to ensure compliance with these complex and evolving rules.