IR35 · Contractor guide · Updated May 2026

IR35 explained: inside vs outside IR35 for UK contractors.

Written by Iftikhar Rashid FCCA — Managing Partner, RR Accountants. 16 years in practice, specialist in contractor and limited company tax.

What is IR35?

IR35 (the off-payroll working rules) is UK legislation that taxes contractors working through a personal service company (PSC) as employees if their working arrangements resemble employment. An inside IR35 determination means the engagement is treated as employment — income is taxed as a deemed salary with PAYE and National Insurance. An outside IR35 determination means the contractor can use their PSC tax efficiently, extracting income through salary and dividends. For medium and large clients, the end client makes the determination since April 2021. [VERIFY: gov.uk]

Who this applies to: UK contractors working through a personal service company (PSC/limited company).

Why it matters: Inside IR35 typically costs a contractor 15–25% of gross contract income compared to outside IR35. On a £600/day rate, that is £30,000–£50,000+ per year.

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Inside IR35 vs outside IR35

Inside IR35

  • ✕Engagement treated as employment for tax
  • ✕Fee processed as deemed salary payment
  • ✕PAYE income tax deducted at source
  • ✕Employee NI deducted at source
  • ✕Employer NI borne by fee-payer (agency or client)
  • ✕Cannot use salary + dividends strategy for this engagement
  • ✕No tax benefit from PSC for this contract
  • ✕5% expenses allowance available (private sector only) [VERIFY]

Outside IR35

  • ✓Genuine business-to-business arrangement
  • ✓Income received by PSC in full
  • ✓Extract via salary + dividends strategy
  • ✓No PAYE or NI on dividend extraction
  • ✓Full PSC tax efficiency maintained
  • ✓Can claim allowable business expenses
  • ✓Retain profits within company for reinvestment
  • ✓Annual accounts and CT600 still required

The key IR35 tests

HMRC assesses the real working relationship — not just what the contract says. Source: gov.uk/guidance/understanding-off-payroll-working-ir35

Substitution

High weight

Outside IR35

You can send a qualified substitute to perform the work without client approval

Inside IR35

You must personally perform all the work — no substitution permitted

Control

High weight

Outside IR35

You decide how, when, and where the work is done

Inside IR35

The client controls your hours, methods, and location

Mutuality of obligation

High weight

Outside IR35

No obligation for the client to offer work or you to accept it beyond the contract

Inside IR35

Expectation of ongoing work; you are expected to accept it

Financial risk

Medium weight

Outside IR35

You bear genuine financial risk — can lose money, must fix errors at your own cost

Inside IR35

No financial risk — paid regardless of outcome

Integration

Medium weight

Outside IR35

You are visibly a supplier — different equipment, email, treatment from employees

Inside IR35

You are integrated into the workforce — same systems, management structure, benefits

IR35 — frequently asked questions

What is IR35?

IR35 (officially the off-payroll working rules) is UK tax legislation that determines whether a contractor working through a personal service company (PSC) should be taxed as an employee of the end client. If the working arrangement resembles employment — same control, no substitution, no financial risk — HMRC treats the income as employment income and taxes it accordingly, regardless of the PSC structure.

What is the difference between inside and outside IR35?

Outside IR35: the engagement does not resemble employment. The contractor can extract income through salary and dividends from their PSC, retaining the tax efficiency of company ownership. Inside IR35: the engagement is treated as employment for tax purposes. The fee must be processed as a deemed salary payment, with PAYE and NI deducted. The contractor cannot use the dividend strategy for that engagement.

Who decides IR35 status?

Since April 2021, for medium and large clients (public sector and private sector), the end client (the business engaging the contractor) is responsible for assessing IR35 status via a Status Determination Statement (SDS). For small private-sector clients, the contractor's own PSC remains responsible for the determination. [VERIFY: current rules at gov.uk/guidance/understanding-off-payroll-working-ir35]

What are the IR35 tests?

HMRC assesses IR35 status using several key tests: (1) Control — does the client control what, where, and how you work? (2) Substitution — can you send someone else to do the work? (3) Mutuality of obligation — is the client obliged to offer work and you obliged to accept? (4) Financial risk — do you bear genuine business risk? (5) Integration — are you treated as part of the workforce? HMRC's CEST tool provides a determination, but it is not always reliable and is not binding.

How much more tax do I pay inside IR35?

Inside IR35, the deemed salary is subject to income tax at your marginal rate plus employee National Insurance — and the fee-payer (the agency or end client) must deduct employer NI too. The effective tax rate inside IR35 is significantly higher than the salary-plus-dividends approach outside IR35. The difference is commonly estimated at 15–25% of gross contract income, though exact figures depend on rate, personal allowance, and structure. [VERIFY: current NI and income tax rates at gov.uk]

Can I challenge an inside IR35 determination?

Yes. If a client issues a Status Determination Statement placing you inside IR35, you can use the client-led disagreement process to challenge it. You need to provide evidence against the key employment indicators — typically via a carefully worded contract and evidence of actual working practice. The contract alone is not sufficient; HMRC looks at the real working relationship.

Does IR35 apply to all contractors?

IR35 applies to contractors working through a personal service company (PSC). It does not apply to sole traders (who are taxed as employed or self-employed on their own income), umbrella company workers (already on PAYE), or genuinely self-employed individuals without a PSC. The rules also do not apply to small private-sector clients, where the PSC retains responsibility for the determination.

What should I do before signing a new contract?

Before signing: (1) review the contract for employment indicators (substitution clause, control language, mutuality of obligation); (2) run the CEST tool as a guide; (3) consider an IR35 assessment from a specialist; (4) document how the engagement actually works in practice — not just what the contract says. We review contracts and working practices for every contractor client before they sign.

Related guides and services

Source: gov.uk — Understanding off-payroll working (IR35). This guide is for information only — not personalised tax advice.

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Iftikhar Rashid FCCA · 16 years · Specialist in contractor and PSC tax