What IR35 actually is
IR35 is the nickname for the off-payroll working rules — anti-avoidance legislation originally introduced in 2000 to stop people leaving permanent jobs on Friday and returning as "contractors" doing the same job on Monday at half the tax rate. The rule is simple in concept: if your working relationship looks like employment in all but name, you should be taxed like an employee, even if you invoice through a limited company.
What "looks like employment" means in practice is messy and case-law-driven. HMRC's Check Employment Status for Tax (CEST) tool and the case law it's built on consider many factors — but three carry the most weight.
Substitution
Can you send someone else to do the work in your place, at your discretion and your cost?
A real right of substitution — exercised at least once during the contract, with the client accepting the substitute — is the single strongest "outside IR35" indicator. Employees can't substitute; contractors can. If your contract says "personal services" or "you'll perform the work yourself", that's an indicator of inside status.
Mutuality of obligation (MOO)
Does the client have an obligation to offer you work, and you an obligation to accept it?
Real freelancers can turn down work. Employees can't (without consequences). If your contract is structured as "we'll provide a project and you'll deliver it" with no obligation to continue beyond the current project, that's outside-IR35-favourable. If it's "you'll work for us as we direct, ongoing", that's inside-IR35-favourable.
Control
Does the client direct how, when and where you work?
The more control the client exercises, the more it looks like employment:
- Set hours? Inside indicator
- Required to attend internal meetings? Inside indicator
- Have a line manager assigning daily tasks? Inside indicator
- You decide your method and timetable, with agreed deliverables? Outside indicator
Smaller factors also count: do you provide your own equipment, do you take financial risk (e.g., would you fix a defect at your own cost), are you "part and parcel" of the organisation (named in the org chart, on the company directory, attending all-hands events), how many clients you have at once.
Who decides status
This is the part that changed in 2021 and continues to trip up contractors.
| Engagement type | Who decides IR35 status |
|---|---|
| Public sector (since April 2017) | End client |
| Private-sector medium/large companies (since April 2021) | End client |
| Private-sector small companies | Contractor's own Ltd company |
| Overseas clients with no UK presence | Contractor's own Ltd company |
A "small" private company meets two of: turnover under £10.2m, balance sheet under £5.1m, ≤50 employees.
End clients issue a Status Determination Statement (SDS) at the start of the engagement, plus on any material change. If you disagree with the SDS, you have 45 days to challenge it through the "client-led dispute resolution process".
Many clients (especially financial services and the public sector) took a blanket "inside IR35" approach in 2021 to avoid the risk of getting it wrong. That's been slowly relaxing — partly because of the April 2024 offset rule (more on this below), partly because outside-IR35 contracts genuinely deliver substantial savings to the end client too.
How tax works inside IR35
Inside-IR35 contracts are typically paid through an umbrella company. The umbrella employs you under a contract of employment, invoices the client, deducts the costs of being an employer, and pays you a salary through PAYE.
Deductions from your day rate before you see the money:
- Employer's National Insurance at 15% on earnings above £5,000 (2026/27)
- Apprenticeship Levy at 0.5% (large umbrellas only — most pass it on)
- Umbrella margin, typically £15-£25 per week
- Holiday pay accrual — sometimes rolled into your headline rate, sometimes held back
What's left becomes your taxable salary. From that you pay:
- Income Tax at 20% / 40% / 45% via PAYE
- Employee NI at 8% / 2%
- Pension contributions (auto-enrolment minimum 5% unless you opt out)
- Student loan repayments if applicable
Practical effect: on a £500/day contract working 46 weeks a year (£115,000 revenue), inside-IR35 take-home is typically £73,000-£77,000 — about 65% of revenue.
How tax works outside IR35
Outside-IR35 contracts are typically run through your own limited company. You're a director, the company invoices the client, and you pay yourself a mix of salary and dividends.
Salary
Most contractors pay themselves a director's salary at the £12,570 personal allowance — high enough to count as a "qualifying year" for State Pension, low enough to attract zero Income Tax and minimal NI. The salary is also Corporation Tax deductible.
Dividends
The remaining profit, after Corporation Tax, comes out as dividends. For 2026/27:
- £500 dividend allowance tax-free
- 8.75% on dividends in the basic-rate band (£12,571-£50,270 total income)
- 33.75% in the higher-rate band (£50,271-£125,140)
- 39.35% in the additional-rate band (£125,141+)
Dividends are not subject to NI — the structural reason outside-IR35 take-home is higher than inside.
Corporation Tax
| Profit band | Rate |
|---|---|
| £0-£50,000 | 19% (small profits rate) |
| £50,001-£250,000 | 26.5% effective (marginal relief) |
| £250,001+ | 25% |
Allowable expenses
Legitimate business costs reduce taxable profit:
- Accountant fees (£900-£1,800 per year for contractor accountants)
- Software subscriptions
- Training and professional development
- Business travel (not commuting to a single client site for more than 24 months)
- Mobile and broadband (business proportion)
- A small home-office allowance (£6/week with no receipts, or actual cost with apportionment)
- Professional indemnity insurance
Practical effect: on the same £500/day, 46-week contract (£115,000 revenue), an outside-IR35 contractor with £3,000 of allowable expenses typically takes home £84,000-£88,000 — about 75% of revenue. The ~£11,000 difference vs inside-IR35 is the IR35 premium.
Worked example: £600/day for 9 months
9 months × ~22 working days × £600 = £118,800 revenue.
| Inside IR35 (umbrella) | Outside IR35 (Ltd co) | |
|---|---|---|
| Gross revenue | £118,800 | £118,800 |
| Employer NI / margin | −£17,000 | — |
| Allowable expenses | — | −£3,500 |
| Corporation Tax | — | −£28,400 |
| Director's salary (paid) | — | £12,570 |
| Income Tax + employee NI on salary | −£26,800 | £0 |
| Dividend tax | — | −£20,500 |
| Net to contractor | £75,000 | £86,400 |
| Percentage of revenue | 63% | 73% |
£11,400 difference. For a long-running contract, that's real money. For a three-week stint, it's not worth the company setup cost.
Hidden costs of outside IR35
Outside isn't always better. Before assuming it is, count:
Administrative time — 3-5 hours a month for bookkeeping, plus annual accounts and Self Assessment. Cloud accounting software automates most of this.
Accountant fees — £900-£1,800 a year for a contractor accountant. Worth every penny if your day rate is £400+ — corp tax planning alone usually covers the fee.
Business banking — you need a business bank account. Free options exist at Tide, Starling Business, Revolut Business. Wise Business saves FX margins on overseas invoicing.
Investigation risk — HMRC can challenge an outside-IR35 determination. Since 2021 the liability sits with the end client in most cases, but small-company exemptions and pre-2021 contracts can leave the contractor exposed. Standard insurance from Markel, Qdos or Kingsbridge runs £150-£300 a year.
No employee benefits — no sick pay, no maternity from a client, no employer pension match, no holiday entitlement, no statutory notice. Day rates are higher partly because they have to be.
April 2024 offset rule — the big recent change
Until April 2024, if HMRC retrospectively determined a contract was inside IR35, the end client faced the full PAYE liability — even though the contractor's Ltd had already paid Corporation Tax and dividend tax on the same income. This "double taxation" risk was the main reason so many clients went blanket-inside.
From April 2024, HMRC offsets the Corporation Tax and dividend tax already paid by the contractor's Ltd against the deemed PAYE liability. This significantly reduces the cost of being wrong for end clients — and has been steadily reopening outside-IR35 opportunities through 2024 and 2025.
For contractors, the offset rule is a mostly positive change: more outside-IR35 contracts on offer.
Decision framework
| Contract characteristic | Day rate | Outside IR35 confirmed? | Recommended structure |
|---|---|---|---|
| Short (<3 months) | Any | Inside | Umbrella |
| Short (<3 months) | Any | Outside | Umbrella (Ltd setup cost not justified) |
| Long-running | <£350 | Outside | Probably umbrella (marginal call) |
| Long-running | £350+ | Outside | Limited company |
| Long-running | £350+ | Inside | Umbrella (no choice) |
| Mixed contracts | Any | Mixed | Limited company + umbrella in parallel |
If your contract is borderline, getting a professional contract review (Qdos, Kingsbridge, Markel — typically £80-£200) is worth the peace of mind. Same applies if you're planning to argue against an SDS.
What's changed recently
- April 2024 offset rule: reduced double-taxation risk for end clients, slowly reopening outside-IR35 contracts (described above)
- April 2024: Class 2 NI for self-employed abolished. Doesn't directly affect Ltd company contractors but matters if you have side income as a sole trader
- April 2024: Class 4 NI for self-employed cut from 9% to 6%, narrowing the sole-trader / Ltd gap at lower profits
- Dividend allowance: cut from £1,000 to £500 in April 2024, holds at £500 for 2026/27
In short
Inside IR35 = PAYE through an umbrella, ~65% take-home of day rate. Outside IR35 = limited company with salary + dividends, ~75% take-home.
The 10-percentage-point difference is the main commercial reason contractors push back on blanket-inside determinations. Whether your specific contract is genuinely inside or outside depends on the three core factors — substitution, MOO, and control — applied to the actual working pattern (not just the contract paperwork).
For the operational steps once you've decided outside is right, see how to set up a limited company. For the broader sole-trader vs Ltd comparison, see sole trader vs limited company. For the umbrella-specific side, see umbrella company vs limited company.