What is IR35 and how does it work?

IR35 applies to contractors who provide services through a PSC. If the contractor would be an employee if engaged directly by the client, the engagement is 'inside IR35' and tax/NIC must be paid as an employee. The key tests are control, substitution, and mutuality of obligation. IR35 (the intermediaries legislation, ITEPA 2003, Part 2, Chapter 8) applies to contractors who provide services to a client through an intermediary (typically a personal service company, or PSC). The purpose of IR35 is to prevent 'disguised employment' — where a person would be an employee but provides their services through a PSC to reduce their tax and NIC. How IR35 works: (1) The engagement — a contractor provides services to a client through a PSC. The PSC invoices the client (or an agency) for the services, and the contractor is paid a salary or dividend from the PSC. (2) The hypothetical contract — HMRC considers what the position would be if the contractor had provided the services directly to the client (without the PSC). Would the contractor be an employee of the client? (3) Employment status tests — HMRC applies the standard employment status tests to the hypothetical contract: (a) Control — does the client control how, when, and where the contractor works? If the client has significant control, this indicates employment. (b) Personal service / substitution — can the contractor send a substitute to do the work, or does the client require the contractor personally? If the contractor can send a substitute (and the client cannot reasonably refuse), this indicates self-employment. If the client requires the contractor personally, this indicates employment. (c) Mutuality of obligation (MOO) — is the client obliged to offer work to the contractor, and is the contractor obliged to accept it? If there is mutuality of obligation, this indicates employment. (4) Inside vs outside IR35 — if the tests indicate that the contractor would be an employee, the engagement is 'inside IR35', and tax and NIC must be paid as an employee. If the tests indicate self-employment, the engagement is 'outside IR35', and the contractor can continue to be paid through the PSC (with corporation tax and dividends). (5) Other factors — HMRC also considers other factors, such as the equipment provided, the financial risk, the length of the engagement, and the integration with the client's business. IR35 is complex and fact-specific, and specialist advice is recommended for each engagement. Relevant legislation: ITEPA 2003, Part 2, Chapter 8 (IR35 — intermediaries legislation); ITEPA 2003, Part 2, Chapter 10 (off-payroll working — private sector, from April 2021); ITEPA 2003, Part 2, Chapter 7 (public sector off-payroll, from April 2017). Example: A contractor provides IT services to a bank through a PSC. The contractor works at the bank's office, uses the bank's equipment, follows the bank's instructions, and cannot send a substitute. The bank controls how, when, and where the contractor works. This engagement is likely 'inside IR35' — the contractor would be an employee if engaged directly by the bank. Tax and NIC must be paid as an employee. Common mistake: Assuming that having a limited company (PSC) automatically means the contractor is outside IR35. The IR35 status depends on the working practices and the contract, not the existence of the PSC.

What are the off-payroll working rules?

From April 2021 (private sector) and April 2017 (public sector), the off-payroll rules shifted the IR35 determination from the contractor to the client. The client issues a Status Determination Statement (SDS), and the fee-payer operates PAYE if the engagement is inside IR35. The off-payroll working rules (ITEPA 2003, Part 2, Chapter 10) changed the responsibility for determining IR35 status. Before the changes (before April 2021 in the private sector), the contractor (through their PSC) was responsible for determining whether each engagement was inside or outside IR35. After the changes: (1) Client determines status — the client (the business receiving the services) is now responsible for determining whether each engagement is inside or outside IR35. The client must take 'reasonable care' in making the determination. (2) Status Determination Statement (SDS) — the client issues an SDS to the contractor and the fee-payer (the agency or the client itself), stating whether the engagement is inside or outside IR35 and the reasons for the determination. (3) Fee-payer operates PAYE — if the engagement is inside IR35, the fee-payer (the entity that pays the PSC) must operate PAYE on the payment, deducting income tax and NIC before paying the PSC. (4) Disagreement process — the contractor can dispute the SDS through the client's statutory disagreement process. The client must consider the disagreement and respond within 45 days. (5) Small companies exemption — the off-payroll rules do not apply to small companies (turnover < £10.2m, balance sheet < £5.1m, employees < 50). For small company clients, the contractor remains responsible for determining IR35 status (as before the changes). (6) Public sector — the off-payroll rules have applied to the public sector since April 2017 (under a slightly different regime). (7) Labour market intermediary — if the engagement involves a labour market intermediary (e.g., a recruitment agency), the intermediary may have responsibilities under the Conduct of Employment Agencies and Employment Businesses Regulations 2003. Relevant legislation: ITEPA 2003, Part 2, Chapter 10 (off-payroll working — private sector, from April 2021); ITEPA 2003, Part 2, Chapter 7 (public sector off-payroll, from April 2017); Finance Act 2020 (off-payroll changes). Example: A large bank engages a contractor through a PSC and an agency. The bank determines that the engagement is inside IR35 and issues an SDS to the contractor and the agency. The agency (the fee-payer) operates PAYE on the payment, deducting income tax and NIC before paying the PSC. The contractor can dispute the SDS through the bank's disagreement process. Common mistake: Assuming that the off-payroll rules apply to all clients. Small companies (under the size thresholds) are exempt — the contractor remains responsible for determining IR35 status for small company clients.

How can I challenge an IR35 determination?

For off-payroll engagements, dispute the SDS through the client's disagreement process (45-day response). For contractor-determined engagements, challenge through HMRC's internal review and Tribunal appeal process. The Tribunal will determine the IR35 status based on the employment tests. Challenging an IR35 determination depends on who made the determination: (1) Off-payroll engagements (client-determined) — if the client has issued an SDS that the contractor disagrees with: (a) Disagreement process — the contractor can dispute the SDS through the client's statutory disagreement process. The contractor provides reasons for the disagreement and any supporting evidence. The client must consider the disagreement and respond within 45 days. (b) If the client maintains the SDS — the contractor can escalate the dispute, but there is no formal appeal process beyond the client's disagreement process. The contractor can seek a judicial review of the client's determination (though this is complex and expensive). (c) HMRC — the contractor can contact HMRC's IR35 review service, which provides an independent review of the SDS (though this is not binding). (2) Contractor-determined engagements — if HMRC opens an enquiry into the contractor's tax return and determines that an engagement is inside IR35: (a) Internal review — the contractor can request an internal review within 30 days of HMRC's determination. (b) Tribunal appeal — if the internal review does not resolve the dispute, the contractor can appeal to the First-tier Tribunal within 30 days. The Tribunal will determine whether the engagement is inside or outside IR35 based on the employment status tests (control, substitution, MOO, and other factors). (c) Upper Tribunal — either party can appeal to the Upper Tribunal on a point of law. (3) Preparing the challenge — to challenge an IR35 determination, the contractor should: (a) gather evidence of the working practices (contract, timesheets, emails, witness statements), (b) obtain a professional IR35 assessment, (c) consider the case law on employment status (e.g., Ready Mixed Concrete, Mutuals, Primary Statement), and (d) seek specialist advice. IR35 disputes are complex and fact-specific, and specialist advice is essential. Relevant legislation: ITEPA 2003, Part 2, Chapter 8 (IR35 — appeal provisions); ITEPA 2003, Part 2, Chapter 10 (off-payroll — disagreement process); TMA 1970 (enquiry and appeal provisions). Example: A contractor's engagement is determined as inside IR35 by the client (SDS). The contractor disputes the SDS through the client's disagreement process, providing evidence that the contractor can send a substitute and is not controlled by the client. The client reviews the disagreement and changes the SDS to outside IR35. If the client maintains the SDS, the contractor can contact HMRC's IR35 review service or seek a judicial review. Common mistake: Not using the client's disagreement process. The process is a statutory right, and the client must respond within 45 days. Many SDSs are changed through this process, and it is the first step in challenging an IR35 determination.

What is the CEST tool and should I rely on it?

CEST (Check Employment Status for Tax) is HMRC's online tool for determining IR35 status. While it can provide an indication, it is not definitive and has been criticised for oversimplifying the tests. For complex or high-value engagements, obtain professional IR35 advice rather than relying solely on CEST. CEST (Check Employment Status for Tax) is HMRC's online tool for determining whether an engagement is inside or outside IR35. How CEST works: (1) Questions — the tool asks a series of questions about the engagement, covering control, substitution, mutuality of obligation, and other factors. (2) Determination — based on the answers, CEST provides a determination (inside or outside IR35). (3) HMRC's position — HMRC has stated that it will stand by CEST determinations (if the tool is used correctly and the answers are accurate). However, there are significant limitations: (a) Oversimplification — CEST asks a limited number of questions and does not capture the full complexity of the employment status tests. The tool has been criticised for oversimplifying the control and substitution tests. (b) Binary answers — CEST requires yes/no answers, which may not reflect the nuanced reality of the engagement. (c) No MOO question — CEST does not ask about mutuality of obligation (MOO), which is a key employment status test. (d) Case law — CEST does not fully reflect the case law on employment status, which is complex and evolving. (e) Tribunal challenges — several Tribunal cases have found that CEST determinations were incorrect, and the tool's reliability has been questioned. (f) HMRC's commitment — while HMRC has stated that it will stand by CEST determinations, this only applies if the tool is used correctly and the answers are accurate. If the answers are incorrect or incomplete, HMRC may not be bound by the determination. For complex or high-value engagements, the contractor or client should obtain a professional IR35 assessment from a specialist, rather than relying solely on CEST. A professional assessment considers the full range of factors and case law, providing a more robust and defensible determination. Relevant legislation: ITEPA 2003, Part 2, Chapter 8 (IR35); ITEPA 2003, Part 2, Chapter 10 (off-payroll); HMRC CEST guidance. Example: A contractor uses CEST to determine their IR35 status. CEST asks about control and substitution, and the contractor answers 'no control' and 'substitution allowed'. CEST determines 'outside IR35'. However, the contractor's contract includes a mutuality of obligation clause, which CEST did not ask about. A professional assessment may determine that the engagement is inside IR35, despite CEST's determination. Common mistake: Relying solely on CEST for complex or high-value engagements. CEST is a useful tool for simple engagements, but it oversimplifies the employment status tests and may produce incorrect determinations for complex cases.

How can I manage IR35 compliance for my business?

Manage IR35 compliance by: assessing each engagement, using CEST for simple cases and professional advice for complex ones, documenting assessments, reviewing contracts, communicating with contractors, and implementing an IR35 policy and process. To manage IR35 compliance for a business that engages contractors: (1) Assess each engagement — for each contractor engagement, determine whether it is inside or outside IR35, using the employment status tests (control, substitution, MOO, and other factors). The assessment should consider the actual working practices, not just the written contract. (2) Use CEST for simple cases — for simple, low-risk engagements, use HMRC's CEST tool to obtain an initial determination. Keep a copy of the CEST determination for your records. (3) Obtain professional advice — for complex, high-value, or high-risk engagements, obtain a professional IR35 assessment from a specialist. The assessment should consider the contract, the working practices, and the case law. (4) Document the assessment — keep detailed records of the IR35 assessment for each engagement, including: (a) the contract and any side letters, (b) the working practices (how the contractor works in practice), (c) the employment status tests and the reasoning, (d) the CEST determination or professional assessment, and (e) the SDS (for off-payroll engagements). (5) Review contracts — ensure that the contracts reflect the actual working practices and support the IR35 status. If the contract says one thing but the working practices say another, the working practices will prevail. (6) Communicate with contractors — for off-payroll engagements, communicate the IR35 determination to the contractor and the fee-payer, and provide the SDS. Explain the reasoning and the contractor's right to dispute the SDS. (7) Implement an IR35 policy — create a company-wide IR35 policy that sets out the process for assessing engagements, the responsibilities of different teams (HR, procurement, finance), and the documentation requirements. (8) Monitor and review — regularly monitor and review the IR35 status of ongoing engagements, as the working practices may change over time. (9) Specialist advice — engage a specialist IR35 adviser to help design and implement the compliance process, and to assess complex engagements. By implementing a robust IR35 compliance process, the business can minimise the risk of HMRC challenges, penalties, and reputational damage. Relevant legislation: ITEPA 2003, Part 2, Chapter 8 (IR35); ITEPA 2003, Part 2, Chapter 10 (off-payroll); HMRC CEST guidance; HMRC Employment Status Manual. Example: A company engages 50 contractors through PSCs. It implements an IR35 compliance process: (a) each engagement is assessed using CEST (for simple cases) or a professional assessment (for complex cases), (b) the assessment is documented and the SDS is issued to the contractor and the fee-payer, (c) the contracts are reviewed to ensure they reflect the working practices, (d) the company has an IR35 policy and process, and (e) the engagements are reviewed annually. The company has a robust compliance process and minimises the risk of HMRC challenges. Common mistake: Not assessing the actual working practices. The IR35 status is determined by the working practices (how the contractor works in practice), not just the written contract. If the contract says 'outside IR35' but the working practices indicate employment, the engagement is inside IR35.

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IR35 & Off-Payroll Working Disputes

IR35 and off-payroll working rules determine whether a contractor is treated as an employee for tax. Understand the rules, how to challenge HMRC determinations, and how to manage IR35 compliance.

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IR35 (also known as the intermediaries legislation) and the off-payroll working rules determine whether a contractor who provides services through a personal service company (PSC) is treated as an employee for tax purposes. If the rules apply, the contractor must pay income tax and NIC as if they were an employee, and the fee-payer (the client or agency) must operate PAYE. Disputes often arise over whether a particular engagement is 'inside' or 'outside' IR35. Understanding the rules, how to challenge HMRC determinations, and how to manage IR35 compliance is essential for contractors and businesses engaging contractors.

The IR35 Rules

IR35 applies to contractors who provide services through an intermediary (typically a PSC). If the contractor would be an employee if they provided the services directly to the client, the engagement is 'inside IR35', and the contractor must pay tax and NIC as an employee. The key tests are: (1) Control — does the client control how, when, and where the contractor works? (2) Substitution — can the contractor send a substitute? (3) Mutuality of obligation — is the client obliged to offer work, and is the contractor obliged to accept it? If these tests indicate employment, the engagement is inside IR35.

The Off-Payroll Changes

From April 2021 (in the private sector) and April 2017 (in the public sector), the off-payroll working rules shifted the responsibility for determining IR35 status from the contractor to the client. Under the off-payroll rules: (1) The client (not the contractor) determines whether the engagement is inside or outside IR35. (2) The client issues a Status Determination Statement (SDS) to the contractor and the fee-payer. (3) The fee-payer (the agency or the client) operates PAYE if the engagement is inside IR35. (4) The contractor can dispute the SDS through the client's disagreement process.

Challenging an IR35 Determination

If HMRC determines that an engagement is inside IR35 (or a client issues an SDS that the contractor disagrees with): (1) Client disagreement process — for off-payroll engagements, the contractor can dispute the SDS through the client's statutory disagreement process. The client must respond within 45 days. (2) HMRC enquiry — if HMRC opens an enquiry into the contractor's tax return (for engagements where the contractor is responsible for the IR35 determination), the contractor can challenge the determination through the internal review and Tribunal appeal process. (3) Tribunal appeal — the contractor can appeal to the First-tier Tribunal, which will determine whether the engagement is inside or outside IR35 based on the employment status tests.

Managing IR35 Compliance

To manage IR35 compliance: (1) Assess each engagement — determine whether each engagement is inside or outside IR35, using the employment status tests. (2) Use CEST — HMRC's Check Employment Status for Tax (CEST) tool can provide an indication, but it is not definitive and has been criticised for oversimplifying the tests. (3) Obtain professional advice — for complex or high-value engagements, obtain professional IR35 advice. (4) Document the assessment — keep detailed records of the assessment, including the contract, the working practices, and the reasoning. (5) Review contracts — ensure that contracts reflect the actual working practices and support the IR35 status. (6) Communicate — for off-payroll engagements, communicate with the client and the fee-payer about the IR35 status.

Key Points

What You Need to Know

IR35 applies to contractors providing services through a PSC who would be employees if engaged directly
Key tests: control, substitution, and mutuality of obligation
The off-payroll rules (April 2021) shifted the IR35 determination from the contractor to the client
The client issues a Status Determination Statement (SDS) which the contractor can dispute
IR35 determinations can be challenged through the client disagreement process, internal review, or Tribunal

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