What Is IR35?

As a contractor, how you are taxed depends on how HMRC views the nature of your engagement – not just how you view it, or even how the agency or client describes it. IR35 is the legislation that governs this. It is used to determine whether you are working as a genuinely independent contractor through your Limited Company, or whether the engagement is closer to employment for tax purposes.

This guide explains IR35 in plain English, clarifies what it means in practice, and outlines what you can and cannot influence during the process. It also shows how you can continue to operate through your Limited Company where appropriate, while still having a compliant structure in place for inside IR35 roles.

• IR35 decides how a contract is treated for tax purposes – not whether you are a contractor
• Status is assessed per engagement, not per person, so it can change between roles
• The client normally decides whether a role is inside or outside IR35, not the contractor
• Working practices matter more than contract wording – HMRC look at what happens in reality
• If a role is inside IR35, tax is usually paid through PAYE before income is released
• You can still keep your Limited Company even if one or more roles are inside IR35
• Many contractors use an umbrella structure for inside IR35 roles for simplicity and compliance

IR35 is tax legislation that determines whether HMRC treats a contractor as self-employed for a specific engagement or as a “deemed employee” for tax purposes.

If you are outside IR35, the engagement is considered a genuine business-to-business service, and you can operate through your Limited Company. If you are inside IR35, the role is treated like employment for tax purposes, and income is usually taxed through PAYE.

IR35 was introduced to prevent what HMRC considers “disguised employment” – situations where an individual works in the same way as an employee but is paid as if they were a contractor to reduce tax and National Insurance.

The legislation was designed to ensure consistency in tax treatment where the working arrangement resembles employment rather than consultancy.

HMRC looks at the overall nature of the relationship, not just the contract. The key question is whether the contractor is delivering a service, or performing a role within the organisation.

If the contractor is treated as part of the team, follows the client’s working patterns, and is managed like an employee, HMRC is more likely to view the arrangement as inside IR35.

IR35 doesn’t change your professional status – but it changes how you are taxed and how the engagement is structured. That is why two contractors performing similar work can be taxed differently depending on how their engagements are set up.

James, an experienced IT consultant, joined a large transformation project. The contract suggested autonomy, but in practice he was required to follow internal processes, attend daily team meetings and work to fixed hours alongside permanent employees.

When the client reviewed the engagement, it was placed inside IR35 based on working practices. He chose not to contest it and used an umbrella arrangement for this assignment while retaining his Limited Company for future outside IR35 work.

IR35 status is based on the working reality of the engagement – how the contractor operates day to day. HMRC applies a series of tests that look at whether the contractor is functioning as a business, or as part of the client’s organisation.

The most influential factors are:

• Control – Who decides how, where and when the work is done?
• Substitution – Is the work personal to you or can your limited company send someone else to work on the project?
• Mutuality of obligation – Is there an expectation of ongoing work beyond deliverables?

These tests are explored in much more detail in our supporting blog posts, but at a high level, the more an engagement resembles employment in practice, the more likely it will fall inside IR35.

Even if a contract contains strong “outside IR35” clauses, if day-to-day working conditions look like employment (for example, fixed hours, direct supervision, or mandatory internal processes), the engagement can still be viewed as inside IR35. HMRC give more weight to behaviour and structure than wording.

Secondary indicators can also play a role, such as:

• Whether you bear financial risk or are simply paid for time
• Whether you are integrated into the client’s organisation
• Whether you provide your own tools/resources
• How much autonomy you have over delivery

These are not decisive individually, but together they shape the overall picture of the engagement.

When a contract is inside IR35, the engagement is treated as employment for tax purposes only. You are still a contractor, but HMRC requires the income to be taxed in a similar way to salary before it is paid to you, typically through PAYE.

Instead of receiving gross payment into your Limited Company and then deciding how to extract income, deductions such as income tax and National Insurance are applied upfront. This usually reduces take-home pay compared with an equivalent outside IR35 contract.

Yes, if you are caught by IR35 and decide to use an umbrella company rather than your limited company for the contract, your company does not need to close or become inactive.

Many contractors continue operating through their company on other roles while working through an umbrella company on an inside IR35 contract.

For inside IR35 roles, a large number of contractors choose to be paid through an umbrella arrangement instead of through their limited company because it streamlines PAYE deductions and removes administration. This isn’t mandatory in all cases, but it is often the most practical route.

When a role is assessed as outside IR35, HMRC recognises the engagement as a genuine business-to-business service. You are treated as self-employed for tax purposes and can operate through your Limited Company without the need for your income to be taxed as salary. This means you are able extract dividends instead.

Outside IR35 means you have more control over how you deliver the work, reflecting autonomy rather than employment. You can choose how to structure your income, which is normally more tax-efficient than PAYE.

This is why many contractors prefer outside IR35 engagements where the working model genuinely supports it.

Outside IR35 engagements normally involve a defined scope of work, greater independence in delivery, and less integration into the organisation’s internal management structure. The client is purchasing an outcome or service, not time or labour.

If working practices begin to resemble employment – for example, fixed supervision, mandatory hours or integration into permanent teams – the status can change. For this reason, ongoing working style is as important as the contract itself.

Under the current legislation, the decision is primarily made by the end client, usually documented in a Status Determination Statement (SDS). The contractor is expected to comply with this outcome.

Contractors typically have the most influence before onboarding begins – during early conversations about scope, deliverables and autonomy. Once the client has defined the role internally, there is usually limited scope to adjust it.

Many organisations take a cautious stance on IR35 because they carry the financial liability if the status is challenged and later found to be incorrect.

Since the 2021 reforms, it is the client – not the contractor – who HMRC will pursue if a role has been wrongly treated as outside IR35. This can lead to backdated tax bills, interest and penalties.

Because of this risk exposure, some clients choose to classify a role as inside IR35 even if it could potentially be structured outside, simply because it removes the possibility of future liability. The decision is often a risk-management step rather than a judgement on the contractor’s working style or professionalism.

There is a dispute process, but it is handled by the same client that made the original determination. While challenges are possible, most contractors choose not to escalate because they do not want to jeopardise the engagement or the client relationship.

In practice, IR35 outcomes are often shaped by how the client chooses to structure the role, rather than how the contractor views it.

This is why many contractors focus on making sure they have the right working model in place from the outset of each new engagement.

IR35 affects how each engagement is structured and how income is processed, but it does not define your capability or professionalism as a contractor. Many people now move between inside and outside IR35 roles depending on the client, project and working practices. One contract does not set your long-term status.

The key is having the right structure in place for whichever outcome applies – and knowing what options are available if circumstances change.

At SG Accounting, we support contractors on both sides of IR35:

• When outside IR35, helping you operate efficiently through your Limited Company
• When inside IR35, providing a compliant, straightforward alternative via an umbrella arrangement if required

If you’d like guidance on your current contract or future engagements, we’re here to help you choose the route that best fits your working model.

(Header image: designed by Drazen Zigic – Freepik.com)