IR35 Guide

A contractor emails your People Ops inbox on a Friday asking for their Status Determination Statement. Your HR lead forwards it to Legal. Legal forwards it back to HR.

No one owns the process.

This is the situation most medium-sized employers found themselves in after April 2021, when the off-payroll working rules shifted IR35 determination liability away from contractors and onto the end client.

If you engage contractors through personal service companies (PSCs) and your organisation meets the size thresholds, you are now the person HMRC will hold accountable for getting it right.

This guide explains what IR35 requires of you, what changed in April 2021, how the determination process works, where CEST helps and where it falls short, and what a contractor dispute looks like from your side of the table.

What are the IR35 off-payroll working rules and why do they matter for your business?

IR35 is the common name for legislation that sits in Chapter 10 of the Income Tax (Earnings and Pensions) Act 2003.

Its purpose is to ensure that a worker who provides services through their own limited company, but whose day-to-day working relationship with a client looks and feels like employment, pays broadly the same Income Tax and National Insurance as a directly employed person would.

The rules apply when a contractor provides services through an intermediary, most often a PSC, and would be considered an employee of the end client if the intermediary did not exist.

HMRC’s language is deliberate: the test is not about contracts or labels, it is about the reality of the working relationship.

When an engagement falls inside IR35, the fee-payer, which is usually the agency in the supply chain or the client if there is no agency, must deduct income tax and employee National Insurance from the deemed employment payment and pay employer National Insurance on top.

When it falls outside IR35, the contractor invoices through their PSC as normal and handles their own tax.

The financial stakes are real. An inside-IR35 engagement adds roughly 13.8% employer NIC to your costs on the deemed payment, in addition to the PAYE and employee NIC the fee-payer must account for.

If HMRC later challenges a determination you made in error, you inherit the liability for the tax that should have been deducted, plus interest, plus potential penalties.

What changed in April 2021 and does the reform apply to your organisation?

Before April 2021, contractors working in the private sector were responsible for assessing their own IR35 status and paying the appropriate tax.

The 2021 reform, introduced under the Finance Act 2020, moved that responsibility to the end client for most private-sector engagements.

The reform applies to you if your organisation is medium or large under the Companies Act 2006 definition. In practice, this means your business meets at least two of the following three conditions:

• Annual turnover above £10.2 million
• Balance sheet total above £5.1 million
• More than 50 employees

If you are below those thresholds on two or more measures, you are classified as a small client and the responsibility for IR35 determination remains with the worker’s intermediary.

You must confirm your size in writing if the agency or worker asks.

Group company rules apply: if your parent company is medium or large, subsidiaries must also apply the off-payroll working rules regardless of their own size.

This catches a number of businesses that assume they fall below the threshold when they look only at their own entity.

Public sector organisations have operated under the same client-side determination obligation since April 2017.

If you work across public and private sector contracts, you have been operating under these rules for longer, but the private reform introduced the additional complexity of mixed contractor populations with different pre-reform histories.

How does the IR35 status determination process actually work?

For each engagement with a contractor operating through a PSC, you must assess whether the engagement falls inside or outside IR35 before work begins, or before any change to an existing contract takes effect.

The status assessment applies the employment status tests developed through decades of case law. Three factors carry the most weight in HMRC’s analysis:

• Substitution: Can the contractor send a substitute in their place, and have they genuinely done so? A right of substitution that exists only on paper and has never been exercised is unlikely to be convincing.
• Control: Who decides how, when, and where the work is done? Contractors who are integrated into the client’s management structure, attend team meetings, and work set hours tend to look more like employees.
• Mutuality of obligation: Is the client obliged to offer work, and is the contractor obliged to accept it? This is the factor CEST does not fully test, and it matters more than HMRC’s official tool implies.

Courts also consider financial risk, whether the contractor is in business on their own account, exclusivity, and the overall picture of the relationship. No single factor is determinative.

The PGMOL v HMRC case, decided by the Supreme Court in 2024, reinforced that employment status assessments must look at the cumulative picture of the engagement, not isolated contract clauses.

You must carry out a fresh determination for each engagement and whenever contract terms or working practices change materially.

One assessment per contractor type is not sufficient: the same contractor providing services on two different scopes of work may have different status on each.

What does a compliant Status Determination Statement need to include?

Once you have made your determination, you must provide the contractor and any agency in the supply chain with a Status Determination Statement.

The SDS is not optional and it must be given before the worker starts or before a new contract takes effect.

A compliant SDS must state your conclusion (inside or outside IR35) and give the reasons for that conclusion. HMRC guidance makes clear that a bare conclusion with no reasoning does not meet the requirement.

If you cannot articulate the factors that led to your decision, the determination is not defensible.

The SDS must be passed down the supply chain. If there is an agency between you and the contractor, you must give the SDS to the agency, and the agency must pass it to the contractor.

Gaps in that chain do not transfer your liability.

If you fail to produce a valid SDS, the liability to account for PAYE and NIC sits with you, not with the fee-payer further down the chain. In a supply chain with an agency, this means you absorb costs that would otherwise fall to the agency.

Getting the SDS right is not bureaucratic box-ticking; it is how the liability chain operates.

Should you rely on CEST, and what are its known limits?

The Check Employment Status for Tax tool is HMRC’s official online questionnaire. HMRC commits to standing by the result it gives, provided you answer accurately and the inputs remain accurate over the life of the engagement.

That is a meaningful commitment and worth taking seriously.

Use CEST. It is free, it provides a documented output, and if your answers are accurate and the engagement does not change, HMRC has committed not to challenge the result.

For straightforward engagements with clear substitution arrangements and no tight control, it will give you a usable answer.

But you should know what it does not test.

HMRC’s published CEST guidance acknowledges the tool does not assess mutuality of obligation, because HMRC’s position is that a contract being entered into at all implies some baseline obligation on both sides.

Employment lawyers and tax tribunals take a different view.

Mutuality of obligation has been a decisive factor in several IR35 cases, and a CEST result of “outside IR35” based on substitution and limited control may not account for a working relationship where the contractor has effectively been on rolling renewals for three years.

CEST also returns an “unable to determine” result on a meaningful proportion of real engagements.

When that happens, you cannot use the tool’s output as your SDS. You need a reasoned assessment, which means documenting your analysis of the three core factors and reaching a conclusion on the balance of evidence.

Most teams do not have this process ready when they first need it.

For complex or high-value engagements, CEST is a useful starting point but not a complete answer.

A specialist employment status review, documented properly and kept on file, is the better protection for engagements that would attract HMRC attention.

What does inside IR35 mean for your payroll costs and contractor relationships?

An inside-IR35 determination has immediate operational consequences. The fee-payer, typically the agency or your payroll team if you engage the contractor directly, must operate PAYE on the deemed employment payment.

This means deducting income tax and employee National Insurance from the payment before it reaches the contractor, and accounting for employer National Insurance on the gross deemed payment.

Employer NIC is currently 13.8% (rising to 15% from April 2025 on the employer’s bill). On a contractor day rate of £600, the employer NIC adds around £83 to the cost of each working day beyond what you pay the contractor.

For a six-month engagement of 120 working days, that is roughly £10,000 in additional NIC before you account for the contractor’s reduced net take-home.

Contractors generally price outside-IR35 engagements knowing they manage their own tax affairs. An inside-IR35 determination often prompts a rate negotiation or, in competitive markets for specialist skills, a decision by the contractor to walk away.

Your Finance team will want to model both scenarios before you finalise the determination, not after.

Outside IR35, the contractor’s PSC invoices as normal. You pay the gross invoice. The tax treatment is the contractor’s responsibility.

Your exposure is limited to making an accurate determination in the first place.

What happens when a contractor disputes your determination?

Contractors have a formal right to dispute an inside-IR35 determination. If a contractor disagrees with your SDS, they can raise a dispute in writing and you must respond within 45 days.

That obligation sits with you as the client, regardless of how the engagement is structured or whether there is an agency involved.

Your response must either confirm the original determination with updated reasoning, or issue a new SDS with a revised conclusion. You cannot acknowledge the dispute and ignore it.

Failing to respond within 45 days transfers the liability to account for PAYE and NIC to you even if it would otherwise sit with a fee-payer further down the chain.

In practice, the 45-day clock starts from the date the contractor raises the dispute, not from when your Legal or HR team acknowledges it internally.

If your contractor dispute process routes through three teams before someone takes ownership, you are already losing time you cannot recover.

The practical answer is to build the appeals process before you need it.

A named point of contact for SDS disputes, a standard 48-hour triage to Legal, and a documented decision log is not a large process to build, but it needs to exist before the first contractor challenge arrives.

What concrete steps should you take now?

If you meet the medium or large company thresholds and you engage contractors through PSCs, start with an audit of your current contractor population. For each active engagement, confirm whether a valid SDS has been issued.

If it has not, issue one before the next contract renewal or extension.

Run every engagement through CEST and document the output. Where CEST returns “unable to determine,” record your own reasoned analysis of the three core factors, including mutuality, and reach a conclusion.

Keep that documentation on file for the life of the engagement and for six years after it ends, in line with HMRC’s standard enquiry window.

Build a dispute response process with a named owner and a 45-day calendar trigger. Make sure the person responsible knows what “45 days” means operationally, in principle.

For high-value or high-volume contractor relationships, a specialist employment status review by an employment solicitor or tax adviser costs considerably less than a successful HMRC challenge.

The NAO’s 2020 report on IR35 in the public sector found compliance failures concentrated in organisations that relied on blanket determinations rather than individual assessments.

The same risk applies in the private sector.

The next time a contractor asks for their SDS, your team should have a process to produce it within a week, not a question about who owns the answer.