UK What Is IR35

IR35 is not a tax rate.

It is a determination that reclassifies contractor relationships as disguised employment, triggering employer National Insurance contributions, apprenticeship levy, and penalties that can exceed the original contract cost.

For People Ops teams hiring UK contractors, IR35 is an operational constraint: every relationship must demonstrate genuine self-employment, or your company becomes liable for employment taxes as if they were staff.

An IR35 determination on a £500-per-day contractor can generate a backdated tax bill of £15,000-£25,000 a year, plus penalties.

What is IR35?

IR35, officially the “off-payroll working rules,” is HMRC’s framework for determining whether a contractor relationship is genuine self-employment or disguised employment.

In our assessment of how IR35 applies to hirers, the SDS documentation requirement is the element companies most often underprepare when HMRC opens a compliance check.

The rules apply when a contractor provides services through their own company (a Personal Service Company, or PSC) but works in a way that resembles permanent employment.

If HMRC decides the relationship would be employment had the contractor worked directly for your company, IR35 applies.

When IR35 applies, your company must deduct income tax and National Insurance from contractor payments as if they were employees, but they get none of the employment rights or benefits. You carry the tax burden; they keep contractor status.

Since April 2021, HMRC’s guidance on understanding off-payroll working (IR35) confirms that medium and large companies (over £10.2 million turnover or more than 50 employees) must make IR35 determinations themselves before engaging contractors.

Small companies remain under the previous rules, where contractors self-determine.

That responsibility means assessing each contractor relationship against three tests: control, substitution, and mutuality of obligation. Get it wrong, and you face the financial consequences.

How does IR35 work in practice?

We reviewed 15 Employment Tribunal decisions from 2022-2024 to see how IR35 determinations work operationally. Your company must assess three relationship factors before the contractor starts.

Control test

HMRC examines who controls how, when, and where the work gets done.

If your company dictates working hours, requires meeting attendance, or gives detailed task instructions, this suggests employment rather than self-employment.

Here’s what catches companies: the daily standup where contractors report alongside employees, the “optional” meetings they cannot really skip, the project manager who reviews their work like employee output. These everyday patterns matter more than contract language.

Substitution test

Can the contractor send someone else to do the work without your approval? An unrestricted right to provide a substitute strongly suggests self-employment.

Most tribunal cases we analysed show that theoretical substitution rights do not count. The contractor must be genuinely able and willing to provide substitutes, and you must accept them without vetting. If your team would panic at a stranger showing up Monday to replace your contractor, the right is fictional.

Mutuality of obligation test

In employment relationships, the employer must provide work and the employee must accept it; self-employed contractors can refuse work without breaking the relationship. If your contract guarantees minimum work volumes or requires the contractor to be available for ad-hoc requests, this suggests employment-like obligation.

The Friday afternoon “quick task” that becomes expected availability is where this test fails.

The determination requires written assessment and evidence. HMRC’s Check Employment Status for Tax (CEST) tool provides guidance, but tribunal decisions show it is not always reliable in complex cases.

You must communicate your determination to the contractor before they start. If outside IR35, document your reasoning; if inside, you become responsible for operating PAYE. Neither option feels clean.

Why does IR35 matter for your business?

IR35 decides whether your contractor costs stay predictable or become employment tax liabilities that can double your effective rate. When a relationship is caught, your company becomes liable for employer National Insurance contributions (15% of payments), apprenticeship levy (0.5% for companies over £3 million payroll), and pension auto-enrolment.

A £500-per-day contractor caught by IR35 generates roughly £130 per day in additional employer costs, about £34,000 over a year.

The backdated liability risk matters more than the ongoing cost. HMRC can investigate contractor relationships up to six years retrospectively, and if your IR35 assessments were wrong, you pay the missing taxes, penalties, and interest for the entire period.

Penalties range from 15% to 100% of the tax due, depending on whether HMRC considers the error careless or deliberate.

For a relationship worth £130,000 a year over three years, a wrong determination can generate total liabilities of £150,000-£300,000. That number will trigger every alarm in Finance.

Beyond direct tax costs, IR35 affects operational flexibility. Contractors caught by it may expect employment rights despite not receiving them, creating tribunal risks, and top contractors grow reluctant to work with companies seen as over-cautious on determinations.

If your Finance team is already questioning contractor spend, IR35 liabilities accelerate scrutiny. The conversation shifts from “why contractors?” to “what’s our exposure?”

What are the alternatives to managing IR35 directly?

Companies have four main options for handling contractor relationships while managing IR35 risk. Outsourcing determinations to specialist advisers reduces compliance risk, but only if the adviser gets accurate information about the actual working arrangement rather than a sanitised version.

Direct engagement with self-determination

Engage contractors directly through their PSCs and make your own IR35 determinations. This gives full control over relationship design and cost, but exposes you to the full liability if determinations prove wrong.

This works best when you have clear boundaries between employee and contractor roles, and contractors genuinely operate as independent businesses with multiple clients. It works worst when you need someone to fill an employee-shaped hole.

Umbrella company arrangements

Contractors join umbrella companies that handle employment taxes and provide basic employment rights, becoming an umbrella employee while working for you.

Umbrella arrangements remove IR35 risk from your company but increase costs (umbrella margins typically add 8-12% to contractor rates) and reduce contractor appeal since they lose tax advantages. Top contractors often refuse umbrella arrangements entirely.

EOR and contractor management platforms

Platforms like Deel, Remote, and Multiplier offer contractor management with built-in IR35 assessment, typically providing determination support, documentation, and liability insurance.

These platforms work well for companies with limited contractor volumes or HR expertise, but add platform fees (typically £15-£50 per contractor per month) and may have limited UK-specific IR35 expertise.

The key question is liability allocation. Some platforms provide determination advice but leave you liable for wrong decisions; others offer insurance or guarantees, but read the exclusions carefully. “Comprehensive coverage” often excludes the exact scenarios where you need protection most.

Professional services agreements

Structure relationships as genuine business-to-business services rather than contractor supply.

The contractor delivers defined outcomes rather than time, controls their methods, and typically works from their own premises. This suits specialized consulting better than ongoing roles.

Effectiveness depends on whether the relationship genuinely reflects business-to-business services. If you still expect Monday morning availability and Friday afternoon delivery, the structure solves nothing.

Frequently asked questions

IR35 FAQs

Does IR35 apply to all contractors in the UK?

IR35 applies to contractors working through Personal Service Companies (PSCs) for medium and large companies. It does not apply to sole traders, partnerships, or contracts with companies under £10.2 million turnover.

Contractors working remotely from overseas may also fall outside IR35 scope, but cross-border tax rules apply instead, so check residence and permanent establishment risk before assuming a non-UK PSC sits clear of UK payroll obligations.

Can contractors challenge IR35 determinations?

Yes, contractors can request reconsideration of your determination and ultimately appeal to HMRC. However, the financial liability remains with your company during the dispute. Tribunal hearings for IR35 disputes typically take 18-24 months and cost £25,000-£75,000 in legal fees regardless of outcome, so budget for a multi-year exposure window before issuing a borderline ruling.

What happens if HMRC disagrees with our IR35 determinations?

HMRC can investigate your determinations up to six years after the contractor relationship ends. If they rule differently, you pay backdated employer National Insurance, apprenticeship levy, interest, and penalties of 15-100% of the tax due. The contractor may also face income tax and National Insurance adjustments, but your company liability is separate and non-recoverable from the contractor, so the hirer carries the cost even when the worker has already paid their share.

How do EOR platforms handle IR35 compliance?

Most EOR platforms offer IR35 assessment tools and documentation support, but liability allocation varies significantly. Some provide determination advice while you retain liability for wrong decisions.

Others offer insurance coverage or guarantees, but typically exclude cases where you override their recommendations or provide misleading relationship information. Read the indemnity clause before assuming the EOR carries the HMRC risk.

Does working from home affect IR35 status?

Working from home does not automatically determine IR35 status, but location control matters. If your company sets specific home working hours, mandates video calls, or monitors productivity like an employee, this suggests control indicating employment. Genuine contractors should have autonomy over location and methods, so audit your remote-management practices before assuming a home-based engagement sits outside IR35.

Methodology and disclosure

This guide is based on HMRC’s off-payroll working guidance, the HMRC Annual Report 2023-24 for investigation statistics, 15 Employment Tribunal decisions from 2022-2024, and our analysis of contractor management platform policies across 8 providers.

Whichapp is an independent comparison site for EOR and contractor management services. We may earn referral fees from some platforms mentioned, but we do not recommend specific tax or legal structures.

We have not tested IR35 determination tools directly or verified platform liability insurance coverage terms.

For specific contractor relationships, consult employment tax specialists familiar with your circumstances.