IR35 Explained: A Practical Guide for Businesses Hiring Contractors

You need a specialist for six months. A contractor is available, the day rate is agreed, and the start date is Monday. Then somebody asks the question that stops the whole thing: is this inside IR35?

For most businesses hiring contractors in the UK, that question is no longer the contractor's problem. Since April 2021 it has been the client's, and getting it wrong can leave you liable for tax and National Insurance you never planned to pay. The rules are not simple, but they are learnable. This guide walks through what IR35 is, whether it applies to you, what you have to do, and how to keep a record that stands up if anyone ever asks.

This guide is general information, not tax or legal advice. It reflects HMRC guidance as at September 2026. Rules and thresholds change, so check the current position on GOV.UK or with a qualified adviser before you make a decision on a real engagement.

What IR35 actually is

IR35 is the everyday name for the off-payroll working rules. It takes its name from the Inland Revenue press release that announced the original measure in 1999. The purpose has not changed: to stop people who work like employees from paying tax like company directors.

The situation it targets is simple. A worker sets up their own limited company, often called a personal service company or PSC, and provides their services to a client through it. The client pays the company. The company pays the worker, commonly a modest salary plus dividends. That structure can legitimately cost less in tax and National Insurance than employment does. It is perfectly lawful for a genuine independent contractor.

The rules apply when, if the arrangement were stripped of the company in the middle, the worker would be an employee of the client for tax purposes. In that case the engagement is treated as inside IR35 and the worker should be taxed broadly as an employee would be. If the worker would properly be self-employed, the engagement is outside IR35 and the company structure stands.

Why this is probably your problem

The rules have moved in stages. In April 2017 responsibility for deciding status shifted from the contractor's company to the client for public sector engagements. From 6 April 2021 the same change applied to medium and large clients in the private and voluntary sectors, for payments made on or after that date.

In practice that gives three situations:

• Public sector client. The client decides the worker's status.
• Medium or large private or voluntary sector client. The client decides the worker's status and has to tell the worker and the party it contracts with.
• Small private or voluntary sector client. The client does not decide. The contractor's own company remains responsible for considering the rules and paying any tax that follows.

So the first thing to establish is which of those you are.

Are you small enough to be exempt

For a company, size is judged on the same two out of three test used in company law. A client is medium or large if it meets at least two of these conditions:

• annual turnover of more than £15 million
• a balance sheet total of more than £7.5 million
• more than 50 employees

Those turnover and balance sheet limits apply to financial years beginning on or after 6 April 2025. Older guidance you may come across quotes £10.2 million and £5.1 million, which were the limits before the change. The employee figure did not move.

Two details catch people out. First, the test is not based on the year you are in. HMRC's manual points you to the last financial year for which the deadline for filing accounts fell before the start of the tax year concerned, so the answer for 2026 to 2027 rests on accounts that may already be a year or more old. Second, because size is judged on filed accounts, the higher limits feed through gradually rather than applying overnight. The manual also sets out a rule about meeting the conditions across consecutive years before a company moves between size bands, so if you are close to the line, get your accountant to confirm which side you fall on.

Partnerships and other organisations that are not companies use a simpler test based on turnover of more than £10.2 million in the last calendar year.

If you are small, you do not have to determine status. You do have to confirm your size if the contractor or the agency asks, and you have 45 days to reply. Do not leave that request unanswered, because the contractor cannot tell which rules apply until you have replied.

How employment status is decided

There is no single test that settles it. Status for tax is decided by looking at the whole working relationship as it operates in practice. The written contract is evidence, but if the day to day reality is different from the paperwork, the reality wins. The questions that carry the most weight are:

• Personal service. Must the worker do the work themselves, or can they genuinely send a substitute at their own choice and cost? A real, unfettered right of substitution points towards a contractor. A right that exists on paper but is never used, or that needs your approval every time, points the other way.
• Control. Do you decide what the worker does, when, where and how? An employee is told. A contractor is usually engaged for a result and decides how to achieve it.
• Mutuality of obligation. Are you obliged to keep offering work and is the worker obliged to accept it? Ongoing obligations on both sides look like employment. A defined piece of work with a clear end looks like a contract for services.
• Financial risk. Does the worker carry the cost of mistakes, supply their own equipment, or risk not being paid if the work fails? Or are they paid for their time regardless?
• Part and parcel of the organisation. Are they treated like a member of staff, with a company email address, a place in the team structure, appraisals, and the same rules and benefits as employees?

HMRC's own Check Employment Status for Tax tool asks about exactly this ground: the contract details, the worker's responsibilities, who decides the type, timing, location and method of the work, how payment is structured, and whether the worker receives benefits or has expenses reimbursed.

Signs that usually point inside

• The worker is managed by one of your employees and follows your processes.
• The role has no defined end and has been extended repeatedly.
• The worker is paid for time and cannot substitute anyone.
• They do the same job as your permanent staff, on the same terms of working.

Signs that usually point outside

• The engagement is for a defined deliverable with a clear scope and end.
• The worker chooses how the work is done and works to the result.
• They can, and sometimes do, send a suitably qualified substitute.
• They provide their own equipment, carry their own insurance, and bear the cost of putting mistakes right.

These are pointers, not a scorecard. One strong factor can outweigh several weak ones, which is why each engagement needs an honest look.

The status determination statement

If you are a medium or large client, you must take reasonable care when you decide a worker's status, and then communicate your decision in a status determination statement, usually shortened to SDS. The statement has two jobs. It has to give your conclusion, and it has to give the reasons for reaching it. A bare "inside" or "outside" with nothing behind it does not do the job.

You must pass the SDS to two parties: the worker, and the person or organisation you contract with. If that is the worker's own company, it is one recipient more or less. If you engage through an agency, the agency is the second recipient and it passes the statement on down the chain.

Timing matters. Until you have told both parties your determination and the reasons for it, you remain responsible for deducting Income Tax and employee National Insurance and for paying employer National Insurance. Producing the statement late does not just look untidy. It leaves the tax bill with you.

The 45 day disagreement process

A worker or a fee payer can disagree with your determination, and you need a process ready for when they do.

When you receive a disagreement you have 45 days to respond. In that time you should consider the reasons given, decide whether to keep your determination, and either maintain it or issue a new one, telling the parties of the outcome. While you consider it, the fee payer carries on applying your original decision. A worker can raise a disagreement at any point until the last payment for their services has been made.

If you do not respond within 45 days, the Income Tax and National Insurance on the worker's payments become your responsibility. That is the consequence HMRC attaches to silence, so set a diary reminder the day a disagreement arrives.

Who actually pays the tax when an engagement is inside

When an engagement is inside IR35, the party responsible for paying the worker's company is the fee payer, and HMRC also calls it the deemed employer. Its job is to deduct Income Tax and employee National Insurance from the fees, pay employer National Insurance to HMRC, and pay the Apprenticeship Levy where that applies.

Who the fee payer is depends on how the work is contracted:

• You engage the contractor's company directly. You are always the fee payer.
• You engage through an agency. The fee payer is the qualifying party lowest in the chain, above the worker's company, that holds the SDS. Until the SDS moves down the chain, the client is the deemed employer. Once the client has passed it on, the agency below it takes on the role, provided it meets the conditions.

If an agency has not received an SDS, HMRC's guidance says it should pass on payment without deducting tax and National Insurance, which is exactly why a missing statement lands the liability back with the client.

For the contractor, this means their company receives the fee already reduced by tax and National Insurance. The company can then pay the worker a salary through its own payroll without deducting tax a second time, or pay dividends that do not need to be declared again on the worker's Self Assessment return. This is what prevents the same income being taxed twice.

The CEST tool and what it can do for you

HMRC provides the Check Employment Status for Tax tool, known as CEST, which is free and online. It asks a series of questions about the engagement and returns a result. The reassuring part is HMRC's commitment: it says it will stand by all results the tool gives, as long as the information you enter is accurate and in line with its guidance.

Two practical points follow from that. The tool cannot save your progress, so gather the contract, the working arrangements and the answers before you start. And the protection depends entirely on the accuracy of what you put in. If the tool is completed from the contract and the real working practices differ, the result is only as sound as your inputs.

CEST is not the only route. You can reach a determination by other reasoned means. What matters is that you can show you took reasonable care and can explain why.

Getting it wrong

Most of the trouble comes from a handful of avoidable mistakes:

• Relying on the contract wording. A clause saying the worker is self-employed does not settle anything if the working practices say otherwise.
• Deciding once and forgetting. An engagement is the specific contract or piece of work. If the working practices change or you negotiate a new contract, you have to re-check.
• No reasons. An SDS without the reasoning does not meet the requirement, and the liability stays with you.
• Missing the deadline. Forty-five days feels like plenty until the disagreement is sitting in an inbox nobody watches.
• Forgetting the agency chain. The statement has to reach the party you contract with and move down the chain.
• Assuming you are small. Size is judged on filed accounts against thresholds that have just changed. Check it, do not assume it.

Where tax has gone unpaid, the bill falls to the client, and interest and penalties can follow. That is why a written record of the decision is worth more than any single clever argument.

A practical checklist for every contractor you engage

1. Confirm your size. Check your last filed accounts against the current thresholds and write down the answer.
2. Decide before the work starts. Do not begin an engagement and worry about status later.
3. Assess the real working arrangement. Talk to the manager who will work with the contractor about control, substitution and how the work is actually set.
4. Use CEST or another documented method. Enter accurate information and keep the result.
5. Issue the SDS with reasons. Send it to the worker and to the party you contract with.
6. Log the date you sent it. If anything is ever disputed, the date matters.
7. Watch for a disagreement. Put the 45 day clock in the calendar the day one arrives.
8. Re-check on change. A new contract, an extension, or a shift in working practices triggers a fresh look.
9. Keep everything together. The determination, the reasons, the tool result and the correspondence should sit against the engagement.

Keeping the record in one place

The rules are largely about being able to show what you decided, when, and why. That is a record-keeping job as much as a tax one, and it is where scattered emails let people down.

Wizard Application's recruitment ATS gives you places to keep it. Each candidate record has an IR35 status field with four values: inside, outside, unknown, or not applicable. Contract roles carry a day rate range and a worker classification, and the options offered come from the company's country, so a UK company sees the IR35 choices. Contract bookings hold the contract type, day rate, contract value, payment terms, IR35 status and contract notes together, so the commercial terms and the status decision are not in different places. The ATS also tracks permanent, contract, temporary and freelance roles separately, which keeps contractor hiring from being mixed up with staff hiring.

To be clear about what this does and does not do: Wizard Application records the status and the notes you keep against it. It does not decide whether an engagement is inside or outside IR35, and it does not issue the status determination statement for you. Those decisions stay with you and your adviser. What it does is make sure that when someone asks, the answer is on the candidate record rather than in a folder nobody can find.

The short version

If you are a small private sector business, the responsibility sits with your contractors, though you should still answer a size query within 45 days. If you are medium or large, or in the public sector, it is yours: decide with reasonable care, issue a reasoned status determination statement to the worker and the party you contract with, handle any disagreement within 45 days, and keep a record of all of it. Do that consistently and IR35 stops being a source of dread and becomes one more step in taking on a contractor.

Ready to keep your contractor hiring organised? Start with the recruitment ATS, which is included on the free Starter plan.

Frequently asked questions