Contractor Tax Guide 2025/26
IR35 — or the off-payroll working rules — is UK legislation designed to ensure that contractors who work like employees pay broadly the same Income Tax and National Insurance as permanent staff. Getting IR35 wrong can result in significant tax bills, penalties, and HMRC investigations. This guide explains everything contractors and businesses need to know.
What is IR35?
IR35 (formally the Intermediaries Legislation) was introduced in April 2000. The name comes from the HMRC press release number 35 of 1999. Its purpose is to combat what HMRC calls “disguised employment” — where an individual provides services through a limited company (Personal Service Company or PSC) but is, in reality, working just like an employee.
The key question IR35 asks is: if the limited company didn’t exist, would the worker be an employee of the client? If the answer is yes, IR35 applies and the worker must pay employment-level taxes.
Why does it matter financially?
Being inside IR35 vs outside IR35 has a significant financial impact. Contractors operating outside IR35 can extract income as a combination of salary and dividends, keeping National Insurance Contributions low. Inside IR35 means PAYE income tax and NI — like an employee, but without employment benefits such as holiday pay, sick pay, or a pension.
Inside IR35
Treatment as Employee
- Income subject to PAYE tax
- Employee NI contributions apply
- Employer NI (15%) deducted from rate
- Cannot pay yourself via dividends
- Limited expense claims
- Typically 15–25% lower take-home pay
- No employment rights (no sick pay, holiday pay)
Outside IR35
Genuine Self-Employment
- Flexibility on salary/dividend split
- Lower National Insurance burden
- Wider range of allowable expenses
- Full limited company tax advantages
- Control over how and when you work
- Can have multiple clients simultaneously
- Can send a substitute if needed
The Three Key IR35 Status Tests
Whether a contract is inside or outside IR35 is determined by examining the working relationship holistically. Three tests are particularly important:
1
Substitution — Right of Substitution
Can you send a substitute (another contractor) to do the work in your place, without the client choosing that specific individual? A genuine and unrestricted right of substitution is one of the strongest indicators of outside IR35 status. If the client requires you personally, this points toward inside IR35.
✓ Outside: Can send substitute
✗ Inside: Must be you personally
2
Control — Supervision, Direction & Control
Does the client control how, when, and where you work? A genuine contractor has autonomy over their working methods, hours, and location. If the client dictates your working hours, tells you how to do the job, and treats you just like a member of staff, this points toward inside IR35.
✓ Outside: Full autonomy
✗ Inside: Client controls work
3
Mutuality of Obligation (MOO)
Is the client obliged to offer you work, and are you obliged to accept it? In genuine employment, there is a continuous obligation for the employer to provide work and the employee to do it. A contractor relationship should be project-specific with no expectation of ongoing work once the project ends.
✓ Outside: Project-specific only
✗ Inside: Ongoing obligation
Contract wording alone is not enough
HMRC looks at the actual working practices, not just what the contract says. Even if your contract states you’re outside IR35, HMRC can investigate the reality of your day-to-day working relationship. Your evidence of actual practices is crucial.
Who Determines Your IR35 Status?
Who is responsible for making the IR35 determination depends on the size of the client engaging you:
| Client Type | Who Determines IR35? | Who Bears Tax Liability? |
|---|---|---|
| Public Sector (any size) | The Client | Fee-payer (agency or client) |
| Medium/Large Private Sector | The Client | Fee-payer (agency or client) |
| Small Private Sector | The Contractor’s PSC | The contractor |
What counts as a “small” company?
For 2025/26, a private company is classified as small (and therefore exempt from off-payroll rules) if it meets two or more of the following criteria in its last financial year:
- Turnover not more than £10.2 million
- Balance sheet not more than £5.1 million
- Fewer than 50 employees
2025 Small Company Threshold Change
From April 2025, new small company thresholds (£15m turnover / £7.5m balance sheet) came into force under Companies Act changes. However, because of the two-year assessment rule, the practical impact on IR35 determinations will not be felt until tax year 2027/28 for most contractors. Plan ahead!
Status Determination Statement (SDS)
Where the off-payroll rules apply (medium/large clients, public sector), the client must issue a formal Status Determination Statement (SDS) that:
- States whether the engagement is inside or outside IR35
- Gives the specific reasons for the determination
- Is passed to both the contractor and the next party in the chain (usually the agency)
As a contractor, you have a statutory right to challenge the SDS in writing within 45 days. The client must respond within 45 days with either a revised determination or an explanation of why they are maintaining their decision.
Blanket “inside IR35” decisions are unlawful
HMRC has made clear that blanket inside IR35 determinations for entire departments (without individual assessment) constitute a failure to take “reasonable care” — and the tax liability transfers back to the client. If you have received a blanket determination, seek professional advice.
IR35 Timeline — Key Changes
2000
IR35 Introduced
Intermediaries Legislation enacted. Contractors responsible for their own IR35 determination via their PSC.
2017
Public Sector Reform
IR35 responsibility shifts to public sector clients. They must now determine status and operate PAYE for inside engagements.
2021
Private Sector Reform
Off-payroll rules extended to medium and large private sector companies. Small companies remain exempt. Major market disruption.
2023
Double Taxation Fix
HMRC introduces offset mechanism to prevent contractors being taxed twice when client has already deducted employment taxes.
2025
Employer NI Rises + New Thresholds
Employer NI increases to 15%, raising the cost of inside IR35 engagements. New small company thresholds introduced (impact from 2027/28).
Practical Steps to Protect Your IR35 Position
- Review every contract — ensure it accurately reflects your actual working practices, not just desired terms
- Use HMRC’s CEST tool — the Check Employment Status for Tax tool at gov.uk. HMRC will stand behind a CEST result used correctly
- Document your working practices — maintain evidence of autonomy, multiple clients, right of substitution, and financial risk
- Get a professional IR35 contract review — a specialist will identify and fix red flags before HMRC does
- Check your client’s size annually — changes in their size affect who determines your status
- Challenge unfair SDS decisions — use your statutory right to request a review within 45 days
💡 Real-World Example
Sarah, an IT consultant from Manchester, contracted with a medium-sized firm. The client issued a blanket “inside IR35” determination for all IT contractors. Sarah sought advice from Britvex. We identified that:
- She had a genuine, exercised right of substitution (she had previously sent a colleague on two occasions)
- She set her own hours and worked remotely with no supervision
- She had three other clients simultaneously
- Her contract clearly documented project-specific deliverables
We prepared a formal SDS challenge. The client reviewed the determination and revised it to outside IR35 — saving Sarah approximately £18,000 per year in additional tax.
Frequently Asked Questions
Does IR35 apply to all contractors?
IR35 applies to contractors who provide services through an intermediary (usually a limited company PSC). Sole traders and umbrella company workers are not within IR35 as they already pay employment-level taxes.
What happens if my client gets the IR35 determination wrong?
If a medium or large client incorrectly determines a contractor as outside IR35 and HMRC disagrees, the client (or fee-payer) bears the tax liability plus interest and penalties. From April 2023, an offset mechanism prevents double taxation.
Can I work for a small company and determine my own IR35 status?
Yes. If your client qualifies as a small company, responsibility for the IR35 determination reverts to your PSC. You assess your own status and report/pay through your company’s Self Assessment. Keep detailed records to support your determination.
What is the CEST tool?
CEST (Check Employment Status for Tax) is HMRC’s free online tool for determining IR35 status. While not legally binding, HMRC will stand behind a CEST determination that was completed honestly and accurately with the correct factual inputs.