What Is IR35?
IR35 — formally known as the off-payroll working rules — is a piece of UK tax legislation designed to prevent workers from avoiding income tax and National Insurance by working through a personal service company (PSC) when, in substance, they are employees.
The rules have been around since 2000, but major reforms in 2017 (public sector) and 2021 (private sector) shifted responsibility for determining IR35 status from the contractor to the end client.
Who Does IR35 Apply To?
IR35 applies when:
- A worker provides services through an intermediary (typically a limited company)
- The worker would be considered an employee if they were engaged directly
The key question is one of employment status: if you strip away the limited company structure, does the working relationship look like employment?
The Three Key Tests
Courts and HMRC use three primary tests to assess IR35 status:
1. Substitution
Can the worker send a substitute to do the work? A genuine contractor should be able to send someone else in their place. An employee cannot.
What this means in practice: If your contract includes a substitution clause, it needs to be genuine — not just a clause on paper. If the client would refuse a substitute in practice, the clause will be disregarded.
2. Control
Does the client control how, when, and where the work is done? Employees are typically subject to significant control. Contractors should have autonomy over how they deliver the agreed outcome.
What this means in practice: If the contractor works set hours, uses the client's equipment, and is supervised day-to-day, this points towards employment.
3. Mutuality of Obligation
Is there an obligation on the client to offer work, and on the contractor to accept it? Employment relationships typically involve this mutual obligation. Genuine contractors are engaged for specific projects.
What this means in practice: If the contractor is expected to be available on an ongoing basis and the client is expected to provide continuous work, this points towards employment.
Responsibilities Since the 2021 Reform
Since April 2021, medium and large private sector businesses are responsible for determining the IR35 status of contractors they engage.
If you are a medium or large business engaging contractors:
- You must make a Status Determination Statement (SDS) for each contractor
- You must take reasonable care in making that determination
- You must pass the SDS to the contractor and the fee-payer
- If you get it wrong, you may be liable for the unpaid tax and NI
If you are a small business (meeting two of: ≤50 employees, ≤£10.2m turnover, ≤£5.1m balance sheet), the old rules still apply and the contractor is responsible for their own IR35 determination.
HMRC's CEST Tool
HMRC provides a Check Employment Status for Tax (CEST) tool to help determine IR35 status. It is free to use and HMRC will stand by the result — provided you answer the questions accurately.
However, CEST has been widely criticised for being too simplistic and failing to reach a determination in a significant proportion of cases. It should be used as a starting point, not a definitive answer.
The Consequences of Getting It Wrong
If HMRC determines that a contractor should have been treated as inside IR35:
- The unpaid income tax and NI becomes payable
- Interest and penalties may be added
- The liability falls on the fee-payer (often the end client)
HMRC has been increasingly active in IR35 investigations, particularly in sectors like financial services, technology, and media.
Practical Steps to Manage IR35 Risk
For businesses engaging contractors:
- Review all contractor engagements and make a Status Determination Statement for each
- Ensure your contracts accurately reflect the working arrangements
- Document the factors that support outside-IR35 status
- Review status regularly — circumstances change
For contractors:
- Understand the factors that determine your status
- Ensure your contract and working practices are consistent
- Consider an independent IR35 review for significant engagements
- Keep records of your business activities (other clients, marketing, equipment)
IR35 is complex and the consequences of getting it wrong are significant. Lexl provides IR35 status reviews and advice for both contractors and the businesses that engage them. Book a Clarity Session to discuss your situation.
