Inside vs outside IR35: contractor status explained

Published Saturday 11 April 2026

Table of contents

• What is IR35?
• What does inside and outside IR35 mean?
• How to know if you are inside or outside IR35
• Inside IR35
• Outside IR35 meaning
• Financial impact of being inside IR35
• What to do if you're inside IR35
• Working through an umbrella company
• Navigating IR35: Tips for contractors and businesses
• FAQs on IR35

Key takeaways

• Understand that your IR35 status depends on three key tests: whether you can send a substitute to do your work, who controls how and when you work, and whether there's an ongoing obligation for the client to offer work and you to accept it.
• Keep detailed records of your working arrangements, contracts, and evidence of control over your work methods to support your IR35 status determination and protect against HMRC challenges.
• Recognise that being outside IR35 typically results in £15,000-£20,000 higher annual take-home pay compared to inside IR35 status, but requires you to manage your own tax affairs and company administration.
• Challenge any inside IR35 determination you believe is incorrect by providing evidence about your actual working practices, as your client must respond within 45 days and reconsider their decision.

What is IR35?

IR35 is UK tax legislation that determines whether a contractor should be taxed as an employee or as self-employed. It applies to contractors working through their own limited company or a personal service company.

The rules exist because limited companies often pay substantially lower corporation tax than the combined income tax and National Insurance that employees pay for similar work. Employees pay Income Tax and National Insurance through PAYE. Directors of limited companies can choose how they pay themselves, often resulting in lower tax bills.

HMRC uses IR35 to close this gap. If your working arrangement looks like employment, you pay tax like an employee. If you're genuinely self-employed, you continue paying tax through your limited company.

What does inside and outside IR35 mean?

Your IR35 status determines how HMRC treats you for tax purposes. Here's how the two statuses compare:

Inside IR35 means HMRC classifies you as an employee for tax. Your client or agency deducts Income Tax and National Insurance through PAYE before paying you.

Outside IR35 means you remain self-employed for tax. You keep control of your finances and can:

• pay tax through your limited company
• claim allowable business expenses
• file company accounts and self-assessment returns
• choose how to pay yourself through salary and dividends

If HMRC decides you should have been taxed as an employee, you must pay the tax and National Insurance owed, plus interest. Penalties may apply if you didn't take reasonable care with your tax returns.

The responsibility for determining your IR35 status depends on the size of the business you're working with.

Who decides your status

• Medium and large businesses: Your client must determine your IR35 status and provide a Status Determination Statement
• Small businesses: You remain responsible for determining your own status

These rules were first introduced for the public sector in 2017 and extended to the private sector in April 2021.

How to know if you are inside or outside IR35

HMRC uses three employment tests to determine your IR35 status. No single test decides the outcome. HMRC looks at the overall picture of your working relationship.

Here are the three tests HMRC uses:

1. Right of substitution

This test examines whether you can send a substitute:

• The question: Can you send someone else to do the work in your place?
• Points to inside IR35: The client requires you personally
• Points to outside IR35: You can substitute a qualified replacement at your own cost

2. Control

This test examines who has control over your work:

• The question: Who decides how, when, and where you work?
• Points to inside IR35: The client sets your hours, location, and working methods
• Points to outside IR35: You control how you deliver the agreed results

3. Mutuality of obligation

This test examines the obligations between you and your client:

• The question: Must the client offer work, and must you accept it?
• Points to inside IR35: There's an ongoing expectation of work on both sides
• Points to outside IR35: Each project is a separate engagement with no future obligation

Your written contract and actual working practices both matter to HMRC. The reality of how you work matters as much as what your contract says.

There's an important exception for contractors working with smaller clients.

Small company exemption

If your client is a small business, you determine your own IR35 status, as small organisations are exempt from the off-payroll working rules. A company qualifies as small if it meets two of these three conditions:

• annual turnover of £10.2 million or less
• balance sheet total of £5.1 million or less
• 50 employees or fewer

Given the complexity of IR35 determinations, getting expert help can be valuable.

Why professional advice matters

HMRC reviews IR35 cases individually. Even if some tests point one way, the overall picture determines your status. Recent cases like the PGMOL tribunal show how complex these decisions can be.

If you're unsure about your status, talk to an accountant who understands IR35.

Inside IR35

When you're inside IR35, your client takes on employer-like responsibilities:

• deducting Income Tax and National Insurance from your fees
• determining your IR35 status using employment tests
• providing a Status Determination Statement explaining their decision

You can get help understanding your status:

• professional advice: an accountant can review your contracts and working practices
• HMRC's CEST tool: use the Check Employment Status for Tax tool for initial guidance
• expert support: find an advisor for complex situations through the Xero advisor directory

Outside IR35 meaning

Being outside IR35 gives you more control over your finances. You remain exempt from the off-payroll working rules.

This gives you more control over your finances:

• tax efficiency: pay yourself through a mix of salary and dividends
• business expenses: claim allowable costs against your company profits
• pension contributions: make employer contributions through your company
• retained profits: keep money in your business for future investment

You remain responsible for your own tax affairs, including filing company accounts, corporation tax returns, and personal self-assessment.

Financial impact of being inside IR35

Working outside IR35 typically means higher take-home pay than inside IR35. Your client deducts Income Tax and employee National Insurance from your fees. You may also bear the cost of employer National Insurance contributions.

Here's an example comparison at £500 per day (£110,000 annually):

• Outside IR35: Approximately £75,000–£80,000 take-home after optimal salary and dividends
• Inside IR35: Approximately £60,000–£65,000 take-home after PAYE deductions

The trade-off is simpler admin. Your client handles all tax deductions, so you don't need to manage corporation tax, dividend paperwork, or employer National Insurance calculations.

Actual figures depend on your personal circumstances, expenses, and tax planning. Speak to an accountant for accurate calculations.

What to do if you're inside IR35

If your client determines you're inside IR35, they handle your tax deductions. Here's what happens next:

Your client has specific obligations when making an inside IR35 determination.

What your client must do

Your client must complete these tasks:

• provide a Status Determination Statement explaining their decision
• give you the chance to disagree with the determination
• respond to any disagreement within 45 days
• reconsider the circumstances and either confirm the original decision or issue a new one
• deduct Income Tax and National Insurance from your fees

You have the right to challenge an IR35 determination you believe is incorrect.

If you disagree with the decision

You can challenge the determination by providing evidence about your actual working practices. Your client must consider your response and either confirm or change their decision. If they fail to respond within 45 days, liability for any unpaid tax may transfer to them.

Working through an umbrella company

An umbrella company can simplify working on inside IR35 contracts. The umbrella becomes your employer and handles all tax deductions before paying you a salary.

Here's the process for working through an umbrella company.

How it works

The payment process works like this:

• your client pays the umbrella company
• the umbrella deducts Income Tax, employee National Insurance, and employer National Insurance
• you receive a net salary with a payslip

Before choosing an umbrella company, weigh these factors.

What to consider

Keep these factors in mind:

• Costs: Umbrella companies charge fees, typically £20–£30 per week
• Holiday pay: You accrue holiday pay, which affects your weekly take-home
• Compliance: Choose an umbrella that's Freelancer and Contractor Services Association (FCSA) accredited or compliant with relevant standards

Using an umbrella frees you from running a limited company for inside IR35 work. Some contractors keep their limited company for outside IR35 contracts and use an umbrella for inside IR35 roles.

Navigating IR35: Tips for contractors and businesses

Good documentation helps you determine and defend your IR35 status. Review each client contract individually, as your status may differ between engagements.

For contractors

Keep detailed records of your working arrangements:

• contracts showing the terms of your engagement
• evidence of control over your work methods
• documentation of your right to send substitutes
• proof of financial risk, such as insurance and equipment costs
• records of working for multiple clients

Consider getting professional IR35 insurance to protect against unexpected tax bills if HMRC challenges your status.

For businesses

If you engage contractors, follow these steps to stay compliant:

• assess each contractor's status before they start work
• provide a Status Determination Statement if you determine someone is inside IR35
• set up a process for contractors to challenge your determinations
• keep records of how you reached each decision
• review contractor status regularly, especially if working arrangements change

Work with an accountant to create a robust IR35 assessment process.

Managing your finances with the right tools

Whether you're working inside or outside IR35, keeping your finances organised is key to running a successful business. With clear records, you can easily track your income from different contractors, manage your expenses, and get a real-time view of your cash flow.

Xero's accounting software helps you stay on top of your financial obligations and makes it simple to share information with your accountant. This gives you the confidence to make smart business decisions and focus on what you do best. Get one month free to see how easy it can be.

FAQs on IR35

Here are answers to common questions about IR35 and contractor tax status.

What happens if HMRC disagrees with my IR35 status?

HMRC can investigate your IR35 status and may charge you for unpaid tax, National Insurance, interest, and penalties if they determine you should have been inside IR35. Keep detailed records of your working arrangements to support your position.

Can I be inside IR35 with one client and outside IR35 with another?

Yes. Your IR35 status applies separately to each contract. You might be inside IR35 with one client because they control how you work, while another client engagement qualifies as outside IR35 because you have genuine autonomy.

How often should I review my IR35 status?

Review your status whenever your working arrangements change significantly. This includes changes to how much control the client has, whether you can send substitutes, or if the ongoing nature of the work changes.

Do the IR35 rules apply to sole traders?

No. IR35 only applies to contractors working through their own limited company or personal service company. Sole traders are already taxed as self-employed individuals through self-assessment.

What is a Status Determination Statement?

A Status Determination Statement is a document your client must provide if they determine you're inside IR35. It explains why they reached that conclusion and gives you the right to challenge their decision.