IR35 compliance for small businesses and contractors

Published 10 March 2026

Table of contents

• What is IR35 and how do off-payroll working rules apply?
• Who the IR35 rules apply to
• When the rules apply in the private and public sectors
• Inside vs outside IR35
• How to determine IR35 status and issue an SDS
• Stay compliant with Xero
• FAQs on IR35 rules

Key takeaways

• IR35 or off-payroll working rules require businesses to withhold income tax and NIC on behalf of contractors paid through intermediaries if the contractor works like an employee.
• Whether a worker is inside or outside IR35 depends on who controls the work, whether or not the worker can send a substitute, and whether the client is obligated to provide work and the worker is obligated to accept it.
• Public sector, medium, and large businesses determine the worker's status and handle the taxes. But with small companies, the intermediary determines the status and handles taxes.

What is IR35 and how do off-payroll working rules apply?

The UK's off-payroll working rules are known as IR35, after Inland Revenue's (IR) press release number 35. The IR35 rules require businesses to treat certain contractors who work through intermediaries as employees for tax purposes.

If the off-payroll working rules apply, the business must withhold income tax and National Insurance Contributions (NIC) from the worker's pay and file PAYE reports with HMRC. They don't have to provide statutory payments or enroll the worker in their pension scheme.

Check out the government's overview of IR35 off-payroll working rules.

Who the IR35 rules apply to

The IR35 rules apply when workers provide services to companies through an intermediary. The rules apply to:

• Workers who provide services through their own intermediary to a client: For example, you operate a personal services company and provide services to businesses through that company.
• Clients who receive services from a worker through an intermediary: For example, you hire an independent contractor and you pay them through their personal services company or another intermediary.
• Agencies that provide workers' services to clients through the workers' intermediary: For example, a company hires your agency to help them find a worker. You connect them to a worker who provides services through an intermediary like a personal services company.

When the rules apply in the private and public sectors

IR35 compliance requirements depend on the size of the business and whether the client is in the private or public sector.

Public sector clients, or medium or large private- or voluntary sector clients

When a worker provides services through an intermediary to a public sector client or a medium or large-sized private- or voluntary-sector client, the client must:

• determine if the worker qualifies for the off-payroll working rules
• provide an employment status determination to the worker, along with the reasons for the decision
• withhold income tax and NIC from the worker's pay and remit payments to HMRC

If the worker disagrees with the employment status determination, they can contest it before they receive their final payment. The client has up to 45 days to respond to the worker – during that time, the client should continue paying the worker based on their original determination. After the client reviews the disagreement, they get to decide whether to keep the current status or make IR35 changes.

The IR35 rules consider private and voluntary sector organisations as medium or large if they meet two or more of these three conditions:

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

Otherwise, the organisation is considered small and different rules apply.

Small private sector or voluntary sector clients

When a worker provides services to small private- or voluntary-sector clients, the intermediary must decide if the off-payroll working rules apply. If you're the director of a personal services company, you may end up making your own determination when you provide services to a company.

The client then pays the intermediary, the intermediary pays the worker, and if the off-payroll rules apply, the intermediary pays NIC and income tax to HMRC.

Inside vs outside IR35

The phrase ‘inside vs outside IR35’ refers to whether or not the IR35 rules apply.

If a worker is inside the IR35 rules, they're treated similarly to an employee. The client or the intermediary must pay the employer's portion of NIC and withhold income tax and NIC from the worker's payment.

If a worker is outside IR35, they are genuinely an independent contractor. The client does not treat them as an employee. Instead, the client pays them directly for their services and the worker deals with their own taxes.

How to determine IR35 status and issue an SDS

If you hire a worker through an intermediary, you need to:

• review their IR35 status
• issue a status determination statement (SDS) explaining whether or not they're subject to the off-payroll working rules

Here's how to do that:

1. Gather contract terms and working practices

Review the contract and the worker's responsibilities. You need to understand their role in the company to determine their status.

2. Review control, substitution, and mutuality

Three main factors determine if a worker is truly self-employed or is treated as an employee and subject to the IR35 rules.

• Control: Who decides what work needs to be done and when, where, and how is it done? If the client controls the relationship, the worker is more likely to be covered by the off-payroll working rules.
• Substitution: Can the intermediary send a substitute (provided they can perform the same work), to the client? If substitution is not allowed, the IR35 rules apply.
• Mutuality: Does the client have to provide work and is the worker obligated to accept it? If yes in both cases, the worker may be inside IR35. If not, the worker is self-employed.

If you hire a lot of workers through intermediaries, consider making an IR35 checklist to help you work through the criteria.

3. Use CEST and professional advice where needed

The Check Employment Status for Tax (CEST) tool helps businesses and workers decide whether a worker is an employee, self-employed, subject to IR35, or outside IR35. It's basically an ’IR35 calculator.’ As long as you enter accurate information, HMRC will accept the tool's results. You could also ask an accounting, legal, or tax professional for help.

Here's more info on how to use the CSET tool.

4. Issue an SDS and share it with the contractor and fee payer

Give the contractor the SDS, but remember they have the right to disagree with your determination at any time up until you provide their last payment and give a copy to the fee payer (who pays the intermediary) so they know whether they need to deal with taxes.

5. Keep records and review regularly

Keep records showing how you made your IR35 determination. If the arrangement changes, review the worker's employment status, make IR35 changes as needed, and update the SDS.

Stay compliant with Xero

Whether you hire contractors or provide services to other businesses, Xero can help simplify IR35 compliance. The software makes it easy to securely store accurate records, manage payments, and calculate taxes based on the off-payroll working rules.

If you provide services to other businesses, Xero contractor accounting software helps you track payments and expenses, send invoices, and run financial reports.

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FAQs on IR35 rules

Here are answers to common questions to help you understand IR35 for limited companies:

What is the small company exemption for private sector clients?

Small companies don't need to determine if workers are subject to IR35 rules, and they don't need to handle the worker's tax payments. Instead, the intermediary must make the determination and handle the taxes.

To qualify as a small company under the IR35 rules in 2026, a business must meet two of these criteria:

• annual turnover £15 million or under
• balance sheet £7.5 million or under
• no more than 50 employees

Who is the fee payer in a supply chain with agencies?

The fee payer is the party immediately above the worker's intermediary. If a business hires a worker through an intermediary, the business is the fee payer. The fee payer can be harder to identify if there's a complicated supply chain with multiple businesses, agencies, and workers – but the fee payer is always the entity that pays the intermediary.

Does IR35 apply to contractors employed by an umbrella company?

No – workers employed by umbrella companies are not subject to IR35 rules. When an umbrella company provides a worker to another business, the business pays the umbrella company and the umbrella company then pays the worker as an employee. Because the worker is an employee, the IR35 rules don’t apply.

How do I dispute an SDS I disagree with?

Before your final payment from the client, let them know that you disagree with their SDS, and give them information that supports your claim. The client must respond to you within 45 days. They may change the SDS based on your information or keep it the same.

How often should I review a contractor’s IR35 status?

Review the IR35 status any time your agreement changes or you start a new project. Even if you're working with the same person, their status may change throughout the course of your relationship.

How does IR35 interact with CIS in construction?

The IR35 rules override the Construction Industry Scheme (CIS) rules. If a worker is subject to IR35, you must follow the off-payroll working rules. If not, you may need to withhold taxes from their pay according to the CIS rules instead.