IR35 — officially known as the off-payroll working rules — has been a defining issue for UK contractors since it was significantly reformed in 2021. Whether a contract falls inside or outside IR35 can make a difference of thousands of pounds per year in take-home pay. Yet many contractors still do not fully understand how the rules work, who makes the determination, or what the actual financial impact looks like in practice.
What IR35 actually means
IR35 is HMRC legislation designed to ensure that contractors who work like employees pay broadly similar tax to employees. The rules look at the substance of a working arrangement rather than just its form. If a contractor works exclusively for one client, under that client's supervision and control, using their equipment and integrated into their team, HMRC considers that relationship to be employment — regardless of what any contract says.
The critical distinction is between inside IR35 (the contract is caught by the rules, and the contractor is treated as a deemed employee) and outside IR35 (the contract is genuine self-employment, and the contractor can operate efficiently through a limited company).
Who determines IR35 status?
Since April 2021, the responsibility for determining IR35 status in the private sector shifted from contractors to end clients. Medium and large businesses must now provide a Status Determination Statement (SDS) for each contractor engagement. Small businesses (under two of: 50 employees, £10.2M turnover, £5.1M balance sheet) are exempt — in those cases the contractor's own limited company still makes the determination.
HMRC provides the CEST (Check Employment Status for Tax) tool to help assess status, though its accuracy has been disputed. Many contractors and clients seek specialist IR35 assessments from employment law firms or dedicated IR35 consultancies for higher-value engagements.
The financial difference: inside vs outside IR35
The financial gap between inside and outside IR35 is substantial. Outside IR35, a contractor operating through a limited company takes a salary at the National Insurance-efficient level (£12,570 for 2025/26) and draws the remainder as dividends, which attract lower dividend tax rates and no NI. Inside IR35, the full contract income is treated as a deemed salary subject to full PAYE income tax and both employee and employer National Insurance.
The key tax differences explained
Outside IR35 — limited company route
- Draw a salary at the primary NI threshold (£12,570) — no employee or employer NI on the salary itself
- Pay corporation tax on company profits (19% small profits rate up to £50,000; 25% main rate above £250,000)
- Extract remaining profits as dividends — taxed at 8.75% (basic rate), 33.75% (higher rate) after the £500 dividend allowance
- Legitimate business expenses reduce taxable profit before tax
- Employer pension contributions from pre-tax profits are highly tax-efficient
Inside IR35 — deemed employment
- Full contract value treated as employment income (minus a 5% expense allowance — removed for most workers since 2023)
- Employer National Insurance (13.8%) deducted from the contract fee before it reaches the contractor
- Employee National Insurance (8% up to UEL, 2% above) deducted from the deemed salary
- Income tax at standard PAYE rates on all income above the personal allowance
- No dividend extraction — all income treated as employment income
Umbrella companies for inside IR35 contracts
Contractors working inside IR35 often use umbrella companies rather than their own limited company. The umbrella employs the contractor directly, handling PAYE and NI, and passing the net pay to the contractor. Umbrella fees typically range from £15–£30 per week. While this adds a small cost, it simplifies administration and removes the compliance burden of operating a dormant limited company.
Not all umbrella companies operate compliantly — HMRC has flagged a number of schemes that claim to minimise tax in ways that do not hold up to scrutiny. Contractors should choose FCSA-accredited or Professional Passport-approved umbrellas to avoid unexpected tax liabilities.
Can a contractor challenge an inside IR35 determination?
Yes. Under the off-payroll rules, contractors have the right to challenge a Status Determination Statement they believe is incorrect. The client must respond within 45 days. If the contractor believes the determination is wrong and the client does not change it, the contractor can refer the matter to HMRC. In practice, most contractors either accept the determination, renegotiate the day rate to account for the higher tax burden, or move on to other contracts.
Calculate your IR35 impact
The exact financial difference between inside and outside IR35 depends on your specific day rate, the number of billable days per year, and your personal tax position. Use the GovernStack IR35 Calculator to get a personalised side-by-side comparison based on 2025/26 tax rates.