IR35 Off-Payroll Working Rules – UK

Few pieces of UK tax legislation have generated as much confusion, anxiety, and litigation as IR35. Since its original introduction in 2000 and its significant expansion through the off-payroll working reforms of 2017 and 2021, IR35 has fundamentally changed the relationship between businesses, contractors, and the tax system.

And yet, despite decades of debate and thousands of pages of HMRC guidance, a remarkable number of businesses still get it wrong – either by blanket-determining all contractors as inside IR35 without proper assessment, or by ignoring the rules entirely and hoping for the best. Neither approach ends well.

This guide explains how IR35 actually works, what changed with the off-payroll reforms, how status determinations are made, and what the consequences of non-compliance look like in practice.

Mercans supports UK businesses in building compliant contractor engagement frameworks – from status determination processes to payroll treatment of inside-IR35 workers.

What Is IR35?

IR35 is the informal name for legislation designed to combat what HMRC calls disguised employment – situations where an individual works for a client in a manner functionally identical to an employee but engages through a Personal Service Company (PSC) or other intermediary, thereby reducing their income tax and National Insurance Contributions liability.

The name comes from the Inland Revenue press release that introduced the original legislation in 1999 – Inland Revenue 35. It has stuck ever since.

Formally, IR35 sits within two chapters of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003):

• Chapter 8: the original rules, applying where the worker’s own PSC is responsible for determining and paying tax (relevant for small private-sector clients)
• Chapter 10: the reformed off-payroll working rules, applying where the end client is responsible for determining employment status (relevant for medium and large private-sector clients, and all public-sector clients)

Understanding which chapter applies to a given engagement is the first step in getting IR35 right.

The Core Question IR35 Is Asking

Strip away the legislation and the HMRC guidance and IR35 is really asking one question:

If this contractor were engaged directly – without the intermediary company – would they be an employee?

If the answer is yes, they are inside IR35. The engagement is treated as disguised employment, and the worker’s income from that engagement is subject to income tax and National Insurance as if they were on the payroll.

If the answer is no – if the contractor is genuinely in business on their own account – they are outside IR35, and they can continue to be engaged and paid through their PSC without the additional tax treatment applying.

The challenge is that this question is almost never straightforwardly answered. Employment status in UK law is a facts-and-circumstances test, not a checkbox exercise.

Chapter 8 vs Chapter 10 – Which Rules Apply?

Chapter 8 – Original IR35 Rules

Under Chapter 8, the worker’s intermediary (typically their PSC) is responsible for determining whether IR35 applies to each engagement and for accounting for the correct tax and NICs if it does. This applies where the end client is a small private-sector company (meeting the Companies Act small company definition: two or more of – turnover under £10.2 million, balance sheet under £5.1 million, fewer than 50 employees).

In practice, compliance under Chapter 8 relies entirely on the contractor’s own honesty and diligence – something HMRC has long viewed as an inadequate safeguard.

Chapter 10 – Off-Payroll Working Rules (2017 and 2021 Reforms)

Chapter 10 shifted the responsibility for status determination away from the worker’s PSC and onto the end client. It applies to:

• All public sector engagements (since April 2017)
• Medium and large private-sector engagements (since April 2021)

Under Chapter 10:

• The end client must assess the employment status of each contractor engagement
• The client must issue a Status Determination Statement (SDS) to the contractor and the fee-payer
• The fee-payer (the party that pays the PSC – often a recruitment agency) becomes responsible for deducting income tax and employee NICs and paying employer NICs if the determination is inside IR35
• The liability shifts up the supply chain if the client fails to issue a valid SDS or if the SDS is shown to be negligently prepared

This is the change that sent shockwaves through the UK contracting market. Suddenly, large businesses were legally responsible for tax decisions that had previously sat with individual contractors.

The Employment Status Tests – How Determinations Are Made

There is no single statutory test for employment status under IR35. HMRC and the courts apply a multi-factor analysis developed through decades of case law. The key tests are:

1. Substitution

Can the contractor send a substitute to do the work in their place, and would the client be obliged to accept that substitute? A genuine, unfettered right of substitution points strongly toward outside IR35 – an employee cannot send someone else to do their job.

Critically, the right must be real – not a contractual clause inserted purely for IR35 purposes that would never be exercised in practice. HMRC and tribunals look at working reality, not just contract wording.

2. Control

Does the client control what work the contractor does, when they do it, where they do it, and how they do it? High levels of client control – particularly over the method of working – point toward inside IR35. Genuine contractors typically control their own working methods even if the client defines the deliverable.

3. Mutuality of Obligation (MOO)

Is there an expectation – even an informal one – that the client will continue to offer work and the contractor will continue to accept it? Mutuality of obligation is a hallmark of employment. Genuinely project-based engagements with no expectation of continuity point toward outside IR35.

4. Other Indicators

Beyond the three primary tests, tribunals also consider:

• Whether the contractor provides their own equipment
• Whether the contractor bears genuine financial risk (for example, fixing defects at their own cost)
• Whether the contractor works for multiple clients simultaneously
• Whether the contractor is integrated into the client’s organisation (attending away days, using a client email address, being line-managed)
• The length and continuity of the engagement

No single factor is determinative. IR35 status is always a holistic judgment based on the full picture of how the engagement operates in practice.

The Status Determination Statement (SDS)

Under Chapter 10, the end client must produce a Status Determination Statement for each contractor engagement. The SDS must:

• State whether the engagement is inside or outside IR35
• Give reasons for that determination (a bare conclusion without reasoning is not a valid SDS)
• Be provided to both the contractor and the fee-payer in the supply chain

The client must also operate a disagreement process – contractors have the right to formally dispute an SDS, and the client must respond within 45 days with either a revised determination or a reasoned explanation of why the original determination stands.

If the client fails to produce a valid SDS or does not respond to a disagreement within 45 days, the liability for unpaid tax shifts back to the client – even if a fee-payer is involved in the supply chain.

Inside IR35 – What Happens in Practice

When a contractor is determined to be inside IR35, their income from that engagement is treated as deemed employment income. The practical consequences:

• The fee-payer deducts income tax and employee NICs from payments to the PSC before remitting to HMRC
• The fee-payer pays employer NICs on top of the gross payment
• The PSC receives a net payment – not gross – stripping away the tax efficiency that made PSC contracting attractive
• The contractor cannot claim the dividend/salary split that is the primary tax advantage of operating through a PSC
• The PSC can still exist and operate but gains no tax advantage from the inside-IR35 engagement

For contractors, being placed inside IR35 typically means taking home significantly less from the same gross rate – leading many to renegotiate their day rates upward or to seek outside-IR35 engagements elsewhere.

HMRC’s CEST Tool – Useful But Not Infallible

HMRC provides an online tool called CEST (Check Employment Status for Tax) which asks a series of questions and returns a status determination. HMRC states that it will stand by CEST results where the information entered is accurate and the tool returns a determination.

However, CEST has attracted substantial criticism:

• It does not account for Mutuality of Obligation in the way case law requires
• It returns an inconclusive result in a significant proportion of cases
• It has been challenged and found inadequate in several high-profile IR35 tribunal cases

CEST is a starting point, not a definitive answer. Businesses relying solely on CEST outputs without supplementary legal analysis are exposed. A properly reasoned SDS requires more than a tool printout.

High-Profile IR35 Cases – What the Tribunals Have Said

IR35 litigation has produced some notable judgments that illustrate just how fact-specific these determinations are:

• HMRC v Lorraine Kelly (2019): The television presenter successfully argued she was outside IR35 on the basis that she performed a persona distinct from her personal self – a highly specific and unusual finding
• HMRC v Kickabout Productions (2022): A radio presenter was found inside IR35 despite working for multiple clients, based on the degree of control and integration present in the primary engagement
• ManpowerGroup UK Ltd v HMRC (2023): Addressed supply chain liability questions and the correct treatment of staffing agency arrangements under Chapter 10

These cases underscore a consistent theme: the tribunals look at working reality in granular detail. Contractual documentation matters, but how the engagement actually operates matters more.

How Mercans Supports IR35 and Off-Payroll Compliance

Building a defensible IR35 compliance framework involves more than running contractors through a status tool. It requires a documented process, consistent SDS issuance, a functioning disagreement mechanism, and – for inside-IR35 workers – correct payroll treatment through the supply chain.

Mercans’ UK payroll services support businesses at every stage of this process:

• Structured status determination frameworks tailored to each client’s contractor population
• SDS documentation that meets HMRC’s content requirements
• Payroll processing for inside-IR35 engagements, including correct income tax, employee NIC, and employer NIC treatment
• RTI-compliant submissions through HMRC’s Full Payment Submission system
• Ongoing monitoring of HMRC guidance updates and tribunal decisions that may affect existing determinations

For businesses managing a mixed workforce of employees and contractors across the UK and internationally, Mercans’ global payroll platform provides unified oversight without sacrificing the local compliance precision that IR35 demands. Explore the full range of services at mercans.com.

Frequently Asked Questions

Does IR35 apply to all contractors in the UK, or only those using a PSC?

IR35 specifically targets engagements conducted through an intermediary – most commonly a Personal Service Company but also partnerships and certain other structures. Contractors engaged directly as sole traders do not fall within IR35; instead, their employment status is assessed under separate rules. However, businesses engaging sole traders should still be mindful of employment status risk under general employment law and HMRC’s broader disguised employment provisions. The IR35 rules are specifically about the intermediary vehicle – the PSC – being used to achieve a tax outcome that would not otherwise be available.

Can a contractor challenge an inside-IR35 determination, and what is the process?

Yes. Under Chapter 10, contractors have a statutory right to dispute an SDS through the client’s disagreement process. The contractor must set out in writing why they believe the determination is incorrect. The client then has 45 days to respond – either issuing a revised SDS or providing a written explanation of why the original determination stands. If the client fails to respond within 45 days, the liability for any tax and NICs on the engagement shifts to the client. Contractors who remain dissatisfied after exhausting the client’s process can raise the matter with HMRC, though formal tribunal proceedings are time-consuming and expensive.

What are the risks for a business that ignores Chapter 10 obligations entirely?

The risks are substantial and have multiple dimensions. First, HMRC can assess the business for all unpaid income tax, employee NICs, and employer NICs on affected engagements – potentially going back years. Second, interest accrues on unpaid amounts from the date they should have been paid. Third, HMRC may impose penalties of up to 100% of the unpaid tax in cases of deliberate non-compliance. Fourth, in supply chain arrangements, liability can cascade upward to the end client if the fee-payer fails to account correctly. The reputational risk of an HMRC investigation into contractor arrangements is also significant, particularly for listed companies with public reporting obligations.

Is it legally permissible to make a blanket determination that all contractors are inside IR35?

Technically, a client can determine that all engagements in their organisation are inside IR35 – there is no law requiring outside-IR35 determinations. However, the SDS must still be issued for each engagement with reasons, and the determination must reflect a genuine assessment of the facts of each engagement rather than a blanket policy decision. HMRC has indicated that blanket determinations made without individual assessment are not compliant with Chapter 10 requirements. Furthermore, blanket inside determinations that are commercially unjustified expose the business to contractors renegotiating rates or walking away entirely, creating operational and cost risks that often exceed the compliance savings.

How does IR35 interact with contractors who work across the UK and other countries?

International contractor engagements add a further layer of complexity. The off-payroll working rules apply where the services are performed in the UK – so a contractor based overseas performing services for a UK client in the UK falls within Chapter 10 if the client meets the size thresholds. Conversely, a UK-based contractor performing services for an overseas client outside the UK may fall outside Chapter 10 entirely, reverting to Chapter 8 (self-assessment by the PSC). Double taxation treaty provisions, permanent establishment risk, and the interaction with social security agreements must all be considered for genuinely cross-border engagements. Mercans’ global employer of record and payroll services provide specialist support for businesses managing contractor and employee populations across multiple jurisdictions simultaneously.