There’s no two ways about it: IR35 is complicated. The rules for small businesses are different from those for larger businesses, and they only apply depending on the extent to which the contractor, and the nature of your working arrangement with them, meets a set of convoluted criteria.

In this article, we explain how IR35 works, who determines whether or not the rules apply, and what you’re responsible for if they do.

What is IR35?

IR35 is a set of off-payroll working rules that were introduced to ensure that contractors who provide their services to clients through their own intermediary, known as a Personal Services Company (PSC), pay the correct tax. 

As the director of their own limited company, these contractors are entitled to pay themselves a salary up to the personal allowance threshold (£12,570) and then to pay themselves in dividends, which are taxed at a lower rate than income and are not subject to National Insurance Contributions (NIC). 

However, in situations where the working relationship between you, the client, and the contractor is no different from that of a regular employee, they fall inside IR35 and must make a ‘deemed payment’ of income tax and NIC to HMRC. As the ‘deemed employer’, you are responsible for making these deductions (more on this below).

Who determines whether IR35 applies?

When it first became law in 2000, contractors were responsible for determining whether they fell inside or outside IR35. But in 2017 and 2021, the government extended the scope of the legislation to make public and private sector organisations responsible for determining the employment status of any contractor they hire. 

However, this change doesn’t apply to businesses that meet two of the following criteria:

• Turnover of £10.2m or less 
• A total of £5.1m or less on the balance sheet
• 50 employees or fewer

On the other hand, if you exceed these thresholds, you are liable for IR35 and you become the ‘deemed employer’ of any contractor who falls inside IR35.

How do you know if a contractor falls inside or outside IR35?

The IR35 status of any worker who provides their services through an intermediary – be it their own PSC, a partnership, or another individual – is primarily determined according to three principles. 

1. Supervision, direction and control 

To what extent do you as the client employer determine how, when, where, and by whom the contractor’s work is completed? 

A contractor should be able to decide the hours they work and will probably work on a project (rather than an ongoing) basis. On the contrary, if you have a lot of say over how and when they work, they could be a deemed employee.  

2. Substitution

Is the contractor required to carry out the work personally, or can they send a substitute to perform the work in their place? 

If the former, this could indicate that they’re an employee. But so long as the contractor has absolute freedom to reassign the work to a substitute, they fall outside the scope of IR35.  

3. Mutuality of obligation 

Are you obligated to offer ongoing work to the contractor, and are they obligated to accept it when offered? If so, they may well fall inside IR35. To fall outside IR35, there must be no mutuality of obligation.

Other considerations

That’s not all. When determining IR35 status, you should also consider:

• Equipment – a contractor should have their own equipment, rather than having to rely solely on equipment supplied by you

• Presence – a contractor should operate like a real business. That could include having the relevant insurance, a registered office address, and a website

• Exclusivity – a contractor will probably have other clients and not work exclusively for you

• Payment – a true contractor will probably be paid a fixed fee for each project completed, rather than on a weekly or monthly basis

The above is not exhaustive, and it’s possible for a contractor to tick one or more of these boxes but still fall outside IR35. However, if you hire a worker on a self-employed basis and they meet any of the above criteria, HMRC could deem them an employee. 

What are your responsibilities as a deemed employer under IR35?

If you’re classed as the deemed employer under the off-payroll working (IR35) rules, you have a few key responsibilities when it comes to tax and reporting.

Your responsibilities

As the deemed employer, you must:

• Work out the ‘deemed direct payment’ – this is the part of the contractor’s fee that counts as taxable earnings

• Deduct Income Tax and employee National Insurance (NI) from that payment

• Pay employer NI contributions on top of what you pay the worker

• Report everything to HMRC using Real Time Information (RTI), just like you would for your regular employees

• Use the ‘off-payroll worker’ flag in your payroll software (label may vary)

• Apply the Apprenticeship Levy if it applies to your business

These workers aren’t your employees – they’re engaged through their own company, so any employment benefits come from there, not from you. This means that you don’t have to:

• Deduct student or postgraduate loan repayments – the worker handles that in their own tax return

• Provide statutory benefits (like sick pay or maternity pay)

• Enroll the worker in your pension scheme

• Pay holiday 

Next steps for employers

If you engage with self-employed consultants or contractors, and you don’t already, you should take some simple steps to ensure you don’t get caught out:

• Identify and review your consultant/contractor relationships

• Ensure your terms of engagement with contractors and consultants are clear and accurately reflect their true status

Consider how the services are delivered and by who, then potentially change contractors or consultants into employees, possibly with zero-hour contracts or casual worker agreements with gaps between engagements to avoid continuity of service

Further reading

Change in company size threshold – could it slash your red tape? – UK company size thresholds are set to change from April 6, 2025, the first change since 2013. This most likely means that your company could be changing from a medium-sized to small or a small to microbusiness.