IR35 in 2025: A Plain-English Guide for Contractors on Inside vs Outside Status
IR35 — formally, the Intermediaries Legislation — has been a source of confusion, frustration, and significant financial consequence for contractors since its reform in 2021 shifted responsibility for determining employment status from the contractor to the client organisation. Four years on, with HMRC enforcement activity continuing and contractors moving between inside and outside-IR35 roles regularly, a clear understanding of the rules is more important than ever.
What is IR35?
IR35 is the legislation that determines whether a contractor working through a personal service company (PSC) — typically their own limited company — should be treated as an employee for tax purposes. The original legislation was introduced in 2000 to prevent "disguised employment": a situation where someone does essentially the same work as an employee but is paid through a company to reduce their tax and NI liability.
The test is not about the corporate structure but about the substance of the working relationship. HMRC looks at three key factors:
- Substitution: Can the contractor send a substitute to do the work? If yes, that suggests self-employment. If the client requires the specific individual, that points toward employment.
- Control: Does the client control where, when, and how the work is done? High control points toward employment.
- Mutuality of obligation: Is the client obliged to offer work and the contractor obliged to accept it? If yes, that points toward employment.
How the 2021 reform changed things
Before April 2021 (and before April 2017 for the public sector), the contractor's own company was responsible for assessing IR35 status. From April 2021, for medium and large clients (broadly, those with turnover over £10.2m or over 50 employees), the client is responsible for making the Status Determination Statement (SDS) — a written conclusion on whether the engagement is inside or outside IR35. If inside, the fee-payer (the client or agency) must deduct PAYE and NICs from payments.
HMRC's CEST tool
HMRC provides the Check Employment Status for Tax (CEST) tool at cest.service.gov.uk. It asks a series of questions about the working arrangement and produces a determination. HMRC has committed to stand behind CEST outcomes if the facts are entered accurately. However, the tool has been widely criticised for not addressing mutuality of obligation adequately, and several IR35 tribunal cases have produced outcomes inconsistent with what CEST would have determined. Many tax professionals recommend using CEST as a starting point but not as the sole basis for a determination.
Inside IR35: the financial reality
If an engagement is inside IR35, the contractor receives their day rate with PAYE income tax and employee NICs (8% main rate in 2025-26) deducted at source. They also face employer NICs (15% from April 2025) on the same income. From a £500/day rate inside IR35, a higher-rate taxpayer effectively takes home around £290-£310 per day after all deductions — compared to potentially £380-£400 outside IR35 operating through a limited company and taking salary plus dividends efficiently. Run the numbers for your specific day rate.
Outside IR35: the contractor structure
Outside IR35, the contractor operates genuinely in business on their own account. They can take a low salary (typically £12,570 or £9,100 to manage employer NI, depending on their situation) and extract remaining profits as dividends, which are taxed at lower rates than employment income (8.75% basic, 33.75% higher for 2025-26). Corporation tax on company profits is 19-25% depending on the level of profits. Allowable business expenses can be deducted before calculating profits.
Conclusion
IR35 status is not a binary choice the contractor makes — it is a determination based on the actual working relationship. Getting it wrong exposes contractors (and from 2021, clients) to significant tax liability. If you are uncertain about your status, specialist IR35 advice from a qualified tax adviser is worth the cost. Use our IR35 calculator to model the financial difference between inside and outside status for your day rate.