IR35 Explained: Inside vs Outside and What It Does to Your Take-Home

IR35 is the set of rules that decides whether a contractor working through their own limited company is genuinely in business (outside IR35) or is really doing a job that should be taxed like employment (inside IR35). If you are inside, income tax and National Insurance are deducted from the contract fee before you see it; if you are outside, your company is taxed and you decide how to take the money out. On a £110,000 contract in 2026/27 the difference is roughly £3,400 a year in rest-of-UK take-home — much less than contractors expect, and wider in Scotland.

Key points

• IR35 is about tax status, not employment rights. Being inside IR35 does not make you an employee of the client.
• For public sector clients and medium or large private sector clients, the client decides your status and issues a Status Determination Statement.
• If the client is a small private company, your own company decides — and carries the risk if HMRC disagrees.
• The take-home gap has narrowed because dividend rates rose to 10.75% / 35.75% / 39.35% and the dividend allowance is only £500.
• HMRC's CEST tool gives a free indication of status, but it is only as good as the answers you feed it.

IR35 in plain English

Suppose you supply your services through a limited company (often called a personal service company, or PSC). IR35 asks a single hypothetical question: if the contract were directly between you and the client, with no company in the middle, would it look like employment? If yes, the tax system treats the fee as employment income. If no, the company is a normal trading business.

The rules come in two flavours. The original 2000 rules (Chapter 8 of ITEPA) put the decision and the tax bill on your own company. The off-payroll working rules (Chapter 10) moved both to the client — from April 2017 in the public sector and from April 2021 for medium and large private sector organisations. Both are commonly called "IR35".

What inside and outside IR35 actually mean

Outside IR35 means your company invoices the client, pays Corporation Tax on its profit, and you draw a salary and dividends. You can claim business expenses, make employer pension contributions from the company, and control the timing of what you take.

Inside IR35 means PAYE income tax and Class 1 National Insurance are applied to the fee. In practice this happens one of two ways: the fee-payer (usually the agency closest to your company) deducts PAYE and pays the net amount to your company, or you move onto an umbrella company's payroll and are paid as an employee of the umbrella.

The tests that decide it

There is no single statutory test. Courts weigh the whole picture, drawing on decades of case law:

• Personal service and substitution — can your company send a suitably qualified replacement, in practice as well as on paper?
• Control — who decides what you do, how, when and where? A client specifying the outcome is different from a client supervising the method.
• Mutuality of obligation — is the client obliged to offer work and you obliged to accept it, beyond the agreed deliverable?
• Financial risk — fixed price work, rectifying defects at your own cost, your own insurance and equipment all point away from employment.
• Being "part and parcel" — line management responsibility, appraisals, staff benefits and an internal job title point towards it.

What matters is the reality of the engagement, not the wording of the contract. A clause allowing substitution that everyone knows would never be used carries little weight.

Who decides your IR35 status

A client is "small" by reference to the Companies Act size tests — broadly, meeting two of three limits on turnover, balance sheet total and employee numbers. Those company-size limits were raised for accounting periods beginning on or after 6 April 2025, which feeds through to off-payroll working with a lag, so more clients now fall into the small bracket.

Where the client makes the decision it must give you a Status Determination Statement (SDS) setting out the conclusion and the reasons. Blanket determinations that ignore the facts of individual roles do not meet the "reasonable care" requirement, and a client that fails to take reasonable care keeps the liability itself.

There is also a separate change to be aware of: responsibility for operating PAYE on workers supplied through umbrella companies is moving to the recruitment agency, or to the end client where there is no agency.

Take-home inside vs outside IR35: worked example

Take a contract worth £110,000 a year excluding VAT (£500 a day for 220 days). The figures below use 2026/27 rates and assume no other income and a standard Personal Allowance of £12,570.

Outside IR35, through your own company

• Fees £110,000, less £2,000 of running costs (accountancy, insurance, software).
• Salary of £12,570 — no income tax and no employee NI, because both the Personal Allowance and the NI primary threshold sit at £12,570.
• Employer NI on the salary: (£12,570 − £5,000) × 15% = £1,136. A sole-director company with no other employees cannot use the Employment Allowance.
• Taxable profit: £110,000 − £2,000 − £12,570 − £1,136 = £94,294.
• Corporation Tax with marginal relief: (£94,294 × 25%) − ((£250,000 − £94,294) × 1.5%) = £23,574 − £2,336 = £21,238.
• Dividends available: £94,294 − £21,238 = £73,056.
• Dividend tax: first £500 covered by the dividend allowance; £37,200 at 10.75% = £3,999; the remaining £35,356 at 35.75% = £12,640. Total £16,639.

Take-home: £12,570 + £73,056 − £16,639 = £68,987.

Inside IR35, on umbrella payroll

Here the £110,000 is an assignment rate, not your gross pay. Employer costs come out of it before you are paid.

• Umbrella margin of, say, £1,200 leaves £108,800 to cover gross pay plus employer costs.
• Working backwards: gross pay £94,848, employer NI £13,477, Apprenticeship Levy at 0.5% £474.
• Income tax: £94,848 − £12,570 = £82,278 taxable. £37,700 at 20% = £7,540; £44,578 at 40% = £17,831. Total £25,371.
• Employee NI: £37,700 at 8% = £3,016, plus £44,578 at 2% = £892. Total £3,908.

Take-home: £94,848 − £25,371 − £3,908 = £65,569.

The comparison

The gap is about £3,400, or roughly 3% of the contract value. It used to be far larger. Two things closed it: Corporation Tax at up to 25% with marginal relief, and dividend rates of 10.75% and 35.75% against a £500 allowance. Note also that the umbrella figure includes holiday pay within the gross, gives you statutory sick and family pay rights, and comes with pension auto-enrolment — and that the outside figure ignores employer pension contributions from the company, which are deductible for Corporation Tax and can shift the arithmetic considerably.

If you are a Scottish taxpayer

Scottish income tax rates apply to non-savings income such as salary and deemed employment income, but not to dividends. That makes inside IR35 more expensive north of the border and leaves the outside position largely unchanged. On the same £94,848 gross pay, Scottish income tax is £28,414 rather than £25,371 — about £3,040 more — taking inside-IR35 take-home to roughly £62,527 and widening the gap to around £6,460.

Running an IR35 check with CEST

HMRC's free tool, Check Employment Status for Tax (CEST), asks about substitution, control, financial risk and how you fit into the client's organisation, then gives one of three outcomes: employed for tax purposes, self-employed for tax purposes, or unable to determine.

HMRC says it will stand behind a CEST result provided the answers accurately reflect the engagement and the tool was used in line with the guidance. Practical points:

• Save or print the result. Without the reference and the answers given, the outcome is worth little in an enquiry.
• Answer on the reality of the working arrangement, not the contract wording.
• Run one check per engagement. Status can differ between two contracts with the same client.
• CEST has long been criticised for the limited weight it gives to mutuality of obligation, so a borderline role may need a fuller review.

Disputing a status determination

You cannot appeal an SDS to HMRC or to a tribunal. What you can do is use the client-led disagreement process, which every client operating the off-payroll rules must have. You write to the client setting out why you disagree and the evidence; the client must consider it and respond with either a revised determination or the reasons for keeping the original. Clients are expected to reply within 45 days.

Useful ground to cover in a challenge: evidence that a substitute has been offered or used, written confirmation that you set your own hours and methods, the absence of any obligation on either side to offer or accept further work, and a note of your own equipment, insurance and other concurrent clients.

Where your own company made the decision under the original rules, a dispute follows the normal route: HMRC opens an enquiry, issues determinations for PAYE and NIC, and you can appeal to the First-tier Tribunal. Since April 2024 HMRC can set off tax the company and its director already paid — Corporation Tax, dividend tax and any PAYE — against the deemed employment liability, which has cut the headline bills that made earlier IR35 cases so alarming.

If PAYE has been deducted on an inside determination you believe was wrong, and the fee-payer will not change it, the remaining option is to reclaim any overpaid income tax through Self Assessment or a repayment claim. National Insurance already paid is far harder to recover.

IR35 vs self-employed: why sole traders aren't caught

IR35 only bites where there is an intermediary — usually your limited company, sometimes a partnership. A plain sole trader invoicing clients directly is outside the scope entirely, because there is no company in the middle for the rules to look through.

That is not a loophole. Separate agency and employment status rules still apply, and a client who engages a sole trader on employment-like terms can be held responsible for operating PAYE. Sole traders also lose the limited liability and the salary-plus-dividend flexibility that makes outside-IR35 company trading attractive in the first place, and pay Class 4 NI at 6% between £12,570 and £50,270 plus 2% above, with Class 2 credited at £3.65 a week once profits exceed £7,105.

What to do next

Work out the cash difference before you negotiate a rate. Put your day rate and expected days into the IR35 calculator to see inside and outside take-home side by side for 2026/27, and use the contractor calculator to test different salary and dividend splits, employer pension contributions and running costs through your own company. If you have mixed income across the year — part of it inside IR35, part outside — the income tax calculator will show the combined position, including Scottish rates.