Inside IR35 meaning: what it is and who pays
The off-payroll working rules generated an estimated £4.2 billion in additional tax, National Insurance and Apprenticeship Levy up to the end of March 2023, and around 130,000 workers were affected by the April 2021 reform [7]. Behind those figures sits a single label that decides how a contractor is taxed: inside IR35. When an engagement falls inside the rules, the worker is treated as a deemed employee for tax and their pay is subject to PAYE [1].
This guide explains what inside IR35 means, why the label exists, who decides it, and what changes for the worker, the client and the fee-payer once an engagement is inside the rules.
Key takeaways
- Inside IR35 means a worker would be an employee for tax if they were engaged directly, so their engagement is treated as deemed employment [1].
- The party paying the worker's intermediary, the fee-payer, deducts Income Tax and employee National Insurance and pays employer National Insurance to HMRC [2].
- For medium and large clients, the client decides status and issues a status determination statement with reasons [3].
- Employment status turns on control, personal service and mutuality of obligation, not on job title [9].
- Being inside IR35 changes how a contractor is taxed, not whether they keep their limited company [4].
What inside IR35 means
The off-payroll working rules make sure a worker who provides services through their own intermediary pays broadly the same Income Tax and National Insurance as someone employed directly [1]. The intermediary is usually a limited company the worker controls, known as a personal service company, though the rules do not define that term in law [8].
An engagement is inside IR35 when the client decides the worker would be an employee or office holder for tax if they were engaged directly [1]. Those workers are deemed employees and their remuneration for the engagement is subject to PAYE, an outcome HMRC describes as being inside the off-payroll working rules [1]. The test is whether the worker would have been an employee had they provided the same services without the intermediary in the way [5].
The rules were reformed for the public sector in April 2017 and for medium and large private-sector and voluntary-sector clients on 6 April 2021, shifting the status decision from the worker to the client [7]. Businesses that run their own HMRC-recognised payroll software still make the status decision first, then run the deemed employment through payroll.
How employment status is decided
Inside or outside is not a matter of preference. It rests on established employment status tests drawn from case law, and the client must take reasonable care in applying them [3].
The three core status factors
Mutuality of obligation determines whether a contract exists at all: the engager must be obliged to pay, and the worker obliged to provide their own work or skill [9]. Where a worker must perform the services personally and cannot send a genuine substitute, that points towards employment, because personal service is a hallmark of a contract of service [10].
Control is the third pillar: who decides what work is done, and when, where and how [11]. A worker told how to carry out the task and integrated into the client's team looks like an employee; one who runs their own business, uses their own methods and carries financial risk looks self-employed [12]. HMRC's Check Employment Status for Tax tool works through these same factors and gives a result HMRC will stand behind where the answers are accurate [11], a process set out step by step in the guide to checking IR35 status with the CEST tool.
Who makes the determination
For a public-sector client, or a medium or large private-sector client, the client decides status and must issue a status determination statement to the worker and the party it contracts with, giving reasons [3]. Where the end client is small, responsibility for deciding status stays with the worker's own intermediary [1]. A client that fails to pass on the determination or its reasons keeps the Income Tax and National Insurance liability itself [3]. Accountants managing many engagements often track determinations in a multi-client payroll dashboard so each decision can be evidenced.
What changes once an engagement is inside IR35
The label has immediate financial consequences. The fee-payer, the party immediately above the worker's intermediary, deducts Income Tax and employee National Insurance from the deemed direct payment and pays employer National Insurance on top [2]. Employer National Insurance cannot be taken out of the deemed payment, and the fee-payer reports the pay and deductions to HMRC through a Full Payment Submission, exactly as for any employee [2].
For the 2026-27 tax year, employer National Insurance is charged at 15% on earnings above the £5,000 secondary threshold, a rate that rose from 13.8% on 6 April 2025 [15]. The table below sets out where responsibility sits.
| Task | Inside IR35 | Outside IR35 |
|---|---|---|
| Who decides status (medium or large client) | The client [[3]](https://www.gov.uk/guidance/off-payroll-working-for-clients) | The client [[3]](https://www.gov.uk/guidance/off-payroll-working-for-clients) |
| Income Tax and employee NI deducted before payment | Yes, by the fee-payer [[2]](https://www.gov.uk/guidance/fee-payer-responsibilities-under-the-off-payroll-working-rules) | No, paid gross [[1]](https://www.gov.uk/guidance/understanding-off-payroll-working-ir35) |
| Employer NI and Apprenticeship Levy due | Yes, paid by the fee-payer [[2]](https://www.gov.uk/guidance/fee-payer-responsibilities-under-the-off-payroll-working-rules) | No [[4]](https://www.gov.uk/government/publications/off-payroll-working-rules-communication-resources/know-the-facts-for-contractors-off-payroll-working-rules-ir35) |
| Reported through Real Time Information | Yes, with the off-payroll indicator [[2]](https://www.gov.uk/guidance/fee-payer-responsibilities-under-the-off-payroll-working-rules) | No [[1]](https://www.gov.uk/guidance/understanding-off-payroll-working-ir35) |
Being inside the rules does not mean the worker loses their limited company. It changes how the fee for that engagement is taxed, and the payroll must carry the off-payroll worker indicator on the submission [2]. Platforms that embed UK payroll can trigger that deduction and set the indicator automatically through an HMRC-recognised payroll API, and the underlying obligation is the same one covered in the overview of IR35 and off-payroll working. Getting the deduction wrong is costly: HMRC has published a specific method for calculating PAYE liability where the rules are not applied correctly [14].
Conclusion
Inside IR35 is a tax status, not a verdict on how a contractor runs their business. It says that, for a particular engagement, the working reality looks like employment closely enough that HMRC expects employment taxes to be paid at source. The decision rests on control, personal service and mutuality of obligation, and for larger clients it is the client, not the worker, who must reach it with reasonable care and record the reasons.
The practical weight of the label falls on the fee-payer, who must deduct, pay employer National Insurance and report through Real Time Information with the right indicator. For any business engaging contractors, the reliable path is to treat the status decision and the payroll run as two halves of one compliant process rather than separate afterthoughts.
Frequently asked questions
Does being inside IR35 mean the contractor is now an employee?
No. Inside IR35 is a status for tax and National Insurance only. The worker is a deemed employee for those purposes, so PAYE and National Insurance are deducted from the engagement fee [1]. It does not give them employment rights such as holiday pay or redundancy, and they keep their own limited company [4].
Who deducts the tax when an engagement is inside IR35?
The fee-payer does, meaning the party immediately above the worker's intermediary in the labour supply chain [2]. It deducts Income Tax and employee National Insurance from the deemed direct payment, pays employer National Insurance on top, and reports the figures to HMRC through a Full Payment Submission [2].
Can a contractor challenge an inside IR35 determination?
Yes. A worker or deemed employer who disagrees can raise it with the client, and the client must respond within 45 days of being notified [3]. The client should review the determination and either confirm it with reasons or issue a new one. Keeping the evidence behind the original decision is what supports the client if the status is later questioned [6].
What is a status determination statement?
It is the written statement a medium or large client must produce, telling the worker and the party it contracts with whether the engagement is inside or outside IR35 and why [6]. There is no fixed legal format, but it must be in writing and give reasons; without reasons, the tax liability stays with the client [3].
