IR35 penalties: what non-compliance costs

A careless error under the off-payroll working rules can cost up to 30% of the tax HMRC lost, and a deliberate and concealed one up to 100% ^[3]. On top of any penalty, HMRC charges interest on late PAYE at 7.75% from 9 January 2026 ^[8]. Together they turn a wrong status decision into a bill far larger than the original tax.

The off-payroll working rules, commonly called IR35, do not carry their own separate penalty regime. Instead, an incorrect determination that leads to underpaid Income Tax and National Insurance is penalised under the general inaccuracy rules in Schedule 24 of the Finance Act 2007 ^[2]. The rules bite only where an engagement that was in fact inside IR35 was treated as outside it ^[9]. The size of the penalty depends on behaviour, not on the amount alone.

This article sets out who is liable for an IR35 penalty, how HMRC calculates the percentage, how interest and the set-off for tax already paid work, and the reasonable-care defence that removes the penalty entirely.

Key takeaways

• IR35 non-compliance is penalised under the general Schedule 24 inaccuracy rules, not a separate IR35 penalty regime.
• Penalties run from 0% to 30% of lost tax for careless errors, 20% to 70% for deliberate errors, and 30% to 100% where the error is deliberate and concealed.
• HMRC charges late-payment interest on unpaid PAYE at 7.75% from 9 January 2026, base rate plus 4%.
• Since 6 April 2024, tax already paid by the worker can be set off against the deemed employer's liability.
• No penalty is charged where the client took reasonable care, even if the determination was wrong.

Who is liable for an IR35 penalty

Where a medium or large private-sector client, or any public-sector body, gets a status decision wrong, the liability for the unpaid tax and National Insurance falls on the deemed employer, usually the fee payer in the contractual chain ^[6]. The client that failed to run a proper process can also find the liability transferred to it, for example where it does not meet the requirements of the disagreement process ^[12].

Only a small private-sector client is outside this exposure, because responsibility for status stays with the contractor's own company ^[10]. A private-sector client is small where it does not exceed at least two of turnover over £15 million, a balance sheet over £7.5 million, and 50 employees ^[15]. Businesses that hire contractors regularly reduce their exposure by recording each determination in HMRC-recognised payroll software that holds the evidence HMRC asks for.

How HMRC calculates the penalty

The penalty is a percentage of the potential lost revenue, meaning the tax and National Insurance HMRC would have gone without had it not intervened ^[1]. The percentage depends on the behaviour behind the error, graded across three bands ^[4]. The table below sets out the standard domestic ranges.

Within each band, the final figure turns on the quality of any disclosure. A careless error disclosed without prompting can be reduced to as little as 0%, while a prompted disclosure of the same error carries a minimum of 15% ^[3]. For a deliberate error, an unprompted disclosure has a floor of 20% and a prompted one a floor of 35% ^[3]. Coming forward early, rather than waiting for an enquiry, is the single biggest lever a business has over the size of the penalty.

Interest and the set-off for tax already paid

A penalty is not the only additional cost. HMRC charges interest on late PAYE and National Insurance from the date the payment was due until it is paid in full, calculated daily ^[7]. The late-payment rate is set at the Bank of England base rate plus 4 percentage points, which put it at 7.75% from 9 January 2026 ^[8].

One relief softens the blow. Since 6 April 2024, HMRC can set off Income Tax and National Insurance already paid by the worker and their intermediary against the deemed employer's PAYE liability for the same income ^[6]. Before this change, the same income could effectively be taxed twice, once on the contractor and again on the deemed employer. The set-off applies to deemed direct payments made from 6 April 2017 in open and future cases ^[6]. Accountants managing this across several clients often centralise the records in a payroll bureau platform to demonstrate what has already been paid.

The reasonable-care defence

The most important point about IR35 penalties is that they are avoidable. HMRC will not charge a penalty where the client took reasonable care to apply the rules correctly but still reached the wrong conclusion ^[5]. Reasonable care means acting as a prudent and reasonable person in the client's position would, carrying out a thorough determination and keeping records of how each decision was reached ^[5].

Certain shortcuts fail that test. A blanket determination, applying a single outcome across workers on different terms without assessing each one, is treated as a failure to take reasonable care ^[5]. Accurately completing HMRC's Check Employment Status for Tax tool and keeping the result, by contrast, is one of the behaviours HMRC accepts as reasonable care ^[11]. HMRC will stand by a CEST outcome where the information entered is accurate and reflects the real working arrangements ^[14]. HMRC has consistently said its focus is on supporting organisations to get determinations right rather than on penalising genuine mistakes ^[13]. For software platforms embedding compliance into their own products, an HMRC-recognised payroll API can capture the determination trail automatically.

Conclusion

The penalty for getting IR35 wrong is rarely just the tax. It is the tax, plus a behaviour-based penalty of up to 100% of that tax, plus daily interest at 7.75%. What separates a nil penalty from a six-figure one is not the technical difficulty of the decision but whether the business can show it took reasonable care.

That makes the record-keeping around each determination the real point of control. A client that documents its process, avoids blanket decisions and corrects errors early keeps its exposure to the tax itself, while one that cuts corners inherits penalties and interest on top. The mechanics of who decides status and how are set out in the Moonworkers guide to the off-payroll working rules, and the structure the rules apply to is covered in the guide to the personal service company.

Frequently asked questions

Does IR35 have its own penalty regime?

No. There is no separate IR35 penalty. An incorrect status decision that leads to underpaid tax is penalised under the general inaccuracy rules in Schedule 24 of the Finance Act 2007, the same rules that apply to other tax errors ^[2]. The penalty is a percentage of the tax lost, set by reference to the behaviour that caused the error ^[4].

How much is an IR35 penalty?

For a careless error the penalty is up to 30% of the lost tax, for a deliberate error up to 70%, and for a deliberate and concealed error up to 100% ^[3]. The exact figure within each band depends on whether the disclosure was prompted or unprompted and how much the business helped HMRC establish the position ^[1]. Interest on the underpaid tax is charged on top.

Can a business avoid an IR35 penalty entirely?

Yes. HMRC will not charge a penalty where the client took reasonable care to apply the off-payroll rules but still made a mistake ^[5]. Taking reasonable care means running a thorough, individual determination and keeping records, for example an accurate CEST result ^[11]. The underpaid tax and interest would still be due, but no penalty would apply.

Will HMRC tax the same income twice if IR35 is applied late?

Not since 6 April 2024. HMRC can now set off Income Tax and National Insurance already paid by the worker and their intermediary against the deemed employer's PAYE liability for the same income ^[6]. The set-off applies to deemed direct payments from 6 April 2017 in open and future compliance cases, which reduces the risk of over-collection.

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