If you hire freelancers or contractors, someone has probably told you to look into IR35. Most of what you find online is either written for contractors trying to protect their own tax position, or aimed at large corporates running formal compliance programmes. Neither is much use if you run a growing small business and just want a straight answer.
This guide covers IR35 from your perspective - the business owner engaging contractors. It explains what IR35 is, whether the off-payroll working rules actually apply to your company, and what you need to do if they do. For many small businesses, the answer is simpler than the noise around IR35 suggests.
What IR35 Actually Is - and Why It Was Introduced
IR35 is a piece of UK tax legislation designed to tackle what HMRC calls disguised employment. The concern is straightforward: some workers who are effectively employed - working exclusively for one business, under its direction, using its equipment - are paid through a limited company instead. This reduces their tax and National Insurance contributions compared to what an employee would pay on the same income.
IR35 has been around since 2000, but the rules changed significantly between 2017 and 2021. Before those changes, the contractor was responsible for assessing their own IR35 status. After the reforms - known as the off-payroll working rules - that responsibility shifted. For medium and large private sector businesses, it moved to the engager: the business hiring the contractor. That shift is the source of most of the confusion small business owners encounter.
What 'off-payroll working' means
Off-payroll working is HMRC's term for the reformed IR35 rules introduced in the public sector in 2017 and extended to the private sector from April 2021. The phrase reflects the core issue: workers who are functionally employees but are paid off the normal payroll via a personal service company or similar intermediary.
Who IR35 Applies To: The Engager, the Worker, and the Chain
Three parties are typically involved in an IR35 situation. First, the worker - usually an individual operating through their own limited company, known as a personal service company (PSC). Second, the engager - the business that benefits from the worker's services and is responsible for assessing IR35 status under the reformed rules. Third, the fee-payer - often the engager directly, but sometimes an agency or umbrella company sitting between the worker and the end client.
The reformed off-payroll working rules apply when a worker provides services through an intermediary - typically their own limited company - to an end client. If the worker were engaged directly, they would be an employee. That is the test IR35 is designed to catch.
Crucially, the rules only apply to limited company contractors (or other intermediaries). If you hire a sole trader directly - a freelancer who invoices you personally, with no company structure - IR35 does not apply in the same way. General employment status rules apply instead, which is a separate question.
IR35 is not the same as employment status
IR35 is specifically a tax rule targeting workers who operate through a limited company but would otherwise be employees. It does not replace the broader question of whether a sole trader or freelancer should be treated as a worker or employee under employment law. Those are distinct issues - do not conflate them.
The Small Business Exemption: Does IR35 Apply to Your Company?
Here is the question most small business owners actually need answered: do the off-payroll working rules apply to your company at all? For a significant proportion of growing UK businesses, the answer is no - not yet, and possibly not ever.
The reformed IR35 rules include a small company exemption. If your business qualifies as a small company under the Companies Act 2006 definition, you are not required to assess IR35 status for the contractors you engage. The responsibility remains with the contractor's own company.
Your company qualifies as small if it meets two or more of these three conditions in the relevant financial year:
Fewer than 50 employees on average
Annual turnover not exceeding £15 million*
Balance sheet total not exceeding £7.5 million**
If your business is a sole trader or an unincorporated business - rather than a limited company - the small business exemption also applies by default.
What the exemption means in practice
If you qualify as a small company, you do not need to issue status determination statements, run IR35 assessments, or handle any deduction of tax or National Insurance for your limited company contractors. The contractor's PSC remains responsible for assessing and managing their own IR35 position. Your obligation is simply to engage them properly - and to understand when your size might change.
One important note: the exemption applies to the engager's size, not the contractor's. And if your business is part of a group, the group's size - not just your subsidiary's - determines whether the exemption applies.
What Off-Payroll Working Means in Practice for Small Businesses
If you are within the small company exemption, IR35 does not change your day-to-day relationship with limited company contractors. You can continue engaging them as you do now - receiving invoices, paying their company, and treating them as self-employed suppliers for your purposes.
What you should not do is assume the exemption makes contractor status irrelevant. Two things still matter even when you are exempt from the off-payroll rules:
Employment status for employment law purposes. A contractor who works exclusively for you, is told what to do and when, and has no genuine business of their own could have employment rights claims regardless of how they are structured.
Your company's growth. If your turnover, headcount, or balance sheet crosses the small company thresholds, you will move into scope of the full off-payroll rules. That transition requires advance preparation, not a scramble.
How to Assess Whether a Contractor Is Inside or Outside IR35
This section applies if your company is above the small company thresholds - or if you want to understand what the assessment involves when your business eventually grows into scope.
IR35 status comes down to the nature of the working relationship, not what a contract says on paper. HMRC looks at the substance of how the contractor actually works. Three factors carry the most weight:
The Three Core IR35 Tests
Substitution
Can the contractor send someone else to do the work in their place, without your approval? A genuine right of substitution points toward outside IR35. If the worker must do the work personally - because they are the specific individual you require - that points toward employment.
Control
Do you control how, when, and where the contractor works? If you direct their daily tasks, set their hours, and require them to work on your premises alongside your employees, that is more consistent with employment. A contractor who decides their own working method and schedule is more likely to be outside IR35.
Mutuality of Obligation
Is there an obligation on you to offer work and on the contractor to accept it? Ongoing work with no defined project end, guaranteed income, and no right to decline assignments suggests employment. Discrete projects with a clear scope, agreed deliverables, and no expectation of ongoing work points toward genuine self-employment.
HMRC provides a free online tool called CEST (Check Employment Status for Tax) which works through these questions and gives a status determination. CEST is not legally binding, but HMRC has committed to standing by its output if the information entered is accurate and complete. For most straightforward engagements, it is a practical starting point.
CEST has limitations
CEST does not cover every scenario and has been criticised for gaps in its handling of mutuality of obligation. For complex arrangements - multiple clients, project-based work with ambiguous boundaries, or long-term engagements - take professional advice rather than relying solely on the CEST output.
What You Must Do If a Contractor Is Deemed Inside IR35
If your business is above the small company thresholds and you assess a contractor as inside IR35, specific obligations follow. These apply to the fee-payer in the contractual chain - typically you as the engager, unless an agency sits between you and the contractor.
Issue a Status Determination Statement (SDS). You must give the contractor a written statement of your determination and the reasons for it. This is a legal requirement - not a courtesy.
Deduct tax and National Insurance. The fee-payer must calculate and deduct income tax and employee National Insurance from the contractor's fees before paying them, and pay employer National Insurance on top.
Set up a client-led disagreement process. The contractor has the right to challenge your determination. You must have a process for handling that challenge and must respond within 45 days.
Keep records. HMRC can audit your status determinations. Retain the reasoning behind each assessment, not just the outcome.
Note that an inside IR35 determination does not automatically make the contractor an employee. They do not gain employment rights through IR35. The tax treatment changes; the legal employment relationship does not.
The Consequences of Getting IR35 Wrong: HMRC Investigations and Penalties
HMRC's enforcement focus for off-payroll working has historically targeted large organisations with complex contractor populations. But the risk does not disappear for smaller businesses that have moved above the small company thresholds and are not complying correctly.
If HMRC determines that a contractor should have been assessed as inside IR35 and that the correct tax was not deducted, the liability falls on the fee-payer - typically the engager. That means unpaid income tax, unpaid National Insurance contributions, interest on late payment, and potential penalties. In cases where HMRC finds the determination was not made with reasonable care, penalties can be substantial.
Blanket determinations create their own risk
Some businesses - particularly larger ones that have moved into scope - respond to IR35 by treating all contractors as inside IR35 regardless of their actual working arrangements. This avoids the assessment burden but creates a different problem: genuinely self-employed contractors may disengage, and the business loses access to flexible specialist resource. Do not substitute a blanket policy for a proper assessment.
For businesses within the small company exemption, the direct IR35 enforcement risk is low because the responsibility sits with the contractor's company. But reputational risk and future liability are real if your business is growing fast and you have not planned for the transition into scope.
Practical Steps for Small Businesses Engaging Contractors Compliantly
Whether you are exempt from the off-payroll rules today or approaching the thresholds, there are practical steps worth taking now.
Contractor engagement checklist for small businesses
Confirm whether your company currently qualifies as small under the Companies Act thresholds - and track this annually as you grow.
Distinguish between limited company contractors (IR35 relevant) and sole traders (IR35 does not apply in the same way).
Use written contracts for every contractor engagement, with clear scope, deliverables, and end dates. Vague or open-ended agreements create both IR35 risk and employment status risk.
Avoid working practices that look like employment - dedicated desks, fixed hours, day-rate billing for indefinite periods, management through your line structure.
If you are at or near the small company thresholds, take advice before you cross them. Retroactively implementing compliance is significantly harder than planning for it.
If you are already above the thresholds and engaging limited company contractors, run CEST assessments and document your reasoning - even for contractors you assess as outside IR35.
IR35 is genuinely complex at its edges - long-term contractor relationships, sector-specific practices, agency chains with multiple parties. If your situation involves any of those, a qualified employment lawyer or tax adviser will give you far more certainty than a general guide can.
Illustrative example - based on a common UK founder scenario, not a specific documented case
A software development business with 18 employees and £2.8m turnover engages two limited company contractors on rolling three-month contracts. The founder had assumed IR35 was their contractors' concern, not hers. On checking the thresholds, she confirmed the business is well within the small company exemption - both by headcount and turnover. The contractors remain responsible for their own IR35 assessments. She does update her contractor contracts to include clear scope, a right of substitution clause, and project-based billing - both for good practice and to reflect the genuine nature of the working relationship.
The practical reality for most growing UK businesses is this: if you are under 50 employees and below the turnover and balance sheet thresholds, the off-payroll working rules do not currently apply to you. Your contractors manage their own IR35 position. What you need to do is engage them properly, keep your contracts clean, and know when your growth will change that picture.
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* The small company annual turnover threshold was raised from £10.2 million to £15 million for financial years beginning on or after 6 April 2025, under The Companies (Accounts and Reports) (Amendment and Transitional Provision) Regulations 2024 (SI 2024/1303).
** The small company balance sheet total threshold was raised from £5.1 million to £7.5 million for financial years beginning on or after 6 April 2025, under the same SI 2024/1303.
