IR35 Explained: What employers must know

IR35 is no longer just a tax issue handled quietly by payroll. It's a hiring risk that affects how your business engages with contractors. From cost exposure to access to talent, IR35 decisions have real operational and legal consequences. 

Whether you're hiring for a short-term project or building out a flexible workforce, understanding these rules is essential.

If you're also looking to build a more flexible hiring strategy, our freelance and contract recruitment guide breaks down key considerations in more detail.

In this blog, we explain what IR35 is, what it means to fall inside or outside the rules, how the regime works, and what has changed recently. We also provide practical advice on how to stay compliant, avoid unnecessary costs, and attract skilled contractors with confidence.

What is IR35?

IR35 is a UK tax legislation designed to prevent tax avoidance through “disguised employment.” It applies when a contractor provides services through an intermediary, such as a personal service company (PSC), but the way they work reflects that of a direct employee.

If your business is classed as medium or large, you are responsible for determining whether a contractor falls inside or outside IR35. This has been the case since April 2021. If a role is caught by IR35, you must deduct income tax and National Insurance contributions before making payment to the contractor.

Understanding IR35 is vital if you hire off-payroll workers. It helps you manage compliance risks, avoid unexpected liabilities, and maintain a reliable contractor strategy.

What does inside IR35 mean?

When a contractor is deemed to be inside IR35, it means they are working in a way that resembles employment. Even though they operate through a limited company, HMRC treats them as an employee for tax purposes.

You, or the agency paying the contractor, must deduct PAYE and NICs before payment is made. This also means the contractor cannot claim tax reliefs normally available to limited company contractors. For employers, it often translates to increased costs and administration.

An inside IR35 determination doesn't make the person an employee in legal terms, but the tax implications mirror those of employment. It's important to make these calls carefully and document them fully.

What does outside IR35 mean?

If a contractor is genuinely self-employed and operates in a business-to-business arrangement, the engagement can fall outside IR35. This means they remain responsible for their own taxes, and you can pay them gross.

To determine this, the contractor must have genuine autonomy over how they work, including the ability to substitute someone else to deliver the services. They should also bear some financial risk, use their own equipment, and not be integrated into your internal team like a permanent employee.

Outside IR35 contracts are more appealing to high-calibre contractors. But your documentation, contract terms and working practices must align to support this status.

How does IR35 work?

The process of complying with IR35 involves several steps. It starts with a status assessment and ends with managing any liabilities across the supply chain.

Make a status determination

You must assess the contractor's status before they start work. This is often done using HMRC’s CEST tool, but it should be backed up by a review of the contract and actual working practices.

Look at whether the contractor can be substituted, who controls their work, and whether mutual obligations exist between both parties. A mismatch between the contract and reality can lead to trouble.

Issue a Status Determination Statement (SDS)

You must provide the contractor and any agency involved with a written SDS explaining your decision and the reasons for it. This statement needs to be factual and include enough context to show that reasonable care was taken.

The SDS must be shared with all parties in the labour chain. Failure to provide this, or issuing a vague or blanket statement, can make your business liable for unpaid tax.

Handle PAYE and NICs if required

If the role is inside IR35, the fee-payer (usually you or the agency) must calculate and deduct the correct PAYE and NICs from payments made to the contractor’s PSC.

You also need to make employer NICs and report everything correctly to HMRC. If the determination is wrong or deductions are missed, the liability could fall on your business.

Respond to any disputes

Contractors can dispute your determination. You must respond within 45 days and either uphold or revise the SDS with a reasoned explanation.

Keeping accurate records and having clear internal escalation routes can help you respond in time and avoid penalties. It's also an opportunity to demonstrate that your IR35 process is robust.

What do the latest IR35 changes mean?

IR35 rules are still evolving. Two recent changes are particularly relevant for employers:

Set-off rules

As of April 2024, hirers who get a status determination wrong may now offset PAYE/NICs liabilities against taxes already paid by the contractor’s company. This reduces the financial burden but only applies if accurate records are kept.

This means you must have visibility into your contractor's payment history and be able to demonstrate that PAYE has been accounted for somewhere in the supply chain.

Guidelines for Compliance (GfC4)

In January 2025, HMRC introduced a 14-point best practice framework. This now serves as the standard for "reasonable care" and will influence penalties if things go wrong.

If you're not aligning your processes with these guidelines, you're increasing your exposure to fines and reputational damage. It's no longer enough to rely on outdated assessments or ad hoc practices.

Small company exemption

From April 2025, the thresholds for being classed as a small business will increase. If your company qualifies as small, the responsibility for IR35 remains with the contractor, not your business. But this status isn’t fixed and can change from one year to the next.

If you’re close to the threshold, make sure you're actively monitoring your headcount, turnover and balance sheet totals. Reclassification can happen quickly, so it’s important to have a plan in place ahead of time.

What does IR35 mean for employers?

IR35 brings both compliance responsibilities and business risks. You must stay alert to its impact on budgets, processes, and contractor engagement.

Financial exposure

A misclassified contractor can cost your business tens or hundreds of thousands in back taxes, penalties and interest. This is especially true for long-term or high-value contracts.

These liabilities can often extend back several years. Even if you're acting in good faith, failing to meet the reasonable care test can still trigger enforcement action.

Contractor engagement

Top-tier contractors prefer clients who offer outside IR35 opportunities where possible and fair assessments when not. Blanket inside IR35 policies can harm your ability to hire quality talent.

Being transparent about your IR35 approach can help build trust with contractors. It's a competitive edge in a market where skilled talent has choices.

Internal coordination

HR, finance, procurement and hiring managers must work together to build a compliant process. Fragmented decision-making can lead to errors, disputes and liabilities.

A joined-up IR35 workflow, embedded into your existing systems, is far more effective than relying on emails or manual checks. This helps you scale and protects your business.

Tips for complying with IR35 rules

Compliance doesn’t have to be overwhelming. A structured approach, backed by good records and the right partners, can make IR35 easier to manage.

Keep a register of all off-payroll engagements

Track every contractor, agency and umbrella relationship. It’s the first thing HMRC will ask for in an audit.

Include start and end dates, status determinations, SDS copies and fee-payer details. A live tracker makes it easier to spot errors before they become liabilities.

Add IR35 checks to your hiring workflow

Status assessments should be part of your standard onboarding. Make sure no engagement starts without a signed-off SDS.

Consider using automated forms or templates in your applicant tracking or procurement system to trigger these checks early and consistently.

Save CEST outcomes and evidence

Even if you use the CEST tool, keep a copy of the results and back them up with contract reviews, role descriptions and communications.

HMRC treats this as evidence of reasonable care. If you face a challenge, being able to show your workings can make all the difference.

Reassess status regularly

Roles evolve. Contractors stay longer. Re-check status periodically and update the SDS if working practices change.

Set calendar reminders or review points tied to contract extensions. A one-off determination won't cover changes in scope or delivery.

Monitor your company size

If you're close to the small-business threshold, track your growth. Once you exceed the limit, IR35 responsibilities shift to you.

Collaborate with Finance to model your size classification each financial year. If you're near the boundary, plan for the administrative switch.

Review suppliers and processes annually

HMRC expects "reasonable care" to include ongoing reviews. Refresh your training, audit your supply chain, and document your checks.

Conduct yearly training for hiring managers. Check that agencies and umbrellas still meet your compliance criteria. Keep an audit trail.

IR35 isn’t going away. But with the right processes and support, it doesn’t have to be a blocker. Staying compliant helps you protect your budget, keep HMRC off your back and hire the contractors you need to deliver key projects.

We help employers navigate IR35 with confidence. Whether you're hiring inside or outside the rules, we can support you with compliant freelance and contract recruitment services, status assessments and market guidance.

Looking for more detail on hiring freelancers or contractors? Read our ultimate guide to freelance and contract recruitment.