What is IR35, and how do the IR35 rules affect UK employers in 2026?

From 6 April 2025, the turnover and balance sheet thresholds that decide whether a business must apply the off-payroll working rules rose to £15 million and £7.5 million respectively, meaning some employers won't be reclassified as IR35-exempt until the 2027/28 tax year (GOV.UK/HMRC). For everyone still in scope, HMRC continues to actively scrutinise Status Determination Statements and contractor arrangements, and getting an IR35 assessment wrong can mean unpaid tax, National Insurance and penalties landing on the business rather than the contractor. Understanding exactly who the rules apply to, and how to apply them correctly, is now more important than ever for UK employers engaging contractors through a personal service company (PSC).

Who do the IR35 rules apply to?

Off-payroll IR35 rules apply to contractors who provide services through an intermediary, such as a personal service company (PSC), and to medium and large organisations that engage those contractors. Public sector bodies and medium or large private-sector businesses are generally responsible for determining whether a contractor falls inside or outside IR35.

What is IR35?

IR35, also known as the off-payroll working rules, is UK tax legislation designed to ensure that workers who would be employees if they provided their services directly to a client pay broadly the same Income Tax and National Insurance contributions as employees, even when they work through an intermediary such as a personal service company (PSC).

Which businesses must follow IR35 regulations?

Off-payroll working for clients applies to public sector organisations and medium and large private-sector businesses that engage contractors through intermediaries. In most cases, these organisations are responsible for deciding whether a contract falls inside IR35 or outside IR35 and communicating that decision to the worker.

A private-sector business is generally classed as medium or large if it meets at least two of the following: annual turnover above £15 million, a balance sheet total above £7.5 million, or more than 50 employees. These thresholds rose from £10.2 million and £5.1 million respectively for financial years beginning on or after 6 April 2025 (GOV.UK/HMRC ESM10006A).

How can employers determine whether a contractor is inside or outside IR35?

What does inside IR35 mean?

A contractor is generally considered inside IR35 when the working relationship resembles employment. If the contractor were viewed as an employee, were it not for the intermediary, the engagement is likely to fall within the off-payroll working rules, and PAYE obligations may apply.

What does outside IR35 mean?

A contractor operating outside IR35 is considered genuinely self-employed for tax purposes. The contractor's limited company remains responsible for managing tax obligations, and the engagement is treated as a business-to-business arrangement rather than employment.

How should employers carry out an IR35 assessment?

Which factors are considered during an IR35 assessment?

An IR35 assessment considers the reality of the working relationship rather than simply the wording of the contract. HMRC typically examines factors such as control, substitution rights, mutuality of obligation, financial risk and the degree of integration within the client organisation.

👉To note: When assessing IR35 status, employers should consider the overall working relationship rather than relying solely on the written contract. HMRC advises that employment status should reflect both the contractual terms and the contractor's actual day-to-day working practices.

Can employers use HMRC's assessment tools?

HMRC provides the Check Employment Status for Tax (CEST) tool to help organisations evaluate employment status for tax purposes. While the tool can support decision-making, businesses should also maintain evidence demonstrating how conclusions were reached and how working practices align with contractual terms.

What responsibilities do employers have under IR35?

What is a Status Determination Statement?

A Status Determination Statement (SDS) is a formal document explaining whether a contractor falls inside or outside IR35 and the reasons behind that decision. Employers must provide the SDS to the worker and, where applicable, other parties in the labour supply chain.

👉To note: A Status Determination Statement (SDS) must explain both the employment status decision and the reasons for reaching that conclusion. Simply telling a contractor that an engagement is "inside IR35" or "outside IR35" is not sufficient to constitute a valid SDS. 

What does reasonable care mean?

HMRC requires organisations to take reasonable care when applying the off-payroll working rules. Blanket assessments that automatically classify all contractors in the same way are unlikely to meet this requirement. Each engagement should be reviewed individually based on its specific circumstances.

What happens if a business fails to comply with IR35?

Can HMRC open an IR35 enquiry?

Businesses that incorrectly apply the off-payroll working rules may be subject to an IR35 enquiry by HMRC. During an enquiry, organisations may be asked to provide contracts, Status Determination Statements (SDSs), assessment records and other evidence supporting their decisions.

What are the consequences of non-compliance?

Where HMRC identifies non-compliance, businesses may become liable for Income Tax, National Insurance contributions, interest and penalties. HMRC's calculation of PAYE liability may also result in liability transferring through the labour supply chain where responsibilities have not been fulfilled correctly.

How can payroll software help with IR35 compliance?

Why is record-keeping important?

Strong documentation is one of the most effective ways to demonstrate compliance during an HMRC review. Employers should retain contracts, assessment records, SDS documentation and any evidence used to support employment status decisions.

How can payroll software support compliance?

Businesses looking to improve IR35 compliance should consider whether they need payroll software, as it can help manage PAYE obligations, maintain audit trails and centralise employment records. This also makes it easier to respond to HMRC requests for information.

How does IR35 affect contractors and contract arrangements?

IR35 affects how contractors are taxed, how contracts are structured and how organisations approach off-payroll working rules. The status determination can influence take-home pay, payroll obligations and recruitment decisions for both contractors and employers.

Can contractors work through an umbrella company?

Contractors can work through an umbrella company, which acts as their employer and manages PAYE and National Insurance deductions. Umbrella company arrangements are commonly used for engagements that are considered inside IR35.

Can contractors still operate through a limited company?

Yes. Contractors can continue operating through an IR35 limited company, but each engagement must be assessed individually. A contractor may have some contracts that are outside IR35 and others that are inside IR35, depending on the working relationship.

IR35 compliance isn't a one-off exercise. As contractor arrangements, working practices and HMRC guidance evolve, employers should regularly review their IR35 assessments, update their Status Determination Statements (SDSs) where necessary and keep clear records to support every decision. Taking a proactive approach can help reduce the risk of HMRC enquiries while ensuring contractors are engaged under the correct tax arrangements.

Businesses that manage multiple contractors may also benefit from reviewing their off-payroll working arrangements and considering whether payroll software for your business could simplify PAYE administration, improve record-keeping and support ongoing compliance as their workforce grows.

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