What is off-payroll working and how do IR35 rules apply in the UK?

From 6 April 2026, new PAYE rules for umbrella company labour supply chains make agencies and end clients liable for PAYE underpayments, the most significant shift in off-payroll working since the 2021 private sector reform. For businesses engaging contractors through personal service companies, getting the inside or outside IR35 decision right has direct financial consequences: incorrect determinations can trigger backdated PAYE, National Insurance liabilities, and HMRC penalties of up to 100% of the unpaid tax.

What is off-payroll working?

Off-payroll working refers to situations where a worker provides services through an intermediary, such as a personal service company (PSC), instead of being hired directly as an employee. The off-payroll working rules, commonly known as IR35 rules, determine whether that worker is genuinely self-employed or should be treated as an employee for tax purposes.

What does IR35 mean?

IR35 is UK tax legislation designed to prevent contractors from working like employees while paying tax as a self-employed individual through a limited company.

If a contract falls “inside IR35,” the worker must generally pay Income Tax and National Insurance contributions through PAYE, similarly to employees. If the arrangement falls “outside IR35,” the contractor can continue operating as a self-employed business.

Who do the off-payroll working rules apply to?

Off-payroll working rules can apply to contractors working through personal service companies, freelancers providing services through intermediaries, public sector organisations; and also to medium and large private sector businesses hiring contractors. Small private sector businesses are usually exempt from responsibility for determining IR35 status. In these cases, the contractor’s intermediary normally remains responsible for assessing status.

A business qualifies as "small" under the Companies Act 2006 criteria if it meets at least two of the following: annual turnover ≤ £10.2 million, balance sheet total ≤ £5.1 million, or fewer than 50 employees.

How do off-payroll working rules operate in practice?

Off-payroll working rules operate by assessing the real nature of the working relationship between the client and the contractor. The organisation hiring the contractor must determine whether the arrangement falls inside or outside IR35.

What happens if a contract is inside IR35?

If a contractor is considered inside IR35, it means that PAYE tax deductions usually apply, employee and employer National Insurance contributions may be due, and the fee-payer is generally responsible for payroll deductions. In 2026/27, this means deducting PAYE Income Tax and primary Class 1 NICs (8%) from the contractor's invoice, and paying employer Class 1 NICs (15%) and the Apprenticeship Levy on top. Moreover, the contractor receives reduced net pay compared to outside IR35 engagements. In many cases, the fee-payer is the recruitment agency or the client business paying the contractor’s company.

What happens if a contract is outside IR35?

If a contract is outside IR35, the contractor is still responsible for managing their own taxes through their limited company. This usually brings greater flexibility over working arrangements, the ability to pay corporation tax and dividend, and also no employer National Insurance contributions for the client. Nonetheless, HMRC may investigate arrangements if the working relationship appears inconsistent with genuine self-employment. HMRC may charge penalties of up to 100% of the unpaid tax in serious cases involving deliberate non-compliance, alongside interest on overdue amounts.

Who is responsible for determining the IR35 status?

The responsibility depends on the type and size of the organisation. For medium or large private sector businesses, the client is normally responsible for:

• Assessing employment status;

• Issuing a Status Determination Statement (SDS);

• Explaining the reasons behind the decision.

Small businesses are generally exempt, meaning contractors remain responsible for determining their own IR35 status.

What factors does HMRC consider for IR35 status?

HMRC reviews the actual working arrangement rather than simply relying on contract wording. The IR35 guidelines focus on several employment status indicators that are commonly used during IR35 assessments.

How important is control in IR35?

Control is one of the central IR35 tests. HMRC may examine who decides the working hours, who controls completed work, whether the contractor can refuse tasks and if the worker operates independently. 

How does substitution affect IR35 status?

HMRC will consider whether a contractor can send a substitute to perform the work. A genuine right of substitution can indicate that the contractor is operating as an independent business rather than working as an employee.

What is mutuality of obligation?

HMRC may consider whether there is an ongoing expectation for the client to provide work and for the contractor to accept it when assessing employment status for tax purposes.

Why can financial risk influence IR35 decisions?

HMRC may also consider whether the contractor bears financial risk, such as paying business expenses, providing equipment, or correcting work at their own cost.

What are the new umbrella company PAYE rules?

From 6 April 2026, new PAYE rules apply to labour supply chains that include umbrella companies. Under the new rules, responsibility for ensuring PAYE is operated correctly may extend beyond the umbrella company itself.  

Who is responsible for PAYE under the new umbrella company rules?

Where workers are supplied through an umbrella company, the agency that has the contract with the end client is generally responsible for ensuring PAYE is operated correctly. If there is no agency involved, the responsibility falls to the end client. HMRC may recover any underpaid PAYE from the agency or end client if the umbrella company fails to account for the correct amount.

What do employers and agencies need to do before April 2026?

Businesses that engage contractors or temporary workers through umbrella companies should review their labour supply chains and carry out appropriate due diligence on umbrella company arrangements. Agencies and end clients will need processes to verify that PAYE is being operated correctly, as they may become liable for PAYE underpayments under the new rules. These requirements apply to payments made to workers on or after 6 April 2026.

How can employers comply with off-payroll working rules?

Businesses should adopt structured processes to assess contractor relationships consistently. Compliance requires accuracy, as it is more than just updating existing contracts.

How can payroll software support IR35 compliance?

Payroll software can help businesses manage off-payroll working obligations by:

• Applying PAYE deductions correctly;

• Recording contractor payments;

• Maintaining audit trails;

• Supporting payroll reporting requirements;

• Reducing manual payroll errors.

Automated payroll processes may also help businesses respond more efficiently to HMRC reviews and compliance checks.

What should employers review before hiring contractors?

Before engaging contractors, employers should assess:

• The level of managerial control

• Whether substitution is genuinely possible

• Working hours and exclusivity

• Financial risk and independence

• Whether the contractor provides equipment or insurance.

Status assessments should reflect real working conditions, not theoretical arrangements, helping businesses maintain ongoing payroll compliance. 

What are some common off-payroll working examples?

Off-payroll working examples can help employers understand how IR35 rules apply in different situations. The outcome often depends on the level of independence and control within the working relationship.

📌Example of a contractor inside IR35: a marketing consultant works exclusively for one company five days per week using company equipment. The business controls working hours, approves leave, and closely supervises tasks. This arrangement may indicate employment for tax purposes and could fall inside IR35.

📌Example of a contractor outside IR35: a graphic designer provides project-based services for several clients, sets their own schedule, uses personal equipment, and can subcontract work when necessary. This arrangement may support outside IR35 status because the contractor operates more like an independent business.

How should businesses prepare for future IR35 compliance?

Businesses should regularly review contractor arrangements to ensure ongoing compliance with off-payroll working regulations. IR35 status can change over time if working practices evolve.

What documentation should employers keep?

Employers should maintain:

• Contracts and agreements

• Status Determination Statements

• Evidence of working practices

• Communication records

• Payroll documentation

Strong documentation can help demonstrate reasonable care during HMRC investigations.

👉To note: Records should be retained for at least 3 years after the end of the relevant tax year (GOV.UK – Running payroll).

Why are regular reviews important?

A contractor initially operating outside IR35 may later move inside IR35 if:

• Working hours become fixed;

• Supervision increases;

• Exclusivity develops;

• Independence reduces.

Regular reviews can help businesses identify changes before compliance risks escalate.

💡Good to know: HMRC considers the full working relationship rather than relying on one factor alone. In addition, HMRC provides a Check Employment Status for Tax (CEST) tool that businesses can use to help assess IR35 status decisions.

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