IR35 explained for UK contractors: inside vs outside, CEST, and what 'inside' actually costs you

IR35 in one paragraph

IR35 (also called off-payroll working) is the UK tax rule that asks one question: without the limited company in the middle, would this contractor really be an employee of the end client? If the answer is yes, the engagement is inside IR35 and the contractor pays tax broadly as an employee would. If the answer is no, the engagement is outside IR35 and the Personal Service Company (PSC) is taxed as a normal small company, with the usual salary- plus-dividends extraction available.

For a typical £500-a-day contractor, the cash difference between inside and outside is around £8,000 to £12,000 a year. So getting the determination right matters.

Who decides: client size matters

Since April 2021 in the private sector (April 2017 for public sector), the responsibility for the inside / outside decision depends on the end client's size.

A private-sector client is 'small' under the Companies Act 2006 definition if it meets at least two of:

• Annual turnover not more than £10.2m
• Balance sheet total not more than £5.1m
• 50 or fewer employees

So a contractor working through a 30-person agency with £8m turnover is dealing with a small client, and the PSC continues to make its own IR35 determination. A contractor working directly for a FTSE-listed bank is dealing with a large client, and the bank issues the SDS.

The Status Determination Statement (SDS)

If your end client is medium or large, they are legally required to give you a written SDS before you start work, stating whether the engagement is inside or outside IR35 and why. The SDS must also be given to any agency in the chain.

What the SDS must contain:

• The conclusion (inside / outside IR35)
• The reasons for the conclusion
• The factors considered (control, substitution, MoO, financial risk, integration)
• Confirmation that 'reasonable care' was taken in reaching it

If the client does not issue an SDS, or does not take reasonable care in producing it, the tax liability for unpaid PAYE and NI can fall back on the client rather than on you. That is a structural incentive for the client to be careful, although in practice many large clients default to 'inside' to minimise their own risk.

What CEST is and what it does

CEST stands for Check Employment Status for Tax. It is HMRC's free online tool at gov.uk/guidance/check-employment-status-for-tax. You answer a series of questions about the engagement and CEST produces one of six results: self-employed for tax, employed for tax, IR35 rules apply, IR35 rules do not apply, unable to determine employment status, or unable to determine IR35 applicability.

The most important point about CEST: HMRC say they will stand by the determination it produces, as long as the inputs are accurate and reflect the actual working pattern. That makes a CEST result a useful audit defence document, particularly for contractors who run it themselves before accepting a contract determined inside.

Two limitations to be aware of:

• CEST does not test Mutuality of Obligation (MoO) fully. Case law (notably the HMRC v Atholl House case) treats MoO as one of the key tests for employment status, but CEST broadly assumes it is present in every engagement.
• CEST returns 'unable to determine' in about 1 in 5 cases. When this happens, you need specialist advice or insurance, not just another CEST run with slightly different inputs.

The five tests that drive inside vs outside

CEST and tribunal case law both look at a similar group of factors. The five that come up most often in practice:

1. Right of substitution. If the contractor can send a qualified replacement to do the work, the engagement looks more like genuine business-to-business (outside). If the client requires this specific person, it looks like employment (inside).
2. Control. If the client controls how, when, and where the work is done, that points inside. If the contractor controls method and schedule, that points outside.
3. Mutuality of Obligation (MoO). If the client is obliged to offer more work and the contractor is obliged to accept it, that is mutuality. Genuine contractors should be able to turn down work without consequence.
4. Financial risk. Does the contractor stand to lose money if the work goes wrong (rework at own cost, equipment provided, insurance carried)? Employees do not carry these risks.
5. Integration / part-and-parcel. Does the contractor have a manager, a company email, an org-chart slot, holiday entitlement, performance reviews? Those all look like employment.

No single factor is decisive; tribunals look at the whole picture. A contractor with the right of substitution and no financial risk can still be inside if mutuality and control are heavy. A contractor with one rigid factor (e.g. exclusive to one client) and four flexible factors can still be outside.

What inside IR35 actually costs you

Take a contractor on £500 a day, 220 working days a year = £110,000 of contract income. Compare the two routes:

Outside IR35 (PSC, salary + dividends)

• £110,000 invoiced to PSC
• Less: £12,570 director's salary
• Company profit subject to Corporation Tax: ~£97,430
• Corporation Tax at marginal rate (in the £50k-£250k band): ~£24,000
• Available for dividend: ~£73,430
• Personal tax: salary tax-free; dividends taxed (10.75% / 35.75% / 39.35% bands)
• Approximate personal tax on dividends: ~£17,500
• Net cash to contractor: ~£68,500

Inside IR35 (deemed employer deducts PAYE + NI)

• £110,000 contract value
• Employer NI (15%) on the employee equivalent: ~£14,250
• 'Deemed' salary to contractor: ~£95,750
• Less: employee NI (8% / 2%) and income tax (20% / 40%): ~£32,400
• Net cash to contractor: ~£63,350

So inside IR35 in this example costs around £5,000 in net cash compared to outside. The gap widens on higher-value contracts and where there is spousal share splitting available, and narrows on low-value contracts or where personal tax considerations (£100k taper, pension contributions) reshape the picture. Our salary calculator and corporation tax modelling cover the full comparison.

If your client says inside and you disagree

Every medium and large client must operate a Status Disagreement Process (SDP). You have the right to challenge an SDS through this process. The client must respond within 45 days with either a revised SDS or a written explanation of why the original stands.

Practical steps if you receive an SDS you believe is wrong:

1. Get the SDS in writing, including the reasoning
2. Run CEST yourself with accurate inputs reflecting the actual day-to-day work, not the contract template
3. Ask the client (in writing) to revisit the SDS, citing specific factors they may have weighted incorrectly
4. If the engagement is genuinely outside in practice, you can ask for the contract to be redrafted to reflect substitution rights, financial risk, no MoO, etc., and ask for a new determination
5. If unresolved, you can decline the contract or accept it inside and reserve the right to argue at tax tribunal later (rare in practice; expensive)

The 'blanket inside' problem

Since 2021, some large clients have defaulted whole categories of contractors to inside IR35 to minimise their own enforcement risk. This is technically not allowed under the 'reasonable care' requirement, but in practice it has happened.

If you encounter a blanket-inside policy:

• Ask for the SDS reasoning specific to your engagement. A generic statement about the role type, without engagement- specific reasoning, may not meet the reasonable care test.
• Consider an umbrella company route if you accept the work. Umbrella employment moves the contract outside the off- payroll rules entirely (you are employed by the umbrella), but typically nets less than a properly-determined outside- IR35 contract.
• Consider whether the client is genuinely medium / large for IR35 purposes. Group-level totals can sometimes push a seemingly-mid-sized client into 'small' status.

Where the rules go from here

The off-payroll regime has been politically contested but is unlikely to be reversed. The April 2017 / April 2021 shift of responsibility to medium and large clients is now embedded. Recent developments:

• February 2026: HMRC updated the off-payroll guidance to cover student and postgraduate loan repayments on inside-IR35 deemed payments.
• Offset of tax already paid: from April 2024, where HMRC reassess an engagement as inside, they now offset tax and NI already paid through the PSC, reducing the cash impact of a retrospective HMRC challenge.

For most working contractors, the practical priorities for 2026/27 are: get your CEST input accurate, get the SDS in writing for medium / large clients, model the inside vs outside cash difference before accepting any new engagement, and keep contemporaneous evidence of how the work is actually performed.