UK IR35: Navigating Off-Payroll Working Rules For Contractors 2025-26
- MAZ
- 2 hours ago
- 12 min read
Understanding IR35 Basics: What Every UK Contractor Needs to Know for 2025-26
Picture this: You're a seasoned IT contractor in Birmingham, finally landing that lucrative six-month gig with a mid-sized firm. You've quoted your day rate through your limited company, expecting the usual tax-efficient setup. Then the client mentions "IR35 assessment," and suddenly you're wondering if you'll end up paying employee-level taxes despite running your own business. Sound familiar?
None of us loves tax surprises, but here's how to avoid them. IR35 – or the off-payroll working rules – has been around since 2000, designed to ensure contractors who are essentially "disguised employees" pay similar Income Tax and National Insurance Contributions (NICs) as permanent staff. According to HMRC's latest guidance, the rules apply contract-by-contract if, without your intermediary (usually a personal service company or PSC), you'd be deemed an employee.
In my 18 years advising contractors across the UK, I've seen IR35 catch out even the savviest professionals. Many assume they're automatically "outside" because they work flexibly, but HMRC looks at the reality of the working relationship.
Key Rules for the 2025-26 Tax Year
As of December 2025, the core off-payroll rules remain unchanged from the 2021 reforms for medium/large private sector clients and public sector engagements. The big shift coming? From April 2026, updated company size thresholds (turnover up to £15m, balance sheet £7.5m, still 50 employees) will reclassify some clients as "small." This means the IR35 determination responsibility shifts back to you, the contractor, rather than the client – a potential win for flexibility, but it ramps up your compliance burden.
For now, in 2025-26:
● Public sector clients: Always responsible for determining status.
● Medium/large private sector clients: They determine if the engagement is "inside" (deemed employment) or "outside" (genuine self-employment), issue a Status Determination Statement (SDS), and if inside, the fee-payer deducts PAYE tax and NICs.
● Small private sector clients: You (via your PSC) determine status and account for any tax due.
Be careful here, because I've seen clients trip up by blanket-assessing everything as "inside" to play safe – pushing up your costs unnecessarily.
Inside vs Outside IR35: The Real-World Tests
HMRC doesn't rely on your contract wording alone; they examine actual working practices. Key factors include:
● Control: Does the client dictate how, when, and where you work?
● Substitution: Can you send a genuine substitute?
● Mutuality of Obligation (MOO): Is the client obliged to offer work, and you to accept it?
● Financial Risk: Do you bear costs like fixing errors at your expense?
● Integration: Are you part of the client's organisation (e.g., business cards, email address)?
Use HMRC's Check Employment Status for Tax (CEST) tool as a starting point – it's been refreshed in 2025 for clearer language – but don't rely on it solely. In my experience, professional reviews often uncover "outside" indicators CEST misses.
Tax Implications at a Glance for 2025-26
If outside IR35, you operate normally: Pay yourself salary/dividends, claim expenses, and enjoy lower effective tax rates.
If inside IR35, you're taxed like an employee on the "deemed payment" (typically 95% of contract income, minus some allowances). No dividend flexibility, limited expenses.
Here's a quick comparison table based on current rates (England, Wales, NI; Scottish rates differ slightly):
Aspect | Outside IR35 (Typical PSC) | Inside IR35 (Deemed Employment) |
Personal Allowance | £12,570 | £12,570 |
Income Tax Bands | Basic 20% (£12,571-£50,270) Higher 40% Additional 45% (>£125,140) | Same bands, but on gross deemed payment |
Employee NICs | None on dividends | 8% on earnings £12,571-£50,270; 2% above |
Employer NICs | None | Paid by fee-payer (15% from 2025) |
Dividend Tax (if applicable) | 8.75%/33.75%/39.35% after £500 allowance | None – no dividends allowed |
Expenses | Wide range (travel, home office, etc.) | Very limited (e.g., no home-to-client travel) |
Rates sourced from HMRC and the 2025 Budget documents – personal allowance frozen at £12,570, with tapering for incomes over £100,000.
A Hypothetical Case: Tom's Tech Contract
Take Tom, a software developer from Leeds I advised last year. His £600/day contract with a medium-sized client was deemed "inside" due to high control and no substitution right. Pre-IR35, he'd net around £85,000 after tax/NICs. Inside, it dropped to £65,000 – a £20,000 hit.
We reviewed the contract: Added a genuine substitution clause, reduced client control over hours, and evidenced financial risk (Tom fixed bugs unpaid). Re-assessed as "outside," saving him thousands. Lesson? Strong contracts matter.
Now, let's think about your situation – if you're contracting in 2025-26, check your client's size early. Request confirmation if needed; they're obliged to respond.
Mastering IR35 Status Determinations: Practical Steps and Pitfalls for Contractors
So, the big question on your mind might be: How do I actually determine if my contract is inside or outside IR35? Especially with that 2026 threshold change looming, where more clients become "small" and the ball comes back to your court.
In my years advising clients in London and beyond, the most common mistake is assuming "I'm a contractor, so outside." HMRC enquiries don't care about labels – they dig into evidence.
Step-by-Step Guide to Assessing Your Status
Gather Evidence Upfront: Before signing, document everything. Emails, contracts, working practices logs.
Run CEST: Free on gov.uk – input honest answers. Print the result.
Cross-Check with Key Tests: Use HMRC's Employment Status Manual for depth.
Get a Professional Review: Insurance-backed reviews (around £100-200) provide defence in enquiries.
Issue or Request an SDS: If client determines, insist on the statement and reasons.
If you disagree with a client's "inside" call, raise it formally within 45 days – they must respond.
Common Pitfalls I've Seen Clients Face
● Blanket Bans: Some firms deem all contractors inside to avoid risk – negotiate or walk away.
● Umbrella Push: Agencies forcing umbrellas (higher fees, less net pay).
● Multiple Contracts: One inside, one outside? Track separately.
● Scottish/Welsh Variations: Income tax rates differ, but IR35 status is UK-wide.
For rare cases, like emergency contracts or high earners with child benefit charges, factor in the 60% effective marginal rate over £100k.
Original Checklist: Your 2025-26 IR35 Health Check
Here's a practical worksheet I give clients – fill it in for each contract:
Question | Yes/No/Evidence | Impact on Status |
Can I send a substitute? |
| Yes = Strong outside |
Does client control my work? |
| High control = Inside |
Am I obliged to accept/offered work? |
| MOO = Inside |
Do I bear financial risk? |
| Risk = Outside |
Am I integrated (e.g., team member)? |
| Integration = Inside |
CEST Outcome? |
|
|
Professional Review Recommendation? |
|
|
Score mostly "outside" indicators? Likely safe. Borderline? Seek advice.
Honestly, I'd double-check if you're self-employed through a PSC – it's one of the most overlooked areas, and HMRC compliance checks are rising.
Case Study: Sarah's Shift to Small Client
Sarah, a project manager from Manchester, switched clients in mid-2025. Her new engager qualified as small under old thresholds. She self-assessed "outside," claiming travel expenses and dividends. Net gain: £12,000 extra.
But with 2026 changes, if her next client reclassifies as small, she'll need robust evidence – or risk HMRC reclassifying retrospectively.
Losses, Gains, and Planning Ahead: Optimising Your Contracting in 2025-26 and Beyond
Now, let's talk brass tacks – the losses and gains of IR35 for contractors and business owners engaging them.
The "losses" are clear: Inside determinations mean higher tax (no dividends, employer NICs on top), reduced net pay (often 15-25% hit), and admin hassle. For businesses, added payroll costs and risk of penalties if wrong.
But gains? Genuine outside status preserves tax efficiency. And the 2026 small-company shift could revive outside determinations, reducing blanket inside rulings.
Tax Calculation Examples for 2025-26
Assume £100,000 contract value (excluding VAT).
Outside IR35:
● Salary: £12,570 (allowance)
● Dividends: Balance after corp tax (19-25%)
● Effective rate: ~25-30%
● Net take-home: ~£70,000+
Inside IR35:
● Deemed payment: ~£95,000
● Tax/NICs: 20-40% + 8% employee NIC
● Net: ~£55,000-60,000
Plus, employer NICs (15%) often reduce your rate.
Recommendations for 2026 Preparation
● Review current contracts for 2026 impact.
● Build strong outside evidence now.
● Consider alternatives: Fixed-term employment, SOW projects (often outside).
● For business owners: Assess your size – prepare to hand back determination or keep processes.
In my practice, proactive planning saves thousands. If IR35 feels daunting, chat with a specialist – it's cheaper than an HMRC bill.
Summary of Key Points
IR35 ensures disguised employees pay employee-level tax/NICs – rules unchanged core-wise for 2025-26.
Client size determines who assesses status; public/medium-large clients do it, small ones leave it to you.
Key tests: Control, substitution, MOO, financial risk – evidence beats contract words.
Inside means PAYE deduction, no dividends, limited expenses – big net pay hit.
Outside preserves efficiency: Salary + dividends, full expenses.
2026 small-company thresholds (£15m turnover) shift more responsibility to contractors – prepare evidence.
Use CEST + professional reviews; challenge unfair determinations.
Frozen allowances (£12,570 PA) and rates mean fiscal drag – higher effective tax for many.
Hypotheticals like Tom's and Sarah's show negotiation/review can flip status.
Plan now for 2026: Strong contracts, checklists, advice – avoid surprises and maximise gains.
FAQs
Q1: What should a contractor do if their client suddenly reclassifies as small due to the upcoming threshold changes?
A1: Well, it's worth noting that the new small company thresholds – turnover up to £15 million and balance sheet up to £7.5 million – won't fully kick in for IR35 purposes until at least the 2026-27 tax year, depending on the client's year-end. In my experience with clients who've been through similar shifts, the key is to request written confirmation of the client's size early. Once confirmed as small, you'll regain responsibility for your own status determination. Picture a developer I advised in Bristol: his client dropped to small mid-contract, and by proactively reviewing substitution rights and financial risk evidence, he comfortably stayed outside, preserving his dividend flexibility. Don't wait – gather your working practices evidence now to avoid any rushed self-assessment surprises.
Q2: How does working inside IR35 affect pension contributions for contractors?
A2: In my years advising contractors, this is a common oversight that can really sting retirement plans. When inside IR35, your deemed payment is treated like employment income, so auto-enrolment applies if the fee-payer qualifies, but many umbrellas or clients offer minimal schemes. You can still make personal contributions for tax relief, but employer matches are rare compared to outside setups. Consider Rachel from Cardiff I helped – inside on a long gig, she boosted her SIPP with relief at her marginal rate, turning a tax hit into decent growth. Always check your payslips for any employer contributions and top up personally; it's one of the few perks left inside.
Q3: Can a contractor challenge an inside IR35 determination if the client's process seems rushed?
A3: Absolutely, and I've seen it pay off handsomely for clients who've pushed back politely but firmly. You have 45 days to raise a formal disagreement with reasons, and the client must respond within another 45, either upholding or flipping the status. Be careful here – blanket assessments without individual review often crumble under scrutiny. One engineer in Glasgow I worked with disputed a vague SDS lacking evidence on control; the client reversed to outside after proper checks, saving him thousands. Document everything from day one – emails, meeting notes – as it strengthens your case if it escalates to HMRC.
Q4: What expenses remain claimable when a contract is deemed inside IR35?
A4: It's a common mix-up, but inside IR35 severely limits deductions – no home office, travel to site, or subsistence like outside. You're generally stuck with unreimbursed professional subscriptions or minimal mileage if unsupervised. However, in rare cases like multi-site roles without a permanent base, some travel might slip through. Take Mike, a site surveyor from Newcastle I advised: inside on a project, but by evidencing no fixed workplace, he claimed site-to-site mileage relief. Always get client reimbursement where possible pre-contract; it's cleaner and avoids disputes.
Q5: How do multiple concurrent contracts affect IR35 status assessments?
A5: In my experience, juggling multiples is a strong outside indicator, but each contract stands alone – one can be inside while others outside. Clients assess per engagement, so varied working practices help. Consider a consultant in Edinburgh with three gigs: two small clients (self-assessed outside) and one large (inside). We ring-fenced income streams in his PSC accounts to keep compliance straightforward. Track time and invoices separately; it avoids HMRC viewing everything as integrated employment.
Q6: Does IR35 apply differently for contractors based in Scotland compared to England?
A6: The core IR35 rules are UK-wide, so status determination doesn't change, but tax application does because of devolved rates. Inside IR35 in Scotland means your deemed payment hits those extra bands – like 21% intermediate or higher top rates sooner. I've had Scottish clients caught out when adding side income pushes them up brackets faster. For instance, a Dundee contractor inside on £60k faced a bigger bill than his English counterpart due to the 42% band. Factor this in when negotiating rates; higher Scottish liability often justifies asking for more gross.
Q7: What happens if a contractor forgets to account for IR35 on a small client engagement?
A7: Honestly, this is one of the most overlooked areas for contractors used to client-led assessments. With small clients, it's back on you – if inside but untreated, HMRC can reclassify retrospectively, hitting your PSC with back taxes, interest, and penalties. A freelancer from Swansea I sorted out had ignored a borderline gig; we voluntarily disclosed, paid the deemed amount, but negotiated penalty reductions. Run CEST annually per contract and keep contemporaneous records – it's your best defence.
Q8: Can umbrella company fees be offset when working inside IR35?
A8: No direct tax relief on umbrella margins sadly, as they're not allowable expenses inside – it just reduces your net pay. But some umbrellas include perks like enhanced pension or cycle schemes. In my practice, I've seen contractors switch to compliant ones with transparent fees to minimise the bite. Think of it like choosing a better mortgage – shop around; a 5-10% margin difference on a year's contract adds up significantly.
Q9: How does the 2025 tax offset rule help if HMRC disagrees with an outside determination?
A9: This change is a real safety net – if HMRC later says inside, taxes you've already paid via your PSC (corporation, dividends) get credited against the PAYE bill, avoiding double taxation. Previously, clients bore the full risk, leading to cautious blanket insides. One client in Liverpool had an old enquiry reopened; the offset saved his company thousands in duplicates. It encourages fairer assessments, but still document robustly.
Q10: What VAT considerations arise for contractors under IR35 rules?
A10: VAT is separate from IR35 – you can still charge and reclaim if registered, regardless of status. But inside often means the fee-payer handles it differently in chains. I've advised many to stay on flat rate scheme outside for simplicity. A VAT-registered contractor inside lost some input reclaim edges when routed through umbrellas. Review your threshold annually; dropping below £90k might let you deregister and simplify.
Q11: Is it possible to negotiate contract terms mid-engagement to move from inside to outside IR35?
A11: Yes, and I've helped several do exactly that by evidencing changed practices. Add genuine substitution, reduce client control over hours, or shift to deliverables-based. A project manager in Belfast renegotiated after six months – client agreed to looser oversight, flipping to outside and boosting his take-home. Get variations in writing; sudden changes without evidence look suspicious to HMRC.
Q12: How does remote working impact key IR35 factors like control and integration?
A12: Remote has been a game-changer post-pandemic – less daily supervision often points outside, but integration like client emails or tools can pull inside. In my experience, pure remote with own equipment strengthens outside cases. Consider a remote dev from rural Wales: no office access, flexible hours – solid outside despite long-term client. Log your autonomy; it's gold in reviews.
Q13: What are the risks of using a managed service company for contracting?
A13: MSC rules overlap IR35, treating you as employed if it's provider-controlled – big tax bills if caught. I've seen old schemes resurface disguised; avoid anything promising "IR35-proof" without your control. Stick to your own PSC for genuine outside work.
Q14: Can contractors claim the employment allowance if deemed inside IR35?
A14: No, as the allowance is for employers' NICs on staff, and inside the fee-payer claims it if eligible. Your PSC doesn't benefit directly. But in small client self-assessments inside, careful structuring might allow limited offsets. Rare, but worth exploring with advice.
Q15: How should high earners over £100k prepare for IR35 interactions with personal allowance taper?
A15: Inside IR35 accelerates the 60% effective rate trap sooner, as deemed payments count fully. A £120k contractor inside loses allowance faster than outside with salary/dividend mix. I've optimised for clients by precise salary planning outside. Always model both scenarios.
About the Author
Maz Zaheer, AFA, MAAT, MBA, is the CEO and Chief Accountant of MTA and Total Tax Accountants, two premier UK tax advisory firms. With over 15 years of expertise in UK taxation, Maz provides authoritative guidance to individuals, SMEs, and corporations on complex tax issues. As a Tax Accountant and an accomplished tax writer, he is renowned for breaking down intricate tax concepts into clear, accessible content. His insights equip UK taxpayers with the knowledge and confidence to manage their financial obligations effectively.
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