What is IR35? A Contractor's Plain-English Guide (2025/26)

Last updated June 2026

If you contract through your own limited company in the UK, no single set of rules affects your take-home pay more than IR35. Yet it is one of the most misunderstood parts of contracting. This guide explains what IR35 actually is, what “inside” and “outside” mean in practice, who decides, and why it can change your annual income by thousands of pounds.

The one-sentence version

IR35 is a set of tax rules designed to catch “disguised employment” — situations where someone works like an employee but bills through a limited company to pay less tax. If HMRC considers your contract to be disguised employment, you are inside IR35 and taxed broadly like an employee. If your engagement is genuinely that of an independent business, you are outside IR35 and can use the more tax-efficient salary-plus-dividends model.

Why IR35 exists

A permanent employee pays income tax and two layers of National Insurance (their own, plus their employer’s) on every pound they earn. A limited company contractor can instead take a small salary and draw the rest as dividends, which are not subject to National Insurance and are taxed at lower rates. For identical work, that difference can be substantial — so HMRC introduced IR35 to make sure people doing what is effectively a job pay something closer to employee-level tax.

Inside vs outside IR35: what actually changes

Outside IR35 means your company is treated as a genuine business. You typically pay yourself a director’s salary at the personal allowance (£12,570 in 2025/26), the company pays corporation tax on its profit, and you draw the remainder as dividends taxed at 8.75%, 33.75% or 39.35% depending on your band. This usually leaves you with the most take-home pay.

Inside IR35 means HMRC treats the income as employment income. In practice most inside-IR35 contractors work through an umbrella company, which runs full PAYE — income tax and employee National Insurance — and also absorbs employer’s National Insurance and the apprenticeship levy out of the assignment rate. The result is meaningfully less in your pocket than the same rate outside IR35.

You can compare the two side by side for any day rate using our inside vs outside IR35 calculator.

Who decides your IR35 status?

This is the part that changed dramatically. Since the 2021 reform of the “off-payroll working rules”:

• For contracts with medium and large private-sector clients and all public-sector bodies, the client (the end hirer) is responsible for determining your status and issuing a Status Determination Statement.
• For contracts with small private-sector clients, the responsibility remains with your own limited company.

A company counts as “small” if it meets at least two of: turnover under £10.2m, balance sheet under £5.1m, or fewer than 50 employees. If your client is small, you assess your own status — which is why understanding the rules still matters even after the reform.

How status is judged

There is no single test. HMRC and the courts look at the overall picture, weighing several key factors:

• Control — does the client dictate how, when and where you work, like a manager would? More control points toward inside.
• Substitution — could you genuinely send a qualified substitute in your place? A real right of substitution points toward outside.
• Mutuality of obligation — is the client obliged to offer work and are you obliged to accept it? Ongoing obligation looks employee-like.

Secondary factors include whether you take financial risk, provide your own equipment, are “part and parcel” of the organisation, and work for multiple clients. HMRC’s online CEST tool gives an indicative result, but it is not the final word — the contract and the actual working practices both matter.

What inside IR35 costs you in real terms

Because inside-IR35 income is taxed as employment income and carries employer’s National Insurance (15% in 2025/26 above the £5,000 secondary threshold) plus the 0.5% apprenticeship levy, a contractor on a £500 day rate can keep several thousand pounds less per year inside IR35 than outside. The exact gap depends on your rate, days worked and salary strategy — our calculator shows it precisely for your numbers.

What to do with this

1. Find out your status first. For medium/large and public-sector clients, ask for the Status Determination Statement before you sign.
2. Don’t assume inside IR35 makes a limited company pointless — but if most of your contracts are inside, an umbrella is usually simpler.
3. Get the working practices right, not just the contract. A perfect “outside” contract means little if you work exactly like an employee day to day.
4. Keep evidence of substitution rights, multiple clients and business risk in case of an HMRC enquiry.

IR35 is complex and the cost of getting it wrong is real, so treat this as a grounding in the concepts rather than a substitute for advice from a specialist contractor accountant.

The figures and rules here are an explanation for the 2025/26 tax year (rest of UK) and are not tax advice. Always confirm your specific position with a qualified accountant or HMRC.