If you contract through your own limited company, whether you're "outside IR35" decides how you can pay yourself and how much tax you keep control of. Get it right and you run a genuine business. Get it wrong, or have a client get it wrong for you, and HMRC can treat your fees as employment income.
This guide explains what outside IR35 actually means, the tests HMRC uses to judge your status, who decides it under the off-payroll working rules, and the practical steps to keep your contracts on the right side of the line. It's written for limited company contractors and freelancers across IT, engineering, consultancy and similar fields.
We'll keep it plain. Where we show numbers, they're an illustrative example for 2025/26, not a promise about your situation.
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What is IR35 and why does it matter?
IR35, now usually called the off-payroll working rules, is tax legislation aimed at "disguised employment". It targets situations where someone works through their own company but, in reality, behaves like an employee of the client.
The rules ask a simple question. If you stripped away your limited company and looked only at how you work day to day, would you look like an employee? If yes, your contract is "inside IR35" and the income should be taxed broadly like employment income. If no, you're "outside IR35" and you run a genuine business.
The responsibility for deciding this has shifted over time. The rules applied to public sector clients from April 2017, and were extended to medium and large private sector clients from April 2021. That 2021 change moved the decision, in many cases, from the contractor to the client. HMRC's overview sets out the current position in its off-payroll working (IR35) guidance.
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What does outside IR35 mean?
Outside IR35 means HMRC accepts that you're providing services as a genuine business, not as a disguised employee. In practice, that means:
- Your client (or the agency) pays your limited company gross, with no PAYE tax or National Insurance deducted at source.
- You decide how to take money out of the company, typically a mix of salary and dividends.
- You're responsible for your own tax: Corporation Tax on company profits, and Self Assessment on what you draw personally.
- You don't get employee benefits from the client, such as holiday pay, sick pay or a workplace pension.
- You carry the commercial risk and the autonomy of running your own business.
The opposite, inside IR35, treats your fees broadly as employment income. Tax and National Insurance come off before you see the money, and the tax-efficient salary-and-dividend approach isn't available on that income.
If you're a limited company contractor, our contractor accounting service is built around exactly these decisions.
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What are the IR35 status tests?
There's no single box to tick. Status comes from the overall picture, drawn from employment case law. HMRC and clients weigh several factors. These are the ones that matter most.
Control: who decides how, when and where you work?
The more freedom you have over how you deliver the work, your hours and your location, the more you look self-employed. If the client directs your day-to-day tasks, sets your hours and supervises you like a line manager, that points inside.
Substitution: could you send someone else?
A genuine business can usually send a suitably qualified substitute to do the work. If your contract demands that you, personally, do the job and the client could veto any replacement, that points towards employment. The right has to be real, not just words on paper.
Mutuality of obligation: is there an ongoing commitment?
Employment usually involves an expectation that the employer will offer work and the worker will accept it, on a continuing basis. A genuine contractor is engaged for a defined piece of work, with no obligation on either side once it's done. Rolling contracts that quietly run for years start to look like employment.
Financial risk: do you stand to lose money?
Businesses take risk. If you fix your own mistakes at your own cost, provide your own equipment, carry professional indemnity insurance and quote fixed prices, you're behaving like a business. Being paid a day rate with errors corrected on the client's time looks more like employment.
Part and parcel: are you integrated into the client?
If you appear on the org chart, have a company email address, attend staff appraisals and join the team socials, you look like part of the furniture. A genuine contractor stays clearly separate from the client's permanent staff.
No single factor is decisive. A contract can have one or two employee-like features and still be outside IR35 overall. What counts is the realistic picture of the working relationship, not just the contract wording.
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Who decides your IR35 status?
It depends on the size of your end client.
Medium and large clients (and all public sector bodies) are responsible for assessing each engagement. They must produce a Status Determination Statement (SDS) telling you whether you're inside or outside IR35, with their reasons, and pass it down the chain before the work starts. If they get it wrong by treating an inside contract as outside, the liability for the unpaid tax sits with them, not you. That's why some clients play it safe and lean towards inside determinations.
Small clients are exempt. Where the end client is a small company, responsibility for deciding status stays with you, the contractor, just as it did before April 2021. You assess your own contracts and you carry the liability if you get it wrong.
Whether a private-sector client counts as "small" is based on the Companies Act size tests (turnover, balance sheet total and employee numbers). Those thresholds were increased for accounting periods beginning on or after 6 April 2025, so the right figures depend on the client's accounting period. If you're not sure which side of the line a client falls, check the current definition in HMRC's off-payroll working guidance for clients and, if needed, look at the client's filed accounts on Companies House. Don't assume.
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How does outside IR35 affect how you're paid?
When a contract is outside IR35, your company is paid gross and you choose how to draw the money. A common, tax-efficient approach is a modest salary plus dividends. Here's how the pieces fit together for 2025/26.
For 2025/26 the personal allowance is £12,570, the dividend allowance is £500, and dividends in the basic-rate band are taxed at 8.75%. Company profits up to £50,000 are taxed at the 19% small profits rate of Corporation Tax.
Illustrative example
Priya runs a one-person IT consultancy through her limited company. The numbers below are illustrative for 2025/26 and ignore pension contributions and other reliefs.
| Item | Amount |
|---|---|
| Company income (invoiced) | £50,000 |
| Allowable business expenses | £3,000 |
| Profit before director's salary | £47,000 |
| Director's salary | £12,570 |
| Profit chargeable to Corporation Tax | £34,430 |
| Corporation Tax at 19% | £6,542 |
| Distributable profit (dividend) | £27,888 |
On the personal side, Priya's £12,570 salary is covered by her personal allowance, so there's no income tax on it. Her dividend of £27,888 is reduced by the £500 dividend allowance, leaving £27,388 taxable. As that sits within the basic-rate band, it's taxed at 8.75%, giving a dividend tax bill of about £2,396.
Note that even a salary set at the personal allowance triggers a little employer's National Insurance, because the secondary threshold for 2025/26 is £5,000 and the employer rate is 15%. On a £12,570 salary that's around £1,136, payable by the company. The exact optimum salary depends on your circumstances, and it's worth modelling rather than guessing.
To run your own figures, try our take-home pay calculator and dividend tax calculator.
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Outside IR35 vs inside IR35: what's the difference?
The table below summarises the practical differences. The tax outcomes are the headline reason contractors care about status, but the working-practice differences are what actually decide it.
| Factor | Outside IR35 | Inside IR35 |
|---|---|---|
| How you're paid | Company invoiced gross; salary plus dividends | Treated broadly as employment income; tax and NI deducted |
| Who handles the tax | You, via Corporation Tax and Self Assessment | The client, agency or umbrella, via PAYE |
| Control over work | You decide methods, hours and location | Client directs the work like an employer |
| Substitution | Genuine right to send a substitute | Personal service expected |
| Ongoing commitment | Defined engagement, no continuing obligation | Rolling or open-ended, employee-like |
| Financial risk | You bear it (errors, equipment, insurance) | Client carries it |
| Integration | Kept separate from permanent staff | Part and parcel of the client's team |
| Employee benefits | None from the client | Often closer to employee treatment |
Outside IR35 generally leaves you in control of more of your money, because you choose your salary-and-dividend mix rather than having tax deducted at source. But it only applies if the working relationship genuinely supports it.
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How do you check your status with CEST?
HMRC offers a free online tool, Check Employment Status for Tax (CEST). You answer questions about substitution, control, financial risk and how integrated you are, and it gives a view on your status.
A few practical points:
- Answer based on how the work really happens, not just what the contract says. The reality wins if HMRC ever looks.
- CEST sometimes returns "unable to determine". That isn't a failure, it just means the case is borderline and you should get advice.
- HMRC will stand by a CEST result only if your answers are accurate and the working practices match. It's a starting point, not a shield for a contract that doesn't reflect reality.
For anything other than a clear-cut engagement, it's worth having the contract and the working practices reviewed properly.
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Can you be outside IR35 through an umbrella company?
No. When you work through an umbrella company, the umbrella employs you and pays you through PAYE, so you're an employee for tax purposes. The salary-and-dividend approach that comes with outside IR35 simply isn't available on that income.
Umbrella arrangements are normally used for inside IR35 contracts, or where someone doesn't want to run a limited company. To be outside IR35 and pay yourself through dividends, you need to work through your own limited company, with the company invoicing the client directly. Our contractor service and Self Assessment service cover both the company and your personal return.
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How do you challenge a status determination?
If a medium or large client has determined your contract as inside IR35 and you think that's wrong, you have a right to ask them to reconsider.
- Ask for the Status Determination Statement and read the reasons. You're entitled to it.
- Identify which factors they relied on, such as control or substitution.
- Put your case in writing, with evidence: a genuine substitution right, your control over methods and hours, your insurance and equipment, and the defined scope of the engagement.
- Submit a formal disagreement. The client must consider it and respond within 45 days, either confirming or changing the determination.
If the client won't budge, your realistic options are to accept the inside determination, walk away and find an outside engagement elsewhere, or take specialist advice on whether the determination is defensible. Don't drift along assuming you're outside when the paperwork says otherwise, because the deemed tax can be significant.
Want a second opinion on a contract or a status determination? Book a free call with a Zmartly contractor accountant and we'll talk through your engagement and your options. Get in touch with Zmartly.
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FAQs
What does outside IR35 mean?
Outside IR35 means HMRC accepts you're working as a genuine business rather than a disguised employee. Your limited company is paid gross, and you choose how to take the money out, usually as a mix of salary and dividends, paying Corporation Tax on profits and reporting your own income through Self Assessment.
How do I know if I'm outside IR35?
You're more likely to be outside IR35 if you control how, when and where you work, can send a genuine substitute, are engaged for a defined piece of work without an ongoing obligation, bear real financial risk, and are kept separate from the client's permanent staff. No single point decides it; HMRC looks at the overall picture. You can sense-check it with HMRC's free CEST tool.
Who decides my IR35 status?
For medium and large clients, the client decides and must issue a Status Determination Statement. For small clients, you decide your own status and carry the liability if you get it wrong. Whether a client counts as small is based on the Companies Act size tests, and those thresholds increased for accounting periods beginning on or after 6 April 2025.
Can I be outside IR35 through an umbrella company?
No. An umbrella company employs you and pays you through PAYE, so for tax purposes you're an employee and can't use the salary-and-dividend approach. To be outside IR35 you need to work through your own limited company, invoicing the client directly.
How do I challenge an inside IR35 determination?
Ask the client for the Status Determination Statement and its reasons, then submit a written disagreement with evidence of genuine self-employment. The client must consider it and respond within 45 days. If they maintain the inside determination, you can accept it, look for an outside engagement elsewhere, or get specialist advice.
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