IR35 Explained: Off-Payroll Rules and Contractor Invoices

IR35 is the name for the UK off-payroll working rules. They apply when you work for a client through your own limited company but would be an employee if hired directly. Inside the rules, your fees are taxed broadly like salary. For medium and large clients, the client decides your status; for small clients, your own company does.

For contractors, the answer to "inside or outside" changes your take-home pay by thousands of pounds and changes how you invoice. This guide explains who decides status, the small company thresholds that changed from April 2025, how HMRC's CEST tool fits in, and what your invoices should look like in each case.

What IR35 means in practice

The original intermediaries legislation dates from 2000. The more recent off-payroll working rules moved responsibility to the client: first in the public sector from April 2017, then for medium and large private sector clients from 6 April 2021. Today there are two regimes running side by side:

• Client-led rules (Chapter 10, ITEPA 2003): for public sector clients and medium or large private and voluntary sector clients. The client decides status and the fee payer handles tax.
• Intermediary-led rules (Chapter 8): for small private sector clients and most clients with no UK connection. Your own company decides status and, if the rules apply, works out a deemed employment payment at the end of the tax year.

The underlying question is always the same: if your company did not exist and you contracted directly, would you be an employee or self-employed?

Inside vs outside: how status is judged

There is no single test. HMRC and the tribunals look at the whole picture, including:

• Control: does the client decide what you do, how, when and where?
• Substitution: can you genuinely send someone else to do the work, and has that right ever been used?
• Mutuality of obligation: is the client obliged to offer work and are you obliged to accept it?
• Financial risk: do you price fixed jobs, fix defects at your own cost, or invest in equipment?
• Part and parcel: are you treated like staff, with a line manager, staff benefits or appraisals?
• Business on own account: do you have several clients, marketing and your own working methods?

A clear written contract helps, but only if it matches how the work actually happens. A statement of work that defines deliverables rather than hours, and a well-drafted contract, are useful evidence.

The CEST tool

HMRC's Check Employment Status for Tax (CEST) tool asks a series of questions and gives a view on whether the off-payroll rules apply. HMRC says it will stand by the result if your information is accurate and the tool is used as intended. Many clients use it as part of their decision, but some advisers point out that it does not weigh every factor a tribunal might, so treat it as one input, not the final word.

Who decides: the client size test

For private and voluntary sector clients, status responsibility depends on the client's size. A company is small if it meets at least two of the three small company conditions. The thresholds rose for accounting periods beginning on or after 6 April 2025:

Condition	Old small company limit	New limit (periods from 6 April 2025)
Annual turnover	Not more than £10.2 million	Not more than £15 million
Balance sheet total	Not more than £5.1 million	Not more than £7.5 million
Average employees	Not more than 50	Not more than 50 (unchanged)

HMRC's April 2025 Employer Bulletin says the threshold changes will have no practical impact for off-payroll working until 6 April 2027 at the earliest, because a company's size is determined by reference to previous years. So for the 2026/27 tax year, most clients assess themselves on the old figures. From April 2027 onwards, some mid-sized clients may become small, and responsibility for deciding status would pass back to contractors' own companies.

Other points on size:

• If a parent company is medium or large, its subsidiaries must apply the client-led rules too.
• Clients that are not companies (for example, some partnerships) use a simpler turnover-only test. GOV.UK has shown this at £10.2 million; check the current figure.
• Public sector clients always decide status, whatever their size.

The status determination statement

A medium or large client must give you and the next party in the chain a status determination statement (SDS) explaining its conclusion and the reasons for it. It must take reasonable care in reaching that decision. If you disagree, you can make representations, and the client must respond within 45 days. If the client fails to give an SDS, it can end up liable for the tax itself.

Keep every SDS with your contract records. You may need it if HMRC asks questions later, and it is useful evidence when your accountant prepares your company's accounts.

What inside IR35 does to your pay: a worked example

Here is a simplified example for a contractor whose role is inside the rules for a full year, with no other income, in England, using 2026/27 rates.

Item	Amount
Fees for the year (£500 a day, 200 days), excluding VAT	£100,000
Income tax: 20% on £37,700 plus 40% on £49,730	£27,432
Employee National Insurance: 8% on £37,700 plus 2% on £49,730	£4,010.60
Net paid to your company	£68,557.40
Employer National Insurance paid by the fee payer: 15% on £95,000	£14,250

The fee payer bears the employer contributions, but in practice agencies often factor that cost into the rate they offer, which is why inside rates are frequently quoted lower or on an "umbrella" basis. Your company does not pay corporation tax again on the deemed payment it has already been taxed on, but it should record it correctly. For how employer contributions are calculated, see our guide to employer National Insurance.

Outside the rules, the same £100,000 would be your company's income. It would pay corporation tax on profits, and you would extract money through salary and dividends, now taxed at higher rates after April 2026. Our guide to UK dividend tax rates for 2026/27 shows that side of the calculation.

How to invoice when you are inside or outside IR35

The off-payroll rules change who deducts tax, not the basic invoice. Your limited company still invoices for the work. Here is how it differs.

Outside the rules

1. Invoice your agreed day rate or project fee from your company.
2. Add VAT at 20% if your company is VAT registered. Our VAT invoice guide lists what a valid VAT invoice must show.
3. State payment terms and your bank details. You receive the full amount.
4. Your company accounts for corporation tax and pays you as it chooses.

Inside the rules

1. Invoice the same way, with the agreed fee and VAT if registered. Do not deduct tax on the invoice.
2. Reference the purchase order, timesheet and SDS if the client or agency asks you to.
3. The fee payer deducts income tax and employee National Insurance from the VAT-exclusive amount and pays your company the net amount plus VAT.
4. Match the remittance advice to your invoice and keep the payroll details. You will see the deductions on a payslip-style statement.
5. Tell your accountant which income was taxed at source so it is not taxed twice.

Many agencies use self-billing, where they raise the invoice for you. If so, check the figures carefully against your timesheets. Our guides to independent contractor invoices and the contractor invoice template cover the essential fields.

Using our invoice generator for contract work

Our free generator lets you add your company name, registered details, VAT at one rate, a PO number, and notes, which is a good place for a timesheet reference or "Status: outside off-payroll rules per SDS dated 1 May 2026". It creates a PDF in your browser. It does not calculate PAYE deductions, track payments or send invoices for you, which is fine, because the fee payer handles deductions. A clean layout like the corporate invoice template suits agency and enterprise clients.

What happens if HMRC disagrees

If HMRC later decides that a role should have been inside the rules, the party responsible for the tax (usually the fee payer, or the client if it failed to take reasonable care or issue an SDS) can face a bill for the income tax and National Insurance that should have been deducted, plus interest and possibly penalties. Since April 2024, rules allow the tax already paid by the worker and their company on that income to be offset against the deemed employer's bill in some cases, which reduces the risk of the same income being taxed twice. The detail is technical, so take advice if you receive an enquiry.

Where your own company is responsible (small or overseas clients), HMRC can assess the company directly for the tax on a deemed employment payment. Keep a written record of your status assessment for each contract, your CEST result if you used it, and evidence of how the work was actually carried out.

IR35 checklist before you sign a contract

1. Find out whether the end client is public sector, medium or large, or small, and ask who will make the status decision.
2. Ask for the SDS before you start, not after the first invoice.
3. Read the contract for control, substitution and obligation clauses, and check they reflect reality.
4. Agree the day rate on the right basis. An inside rate and an outside rate are not comparable.
5. Confirm who the fee payer is in the chain and how you will be paid.
6. Agree invoicing details: who raises invoices, payment terms, PO numbers and timesheet approval.
7. Diary a review if the role changes, because a role can move inside or outside the rules as duties change.

Many contractors keep a simple file per engagement: contract, SDS, CEST printout, timesheets and invoices. It costs nothing and makes any later IR35 conversation with a client, agency or HMRC much easier.

Common mistakes contractors make

• Accepting an inside determination without checking whether the facts were described correctly.
• Deducting PAYE on their own invoice as well as having it deducted by the agency.
• Assuming that a small client automatically means outside. With a small client, your company still has to assess status under the original rules.
• Forgetting that working practices matter more than contract wording.
• Missing late payments. If an agency pays late, you may be able to claim statutory late payment interest on business-to-business debts.

If you are weighing up whether to keep trading through a company at all, our comparison of sole trader vs limited company sets out the costs and benefits.

This article is general guidance, not tax or legal advice. Employment status is fact-specific, so speak to a qualified accountant or employment status specialist about your contracts.

Conclusion

The off-payroll rules decide who carries the tax risk and how your fees are taxed. Medium and large clients decide status and issue an SDS; small clients leave it to your company. The April 2025 small company thresholds will start to matter from April 2027. Whatever your status, invoice clearly and keep your records tidy. You can create a professional contractor invoice in minutes with our free UK invoice generator, and find more guides in our freelancing section.