IR35: What global teams should know about UK contractor taxation

IR35 is UK tax legislation that affects how contractors are taxed when they work through an intermediary like a limited company. If you're a global company working with UK contractors, or a contractor working with UK clients, IR35 determines whether the contractor pays tax as a business or as an employee.

The rules changed significantly in 2021 when the off-payroll working rules extended to the private sector. Now, medium and large companies are responsible for determining IR35 status and handling tax obligations. Get the determination wrong, and you face back taxes, penalties, and interest.

Disclaimer: This is informational, not legal or tax advice. When making IR35 determinations, consult qualified UK tax advisors or employment counsel familiar with your specific situation.

Why IR35 exists

IR35 (officially called the "Intermediaries Legislation") was introduced in 2000 to prevent tax avoidance. The concern was straightforward: workers were setting up limited companies to provide services, paying themselves through dividends and low salaries to minimize income tax and National Insurance contributions, even though they were effectively employees working under the direction and control of clients.

The legislation asks a fundamental question: if the intermediary (the contractor's limited company) didn't exist, would this person be an employee? If yes, they're "inside IR35" and must pay tax as if they were employed. If no, they're "outside IR35" and can operate as a genuine business.

Originally, contractors were responsible for determining their own IR35 status. But rules shifted in 2017 for the public sector and 2021 for the private sector. Now, the client organization is responsible for making the determination for medium and large companies. This responsibility is called the "off-payroll working rules."

The three core tests for IR35 status

IR35 status is determined by examining the actual working relationship, not just what the contract says. UK tax authorities and courts look at three main factors:

Substitution: Can the contractor send someone else to do the work? A genuine business can substitute workers if needed—they can send a qualified colleague or hire another firm to do the work. An employee cannot—the employer requires that specific person. If the client requires the specific individual and won't accept a substitute, this suggests employment. If the contractor has a genuine right to send a substitute and would actually use that right if needed, this suggests self-employment.

Control: Who controls what work is done, how it's done, when it's done, and where it's done? Employees are controlled by their employer—they're told what to do, when to do it, where to do it, and how to do it. Contractors control their own work—they determine how to deliver agreed outcomes. If the client dictates working hours, location, methods, and processes, this suggests employment. If the contractor decides how to achieve the agreed results, this suggests self-employment.

Mutuality of obligation (MOO): Is there an ongoing obligation for the client to provide work and the contractor to accept it? Employees have MOO—the employer must provide work and pay, the employee must be available and accept assignments. Contractors work on a project basis with no ongoing obligation beyond the specific project. If the relationship is continuous and indefinite, this suggests employment. If each project is separate and neither party has obligation beyond the project scope, this suggests self-employment.

Beyond these three core tests, tax authorities consider other factors: whether the contractor provides their own equipment, whether they bear financial risk, whether they can profit from sound management, whether they work for multiple clients, and whether they're integrated into the client's organization.

Who bears responsibility for determining IR35 status

Responsibility varies based on the client's size and sector:

Small companies: If the client is a small company (fewer than 50 employees, turnover under £10.2M, balance sheet under £5.1M), the contractor's personal service company is responsible for determining status and paying any tax due.

Medium and large private sector companies: The client is responsible for determining status and issuing a Status Determination Statement (SDS). If the contractor is inside IR35, the fee-payer (usually the client or agency) must deduct tax and National Insurance contributions and pay them to HMRC.

Public sector companies: The client is always responsible, regardless of size. The same rules apply as for medium and large private sector companies.

If you're a global company working with UK contractors, you need to determine whether you meet the UK definition of a small company. Most global companies won't qualify as small under UK rules, which means you're responsible for making IR35 determinations and handling tax obligations.

The Status Determination Statement

If you're responsible for determining IR35 status, you must provide the contractor with a Status Determination Statement before the contract starts (or within 45 days of the rules applying to you). The SDS must explain your decision and the reasoning behind it.

The contractor can challenge your determination if they disagree. You must respond within 45 days, explaining whether you're maintaining or changing your decision. If you don't respond to a challenge, you become liable for any tax due, even if the contractor was actually inside IR35.

HMRC provides an online Check Employment Status for Tax (CEST) tool to help make determinations. While not legally binding, HMRC says it will stand by CEST results if you provide accurate information. However, CEST has limitations and doesn't cover all scenarios, so many companies also seek professional advice from accountants or employment lawyers.

Inside IR35 vs outside IR35: The practical difference

If a contractor is determined to be inside IR35, they're treated as an employee for tax purposes (though without employee benefits). The fee-payer must deduct income tax and National Insurance contributions before paying the contractor's company. The contractor receives less money because taxes have been deducted, but they don't receive holiday pay, sick pay, pension contributions, or other employee benefits.

If a contractor is outside IR35, they operate as a genuine business. They invoice the client, receive full payment, and handle their own tax affairs. They can pay themselves through a combination of salary and dividends, potentially reducing their overall tax burden. They have more flexibility but also more responsibility for their own taxes and compliance.

Many contractors prefer to work outside IR35 because it's more tax-efficient and preserves their business autonomy. Many clients also prefer contractors to be outside IR35 to avoid the administrative burden of operating PAYE (Pay As You Earn) for contractors. However, the determination must be based on the actual working relationship, not preferences.

How to structure relationships to stay outside IR35

If you want to engage contractors outside IR35, structure the relationship to genuinely demonstrate self-employment:

Substitution: Include a genuine right of substitution in the contract. The contractor should be able to send a qualified substitute without needing your approval (though they may need to notify you). More importantly, document that this right is real and not just theoretical. If you ever challenge a substitute, the substitution right loses credibility.

Control: Define outcomes and deliverables, not methods and processes. Tell the contractor what result you want, not how to achieve it. Don't require specific working hours or locations unless genuinely necessary for the work. Don't integrate the contractor into your team structure or management hierarchy. Let them work independently.

Mutuality of obligation: Work on a project basis with defined start and end dates. Don't create an expectation of ongoing work. Don't require the contractor to be available for future assignments. Make it clear that each project is a separate engagement with no guarantee of future work.

Financial independence: Pay on a project or milestone basis, not hourly or monthly. Let the contractor use their own equipment. Don't provide employee benefits. Don't include the contractor in company communications or org charts. Ensure the contractor genuinely works for multiple clients.

The critical point: the actual working relationship matters far more than the contract terms. If you treat the contractor like an employee in practice—they work set hours at your location, you provide equipment, you supervise their work closely, they work only for you—IR35 will likely apply regardless of what the contract says.

Documentation and record-keeping

Maintain thorough documentation of your IR35 determinations and the working relationship. Keep copies of the contract, the Status Determination Statement, any challenges and your responses, and evidence supporting your determination (CEST results, professional advice, descriptions of working practices).

Document how the contractor actually works: Do they set their own hours? Do they work from their own location? Do they use their own equipment? Do they work for other clients? Do they have substitution rights? This evidence is crucial if HMRC challenges your determination.

Keep records of invoices showing the contractor's business name and business address. Maintain evidence of the contractor's business operations—website, business insurance, evidence of other clients, business bank account. Store all records for at least six years, as HMRC can investigate historical engagements.

Penalties for getting IR35 wrong

If HMRC determines that a contractor should have been inside IR35 but was treated as outside, the responsible party (client or fee-payer) must pay the tax and National Insurance that should have been deducted, plus interest and potentially penalties.

Penalties are significant. If HMRC believes you were careless in your determination, penalties can reach 30% of the tax due. If they believe you were deliberately non-compliant, penalties can reach 100% of the tax due. Interest accrues from when the tax should have been paid, compounding over years.

HMRC has been actively investigating IR35 compliance since the 2021 rule changes. They target companies with many contractors, particularly in IT, consulting, and professional services. Taking reasonable care in making determinations and keeping thorough records is essential for any company working with UK contractors.

IR35 for global teams

If you're a non-UK company working with UK contractors, IR35 still applies if the contractor is working in the UK or the work is performed for a UK client. You need to determine whether you meet the UK definition of a small company (which is unlikely for most global companies) and make IR35 determinations accordingly.

Many global companies find IR35 compliance burdensome and either restructure to avoid it, work with contractors outside IR35, or use an Employer of Record (EOR) for UK workers who would clearly be inside IR35. Some avoid UK contractors entirely due to the complexity and risk.

If you're working with UK contractors, factor IR35 into your contractor management processes. Make determinations carefully, document thoroughly, and consider professional advice for complex cases. The cost of compliance upfront is far less than the cost of getting it wrong.

The bottom line

IR35 is UK tax legislation that determines whether contractors pay tax as businesses or as employees. Medium and large companies are responsible for making determinations and handling tax obligations. The three key tests are substitution, control, and mutuality of obligation.

To keep contractors outside IR35, structure relationships to demonstrate genuine self-employment: real substitution rights, minimal control, project-based work, and business-to-business operations. Document everything thoroughly, respond promptly to contractor challenges, and seek professional advice when the determination is unclear.

IR35 compliance is complex and has real consequences. Don't guess. Either make careful determinations with thorough documentation, or consult UK tax professionals. The investment in proper advice is worthwhile.