A short history
IR35 takes its name from Inland Revenue press release number 35, published in March 1999. The legislation that followed - Schedule 12 to the Finance Act 2000, now consolidated into Chapter 8 (Part 2) of the Income Tax (Earnings and Pensions) Act 2003 - was designed to stop a pattern HMRC saw growing in the late 1990s: workers leaving employment on Friday and returning on Monday as their own personal service company, paying themselves in dividends to avoid PAYE income tax and Class 1 National Insurance.
Originally, the freelancer's intermediary (usually a limited company) was responsible for assessing IR35 status and accounting for tax accordingly. That changed in 2017 for the public sector and in 2021 for the private sector when the government introduced Chapter 10 - moving responsibility for the determination from the freelancer to the end client, and liability for getting it wrong from the freelancer to the fee-payer in the chain.
Who IR35 applies to
IR35 applies whenever an individual provides services through an intermediary (typically a personal service company, partnership or managed service company) to a client, where - ignoring the intermediary - the relationship would be one of employment for tax purposes.
The two regimes that determine who is responsible for the assessment:
- Chapter 8 ITEPA 2003 applies where the client is "small" (the Companies Act 2006 definition: turnover under £15m, balance sheet total under £7.5m, fewer than 50 employees - meeting two of three). The freelancer's intermediary remains responsible for the assessment and any tax owed.
- Chapter 10 ITEPA 2003 applies to medium and large clients in the public and private sectors. The client must issue a Status Determination Statement (SDS) before the engagement starts and the fee-payer is liable for any underpaid tax.
The three substantive tests
UK courts and HMRC apply a body of case law to determine status, anchored by three primary tests from Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968] 2 QB 497.
1. Right of substitution
An unfettered right to send a suitably qualified substitute, exercisable without client veto, points strongly towards self-employment. The right must be operationally meaningful, not just on paper. PGMOL v HMRC [2024] UKSC 29 reaffirmed that a fettered substitution right (one requiring client approval on subjective grounds) is consistent with employment.
2. Mutuality of obligation
Must the client offer work, and must the worker accept it? Where neither party is obliged, the relationship is not employment. PGMOL clarified that even minimal mutuality during a discrete engagement does not on its own create employment status - control and other factors matter.
3. Control
Who decides how, when and where the work is done? A self-employed contractor brings expertise the client cannot direct in detail. An employee is told what to do day to day. Atholl House Productions Ltd v HMRC [2022] EWCA Civ 501 emphasised that the contract must be read against operational reality.
Secondary factors
- Financial risk - fixed-price quoting, rectification at own cost, equipment provision and insurance all evidence self-employment.
- Integration into the client's organisation - having a permanent desk, being on the staff intranet, attending all-hands meetings cuts the other way.
- Multiple clients and own marketing - being in business on your own account.
- Personal service vs delivered output - is the client paying for the person or for the result?
Inside vs outside IR35: the consequences
Outside IR35. The freelancer's company is paid gross. The company pays corporation tax on profits, and the freelancer extracts income via salary and dividends. Effective tax rates are meaningfully lower than for an equivalent employee, and the freelancer retains operational flexibility.
Inside IR35. Under Chapter 10, the fee-payer must deduct PAYE income tax and Class 1 NI before paying the intermediary. Take-home pay drops by 20-30%. Note that being inside IR35 does not give the worker employment rights - they are treated as an employee for tax only. Holiday pay, sick pay and unfair-dismissal protection do not follow.
Wrong determination. The fee-payer is liable for unpaid tax, plus penalties of up to 100% and interest. HMRC can look back four years (six in cases of carelessness, twenty for fraud). The reputational impact on a client that gets it wrong at scale is also material.
Status Determination Statements
For Chapter 10 engagements, the client must issue an SDS before the engagement starts. The statement must:
- Conclude whether the engagement is inside or outside IR35.
- Set out the reasons for that conclusion.
- Be passed to the worker and to the next party in the chain (typically a recruitment agency or umbrella).
The client must also operate a status disagreement process: if the worker disputes the SDS, the client has 45 days to respond with either a revised SDS or reasons for maintaining the original. Failure to issue an SDS leaves the client with the tax liability regardless of the underlying status.
How to evidence outside-IR35 status
A defensible outside-IR35 position rests on three legs: a contract that reflects genuine self-employment, an operational reality that matches it, and a paper trail that can be shown to HMRC if the engagement is investigated.
- Use a contract drafted to current case law - operational substitution clause, no MOO, no detailed control. Lexara's freelance contract generator applies these by default.
- Run an indicative status check against the IR35 case law before signing. Lexara's IR35 checker walks through the 15 substantive questions and produces a draft SDS.
- Keep evidence of multiple clients, your own equipment, your own insurance and your own marketing.
- Be ready to substitute in practice if you ever need to.
A 2026 footnote
There has been periodic political pressure to soften or repeal IR35, but as of mid-2026 the regime remains in force in substantially the same shape it took in 2021. The Employment Rights Act 2025's extension of day-one rights does not change IR35: tax status and employment status remain separate questions.