TL;DR
IR35 is the common name for the UK off-payroll working rules in Chapters 8 and 10 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA). Chapter 10 applies to medium and large clients and to the public sector. Chapter 8 applies to small clients and is handled by the contractor’s intermediary. From 6 April 2026, the small company turnover threshold rises from 10.2 million pounds to 15 million pounds and the balance sheet threshold rises from 5.1 million pounds to 7.5 million pounds. More UK clients will fall back under Chapter 8 with the contractor handling the determination. The client must issue a Status Determination Statement before paying for services, with reasons. The CEST tool produces a non-binding determination that HMRC will stand behind if inputs were accurate.
What IR35 actually is
IR35 is a press shorthand for the off-payroll working rules. The legal source is the Income Tax (Earnings and Pensions) Act 2003, specifically two chapters of Part 2:
- Chapter 8 is the original 2000 IR35 regime. The contractor’s intermediary (usually a Personal Service Company) determines whether the engagement is inside IR35 and pays tax and NICs accordingly.
- Chapter 10 is the 2017 public-sector reform and the 2021 private-sector reform. For medium and large clients, the client must determine status and the fee-payer must operate PAYE and NICs.
The substantive employment status test is the same under both chapters. It is the common law test developed by UK courts from Ready Mixed Concrete v MPNI (1968) onward, applying three primary factors:
- Mutuality of obligation: Is the client obliged to provide work and the contractor obliged to accept it?
- Control: Does the client have the right to control how, when, and where the work is done?
- Right of substitution: Can the contractor send a substitute to do the work?
Other factors include integration into the client’s business, financial risk, provision of equipment, exclusivity, length of engagement, and how the relationship is characterised in the contract.
Who pays under each chapter
The fee-payer liability rules differ between chapters.
Chapter 10 (medium and large clients, public sector)
| Step | Entity | Liability |
|---|---|---|
| 1. Determine status | Client | Must issue SDS with reasons |
| 2. Receive SDS | Contractor and fee-payer (agency) | Status binds the chain |
| 3. Pay PSC | Fee-payer | Operates PAYE and NICs if inside IR35 |
| 4. Pay contractor | PSC | Pays out post-tax amounts |
If the client fails to take reasonable care in determining status or fails to issue the SDS, the client becomes the fee-payer with primary liability.
Chapter 8 (small clients, contractor’s intermediary handles)
| Step | Entity | Liability |
|---|---|---|
| 1. Determine status | Contractor’s PSC | No SDS required to client |
| 2. Pay PSC | Client | No PAYE responsibility |
| 3. Pay contractor | PSC | Operates PAYE and NICs internally if inside IR35 |
The shift from Chapter 8 to Chapter 10 (or back) depends on whether the client meets the small company criteria.
The small company threshold and 6 April 2026 change
A client is “small” if it meets at least two of three criteria under the Companies Act 2006 Section 382 and 477. From 6 April 2026, the thresholds rise:
| Criterion | Before 6 April 2026 | From 6 April 2026 |
|---|---|---|
| Turnover | Not more than 10.2 million pounds | Not more than 15 million pounds |
| Balance sheet total | Not more than 5.1 million pounds | Not more than 7.5 million pounds |
| Employees | Not more than 50 on average | Not more than 50 on average |
The change applies to accounting periods starting on or after the relevant Companies Act commencement date. HMRC has clarified that the small company status for IR35 purposes is determined based on the client’s accounting periods. A client whose accounting period straddles the change date applies the old thresholds to that period and the new thresholds to subsequent periods.
The effect for US companies: a US-incorporated entity contracting UK contractors must apply the Companies Act 2006 criteria to itself if it qualifies as a UK-connected client under the off-payroll rules. The specific test for non-UK clients involves whether the client has a UK connection in the relevant tax year.
For most US tech companies expanding into the UK, the question is whether the US parent or any UK subsidiary qualifies as small. A UK subsidiary with under 15 million pounds turnover and under 50 employees will typically qualify as small from 6 April 2026 and fall outside Chapter 10.
The Status Determination Statement
The SDS is the document that records the client’s determination of employment status for tax. Required content:
- The conclusion (inside or outside IR35)
- The reasons for the conclusion
- A statement that the determination is the conclusion as a result of reasonable care
The SDS must be passed down the chain to the worker and to the agency or other intermediary that pays the PSC. Failure to provide an SDS makes the client the fee-payer.
The SDS can be appealed by the contractor. The client must respond to the appeal within 45 days and either confirm or change the determination. If the client confirms with reasons, the determination stands. If the client fails to respond within 45 days, the determination is treated as not having been made.
CEST: what it is, what it isn’t
CEST (Check Employment Status for Tax) is HMRC’s online tool for determining employment status. It is a questionnaire that produces a result of “employed for tax purposes” or “self-employed for tax purposes.”
HMRC’s commitment on CEST: HMRC will stand behind a CEST result provided the information entered was accurate and complete. This is the key compliance benefit. If a US client runs CEST honestly, retains the inputs, and the result is “outside IR35,” HMRC’s stated practice is to accept that result.
CEST limitations:
- Does not handle mutuality of obligation well. CEST starts from the premise that mutuality is satisfied if work is performed for payment, which is contested in case law.
- Produces “unable to determine” in some cases, which leaves the client with no formal HMRC backing.
- Updates without notice. A CEST result from 2023 may differ from a 2026 run on identical facts.
Best practice: run CEST at the start of the engagement, save the PDF result, retain the inputs, and re-run CEST annually or when material facts change. For borderline cases, supplement with a written opinion from UK tax counsel or a specialist IR35 firm.
Inside vs outside IR35: what changes
| Aspect | Inside IR35 | Outside IR35 |
|---|---|---|
| Tax treatment | Like employment | Like genuine self-employment |
| Income tax | PAYE deducted by fee-payer | PSC pays via corporation tax and dividends |
| National Insurance | Employer and employee NICs by fee-payer | Class 2 and Class 4 by contractor |
| Apprenticeship Levy | May apply on fee-payer’s payments | Does not apply |
| Take-home percentage | Roughly 55 to 65% of gross | Roughly 70 to 80% of gross |
| Worker rights | Limited employment rights triggered | None |
For US clients, the cost difference is meaningful. An inside-IR35 engagement adds approximately 13.8% employer NICs to gross fees and triggers Apprenticeship Levy at 0.5% above the threshold. An outside-IR35 engagement costs only the gross fee.
Common reasons UK contractors are inside IR35 when working for US clients
US founders often unintentionally drift inside IR35. The most common reasons:
1. Full-time engagement. A UK contractor working 40 hours a week on the US client’s product looks like a disguised employee. Mutuality of obligation is satisfied. Control is satisfied if the client directs work priorities.
2. No right of substitution. The contract specifies “the named individual will perform the services.” This forecloses substitution.
3. Integration into the team. The contractor attends standups, sprint planning, retrospectives. They have a company email address. They appear in the company directory. This is integration evidence.
4. Provision of equipment. The US client provides a laptop, software licenses, or other tools.
5. Exclusivity. The contract restricts the contractor from working for other clients.
6. Long engagement. A two-year continuous engagement looks more like employment than a three-month project engagement.
How to keep a UK contractor outside IR35
Specific structural choices that shift the analysis:
- Engage for defined deliverables with milestones rather than time
- Include and use a genuine substitution clause
- Avoid mandatory attendance at internal meetings
- Avoid providing equipment where avoidable
- Do not include exclusivity restrictions
- Avoid renewing engagements indefinitely without natural project boundaries
- Document that the contractor has other clients
The substance test does not care about the contract title. A “Statement of Work” labelled “Contract for Services” can still be inside IR35 if the substance is employment.
Omnivoo Contract Management generates UK contractor agreements with deliverable-based terms, substitution clauses, and the structural features that support an outside-IR35 determination. The contract does not, by itself, make the engagement outside IR35. The substance has to match. But the contract should not contradict the substance.
Penalties
HMRC enforces IR35 through Pay As You Earn audits and information notices. Penalties include:
| Cause | Penalty |
|---|---|
| Failure to issue SDS | Client becomes fee-payer with full PAYE liability |
| Inaccurate determination through carelessness | Up to 30% of the tax due |
| Inaccurate determination through deliberate but not concealed conduct | 20% to 70% of tax due |
| Deliberate and concealed conduct | 30% to 100% of tax due |
| Late payment | Interest at HMRC’s official rate |
HMRC has a track record of enforcement against media and broadcast companies, IT services firms, and oil and gas operators. Recent reported cases include large tax assessments against the BBC, ITV, and large consulting firms.
Practical compliance plan for a US company
If you are a US company with UK contractors, your IR35 compliance plan needs to address determination, documentation, and process.
1. Identify your UK status. Are you a UK-connected client under the off-payroll rules? Does any UK subsidiary qualify as small? The answer determines whether Chapter 8 or Chapter 10 applies.
2. Inventory UK contractor engagements. For each engagement, capture: name, PSC name, duration, fees, scope of work, working pattern.
3. Run CEST on each. Retain the PDF result and the inputs. If CEST is unable to determine, escalate to specialist advice.
4. Issue SDS for each Chapter 10 engagement. Use a templated SDS that records the CEST result and the reasons. Pass to contractor and to any agency.
5. Set up the appeal process. Designate a person to respond to SDS challenges within 45 days.
6. Annual review. Re-run CEST annually for ongoing engagements. Working patterns can drift over time.
7. Use a templated UK contractor agreement. Templates should include genuine substitution rights, deliverable-based payment, and avoid exclusivity. Contract Management provides UK-compliant templates as part of standard contract generation.
How Omnivoo Contract Management helps
Omnivoo Contract Management supports UK contractor engagements with:
- UK-law-compliant contract templates with substitution clauses, deliverable-based terms, and structural features that support an outside-IR35 determination
- Document storage for CEST results and SDS records
- Audit trail of contract changes, signatures, and payments
- Standard payment flows that do not impose PAYE on the contractor
What Contract Management does not do:
- Run CEST or issue the SDS on the client’s behalf
- Provide UK tax counsel opinions
- Substitute for HMRC due care obligations
Pricing is a flat $49 per finalized contract. Transaction fees pass through at cost. See pricing.
For UK contractor engagements that drift toward full-time work, the cleaner option is often an EOR. Contract Management is the right tool when the engagement is genuinely contracting in substance. Talk to our team about your UK contractor model. Get in touch.