Think you are hiring a contractor through their limited company and avoiding employer NI? IR35, the off-payroll working rules, exists to stop exactly that arrangement when the worker is effectively an employee in all but legal form.
The rules apply where a contractor provides services through their own personal service company (PSC) to an end client. If the relationship has the hallmarks of employment, the contractor is treated as an employee for tax and NI purposes. The fee-payer, which could be your business or a recruitment agency in the chain, must then deduct PAYE income tax and both employee and employer National Insurance from the contractor's gross fees.
A common trap for small business owners: assuming that because the contractor is VAT-registered or uses their own laptop, the contract automatically falls outside IR35. HMRC looks at the reality of the working relationship, not the paperwork. Key factors include substitution rights, control over how and when the work is done, and whether the contractor bears financial risk. A poorly drafted contract that does not reflect the actual working practices will not protect you.
The size of the end client determines who makes the status decision. Medium and large clients, defined as meeting at least two of a turnover over GBP 10.2 million, a balance sheet over GBP 5.1 million, or more than 50 employees, must determine the contractor's status and pass that determination down the chain. Small clients leave the responsibility with the contractor's PSC. If you are the fee-payer, you must act on the determination you receive, even if you disagree with it.
Consider a software company engaging a developer through a PSC at a flat fee of GBP 800 per day. If the determination is inside IR35, the fee-payer must calculate PAYE on that GBP 800, deduct employee NI at 12% on earnings between GBP 12,570 and GBP 50,270 for 2025/26, and pay employer NI at 15% on earnings above GBP 9,100. The developer loses the ability to take dividends at 8.75% or 33.75% and the GBP 500 dividend allowance. They also cannot claim travel and subsistence expenses against that engagement.
If you get the determination wrong, HMRC can pursue you for the unpaid tax, interest, and penalties. The contractor is also blocked from claiming those expenses. You should have a documented process for receiving and reviewing status determinations, and consider indemnity clauses in your contracts with end clients to recover costs if they provide an incorrect determination. For 2025/26, the apprenticeship levy of 0.5% on pay bills over GBP 3 million also applies to deemed employment payments.