Inside vs outside IR35
The difference between the two is not a tax rate. It is whether the tax system treats your contract as a business arrangement or as a job in all but name.
Updated 1 August 20267 min read
IR35 is a set of tax rules, properly called the off-payroll working rules, that exist to answer one question: if the limited company in the middle were taken away, would this look like a job? If the answer is yes, the contract is inside IR35 and has to be taxed like employment. If no, it is outside IR35 and can be taxed as a business arrangement.
That is the whole idea. Everything else, the tests, the paperwork, the arguments with agencies, follows from it.
What changes in practice
| Outside IR35 | Inside IR35 | |
|---|---|---|
| How you are paid | Invoice from your limited company, paid gross | Payslip from an umbrella, paid net of PAYE |
| Tax on the money | Corporation tax, then dividend tax when you draw it | Income tax and National Insurance at source |
| Employer NI | Only on your own small salary | Taken out of the assignment rate before you are paid |
| Expenses | Company can claim allowable costs against profit | Almost nothing, unless you are free of supervision and control |
| Employment rights | None. You are running a business | Umbrella employment rights: holiday pay, sick pay, pension, but not the client's |
| Who carries the tax risk | The client or agency, unless the client is a small company | Nobody. The tax is already paid |
What it is worth
Less than it used to be. On a £500 day rate over 220 days, the gap between the two routes in 2026/27 is a few thousand pounds a year rather than the 20 to 25 per cent uplift that older articles still quote. Three things closed it: corporation tax rose to 25 per cent with an effective 26.5 per cent on profits between £50,000 and £250,000, employer National Insurance rose to 15 per cent on earnings over £5,000, and dividend tax rose again in April 2026.
The gap also moves around with the size of the rate, because the two routes cross different tax thresholds at different points. That is why it is worth doing the sum on your own number rather than trusting a rule of thumb. The IR35 calculator shows both sides and the inside rate you would need to break even.
The three tests that decide it
No single factor settles a status. HMRC and the courts look at the whole picture, but three questions carry most of the weight.
Control
Who decides what you do, how you do it, when and where? A client saying what outcome it needs is normal for a supplier. A client telling you which tasks to pick up each morning, moving you onto unrelated work and setting your hours looks like an employer.
Substitution
Could you send someone else competent in your place and pay them yourself? A genuine, unfettered right of substitution is the strongest single indicator of outside status. A clause that says you may substitute but the client can refuse for any reason is worth nothing, and HMRC knows every version of that clause.
Mutuality of obligation
Is the client obliged to offer you work, and are you obliged to accept it? An employment relationship rolls on. A contract for a defined deliverable, with no expectation on either side once it ends, does not.
Beyond those, the smaller signals add up: being in business on your own account with other clients, carrying your own insurance, using your own equipment where practical, having to fix defects at your own cost, not appearing on the internal org chart, and not taking staff benefits.
What to do with a determination you disagree with
You have a right to a written reason, and a right to challenge it. The client has 45 days to respond to a challenge with either a changed decision or its reasons for keeping the original one. Blanket determinations across a whole category of contractor, without looking at individual engagements, do not satisfy the reasonable care the rules require, and pointing that out politely and in writing works more often than people expect. How IR35 status is decided covers the process and what to put in the letter.
If a contract moves inside
- Work out the rate that leaves you level before you respond, and ask for that number rather than a percentage.
- Check whether the quoted rate is an assignment rate or a PAYE rate. The difference is around 15 per cent of your gross pay, and agencies are not always clear which they mean.
- Consider pension instead of rate. A salary sacrifice contribution through an umbrella escapes income tax and both sides of National Insurance, so it is the most efficient thing you can do with money you were going to lose anyway.
- Pick your own umbrella if the agency lets you, and check its accreditation yourself. The umbrella comparison lists what to look at.
Common questions
What does outside IR35 mean?
It means the engagement is accepted as a business to business contract rather than employment in disguise. You invoice through your own limited company, the company pays corporation tax on its profit, and you decide how and when to take money out as salary and dividends. Nobody deducts PAYE from your invoices.
What does inside IR35 mean?
It means that, for tax purposes only, you are treated as an employee of the client. Income tax and National Insurance are deducted before you are paid, usually by an umbrella company that employs you. You are not an employee of the client in employment law, so you get none of their benefits, no notice period and no redundancy rights.
Can I be inside IR35 on one contract and outside on another?
Yes. IR35 is assessed contract by contract, not person by person. Running two engagements at once with different statuses is normal, and being genuinely in business with several clients is itself a point in favour of outside status.
Is outside IR35 always better?
Financially it is usually better, but by less than most people assume in 2026, and it comes with obligations: company accounts, a corporation tax return, insurance and the risk of an HMRC enquiry into a status you claimed. If your outside rate and your inside rate are close, the admin-free route can be the rational one.
Who is liable if HMRC decides the status was wrong?
For contracts with medium and large private sector clients and all public sector clients, the fee payer, normally the agency, carries the liability for unpaid tax, which is why so many of them are cautious. If your client is a small company, you remain responsible for assessing and paying under the original IR35 rules, and the liability is yours.
General information, not tax advice. IR35 depends on the facts of each engagement and on how the work is done in practice, not only on what the contract says.