The expressions “inside IR35” and “outside IR35” are used throughout the contracting world, but they are often misunderstood.
The terms describe whether a contractor’s engagement should be treated as employment or self-employment for tax purposes, using the same underlying status tests that underpin the IR35 legislation in Chapter 8 of ITEPA 2003 and the Off-Payroll rules (Chapter 10).
In this guide, we explain what the two terms mean in reality, how the tax treatment differs between employment and self-employment, and how a status decision is made using the same core factors covered by our IR35 Status Checker.
If you need an overview of IR35 itself, read IR35 basics.
Inside vs outside IR35 at a glance
| Inside IR35 | Outside IR35 | |
|---|---|---|
| What it means | The working arrangement looks more like one of employment, so the IR35 employment tax rules apply. | The contractor is working as an independent business, so the IR35 employment tax rules do not apply. |
| How payment works | Under the Off-Payroll rules, the fee payer deducts Income Tax and employee NIC before paying the contractor’s company. It also pays employer NIC. Where a private-sector client is small, the contractor’s company applies the Chapter 8 rules and accounts for any deemed employment payment itself. | The client or agency pays the contractor’s company without deducting PAYE or NIC. |
| Employment rights | An inside IR35 decision does not automatically give the contractor employment rights against the client. | An outside IR35 decision does not determine employment rights either. An independent contractor will not normally have rights against the client. |
| What points towards it? | Personal service, close client control and working as part and parcel of the client’s organisation. | A genuine right to substitution, limited client control, financial risk, and clear evidence of genuinely being in business. |
Where the terms originate
The term “IR35” refers to the April 2000 Intermediaries Legislation; it comes from the number of the press release that announced the new rules to the world. It has no secret meaning.
IR35 was created to stop disguised employment, where people work through their own limited companies but carry out their work in the same way as traditional employees.
An engagement is said to be “inside IR35” when it should be treated as one of employment for tax purposes.
An engagement is deemed to be “outside IR35” when the individual is working in a genuinely self-employed way for tax purposes.
Whether your work falls within the IR35 rules depends on long-established employment status tests used by HMRC and the courts.
These tests are explained in HMRC’s Employment Status Manual and include the familiar indicators: control, mutuality of obligation, personal service and substitution, financial risk, integration and business on own account.
We cover all of these factors in our guide to IR35 status tests.
What does “inside IR35” mean?
“Inside IR35” means an engagement is treated as employment for tax purposes.
The individual may operate through a limited company, but for Income Tax and National Insurance purposes, the engagement is treated as one of employment.
Under the Off-Payroll rules, where the end-client is medium or large, the client and fee payer are responsible for determining status and operating PAYE.
The contractor is paid after deductions for Income Tax and employee NIC.
The fee payer also accounts for Employer NIC. The contractor’s limited company receives a net deemed payment after deductions.
If the client is defined as a small company, the Off-Payroll rules do not apply. The contractor determines their own employment status, not the end client.
The small company exemption is explained in full in our guide to the Chapter 8 small business exemption.
What about employment rights?
Being “inside IR35” is purely a tax-related term.
It does not automatically grant the contractor employment rights with the end client.
Employment law uses different tests, and rights such as redundancy pay and holiday pay depend on an employment contract with an actual employer.
In many inside IR35 engagements, the contractor is paid through an agency or an umbrella company, and has no rights against the end client.
What does “outside IR35” mean?
“Outside IR35” means an engagement is a genuine business-to-business arrangement.
For tax purposes, the contract is treated as one of self-employment, with the contractor’s limited company operating as an independent service supplier.
The intermediary company receives gross payments, and the contractor accounts for tax in the usual way.
Corporation tax is paid on a company’s profits, which are usually distributed through a combination of salary and dividends.
An outside IR35 decision depends on whether the hypothetical direct contract between the worker and the client would be one of employment.
Written contracts are central to this assessment, although other evidence may be relevant in establishing the contractual terms and circumstances of the engagement.
A genuine right of substitution, limited client control, financial risk and evidence of operating as a business are all strong indicators of self-employment. Read our guide to the Atholl House case for more on how the hypothetical contract is constructed.
Although outside IR35 engagements are common in project-based contracting, HMRC can still enquire into the status decision.
Contractors should retain evidence of how they reached their status conclusion, including contracts, statements of work, and material showing how the engagement operated in practice.
How the Off-Payroll rules affect status
The Off-Payroll rules set out who is responsible for making the status decision.
Medium and large clients must issue a Status Determination Statement and take reasonable care in reaching their conclusion.
If the role is inside IR35, the fee payer must operate PAYE and deduct employment tax. If it is outside IR35, the contractor’s company remains responsible for tax.
More detail on the process is available in our guides to the Off-Payroll rules and Status Determination Statements.
Understanding why a role is inside or outside IR35
To understand a particular status decision, you need to look at the individual status indicators.
The guides on control, mutuality of obligation, financial risk, integration and business on own account explain how HMRC and the courts assess these factors, and the weight each carries in real disputes.
You can find further resources, including CEST, commercial tools and useful external resources, in our IR35 tools.