IR35 — the off-payroll working rules — decides whether a UK contractor working through their own limited company should be taxed as an employee for that contract.

What does inside IR35 mean?

Inside IR35 means HMRC treats the engagement as employment, so income is taxed through PAYE with Income Tax and National Insurance, just like a regular salary.

What does outside IR35 mean?

Outside IR35 means the contract is a genuine business-to-business engagement. The contractor invoices through a limited company and pays themselves via a small salary plus dividends.

How much more can outside IR35 pay on the same day rate?

Using our reconciled 2025/26 worked example at £500/day (5 days × 46 weeks = £115,000), outside IR35 take-home is £63,610 vs £58,636 inside IR35 — a difference of roughly £5,000 per year, plus a £5,750 employer pension pot on the outside route.

Who decides IR35 status?

For medium and large private-sector clients (and all public-sector clients), the end client issues a Status Determination Statement (SDS). For small private clients, the contractor's own company still makes the call.

Can I use a limited company inside IR35?

Yes, but the fee-payer must deduct PAYE before paying your company, so there's no tax benefit. Most contractors switch to an umbrella company for inside IR35 contracts.

What is an umbrella company?

An umbrella company employs the contractor and runs PAYE payroll on their behalf. It's the standard way to get paid for inside IR35 work.

What happens if HMRC disagrees with IR35 status?

HMRC can open an enquiry, demand back taxes and National Insurance, plus interest and penalties. For medium/large clients, liability usually sits with the fee-payer, but contractors can still be exposed.

Inside IR35 vs Outside IR35: The Real Difference Explained

What is IR35?

IR35 — the off-payroll working rules — is a set of UK tax rules introduced by HMRC to tackle disguised employment. It targets contractors who work through their own limited company (a personal service company, or PSC) but, in reality, operate just like an employee of the end client.

The principle is simple: if your day-to-day working relationship looks like employment, you should pay broadly the same tax and National Insurance as an employee — regardless of how you're invoiced.

What inside IR35 means

If a contract is judged inside IR35, HMRC treats the engagement as employment for tax purposes. The fee-payer (usually the agency or end client) must run PAYE on the contractor's income before paying it across. In practice, most contractors use an umbrella company for these contracts.

Income taxed via PAYE — Income Tax and employee NI
Employer NI and the Apprenticeship Levy come out of the assignment rate
Umbrella margin, holiday pay and pension handled at source
Tax efficiency of a limited company effectively disappears

What outside IR35 means

An outside IR35 contract is a genuine business-to-business arrangement. The contractor runs their own limited company, invoices the client, and decides how to pay themselves — typically a small director's salary plus dividends, with employer pension contributions from the company.

Genuine B2B engagement with a real trading company
Small salary at the primary threshold to minimise NI
Dividends after Corporation Tax on retained profit
Broader expense rules and employer pension flexibility

Inside vs outside IR35 at a glance

These are the practical differences a contractor will feel every month. Take-home figures are reconciled from the worked example below.

What differs	Outside IR35 (Ltd)	Inside IR35 (Umbrella)
Tax treatment	Corp Tax + salary/dividends	PAYE on full assignment rate
National Insurance	Employer NI only on small salary	Employer NI + Apprenticeship Levy deducted first
Business expenses	Broad — accountant, insurance, equipment	Very limited (SDC rules for most)
Pension options	Employer contributions from company (efficient)	Salary sacrifice via umbrella
Employment rights	Company director — no statutory rights	Rights arise through the umbrella employer and depend on the employment arrangement — not automatic against the end client
Holiday pay	Self-funded from company profits	Included / rolled up in assignment rate
Sick pay	Self-funded	Statutory Sick Pay via umbrella
Administration	Limited company + accountant (£80–150/mo)	Umbrella handles everything
Flexibility	High — retain profits, control extraction	Low — PAYE every payslip
Typical 2025/26 take-home (£500/day)	≈ £63,600/yr (£5,301/mo)	≈ £58,600/yr (£4,886/mo)
Best suited for	Genuine B2B contracts, long-term contractors	Inside IR35 assignments, short engagements

Worked example (£500/day, 2025/26)

The following worked example is the single source of truth for every financial figure on this page. All calculations use current HMRC 2025/26 rates.

Scenario and assumptions

Day rate: £500
5 days per week × 46 working weeks = £115,000 gross
England tax code 1257L, Student Loan Plan 2
5% pension contribution on both sides
Outside IR35: £5,000 business expenses, £100/month umbrella margin used for parity on the inside side
All dividends distributed each year (no company retention)

Outside IR35 — Limited Company

Contract income (£500 × 5 × 46)£115,000
Business expenses− £5,000
Employer pension (5%)− £5,750
Director salary− £12,570
Employer NI (15% > £5,000 ST)− £1,136
Profit before Corp Tax£90,544
Corporation Tax (marginal, ~22.4%)− £20,244
Distributable as dividends£70,300
Dividend tax (basic + higher)− £14,258
Student Loan Plan 2 (9%)− £5,002
Employee NI (salary at PT)£0
Income Tax on salary (PA covers)£0

Annual take-home

£63,610

Monthly: £5,301

Inside IR35 — Umbrella

Assignment rate (£500 × 5 × 46)£115,000
Umbrella margin (£100/mo)− £1,200
Employer NI (15% > £5,000 ST)− £14,127
Apprenticeship Levy (0.5%)− £496
Gross salary£99,177
Employee pension (5%)− £4,959
Income Tax (20% + 40%)− £25,119
Employee NI (8% + 2%)− £3,994
Student Loan Plan 2 (9%)− £6,469

Annual take-home

£58,636

Monthly: £4,886

Why the outside route wins on cash

On identical £500/day contracts, the outside IR35 route delivers £63,610/year in take-home pay, versus £58,636/year inside IR35 — a difference of £4,974 a year (about £415/month), plus a £5,750 employer pension pot on the outside route funded by the company before Corporation Tax.

The gap comes from three levers unique to outside IR35: dividends avoid National Insurance entirely, the small director salary sits inside the personal allowance, and employer pension contributions reduce Corporation Tax before profits are extracted.

Money Tools UK Insight

Two contractors can earn exactly the same £500 daily rate yet take home thousands of pounds less each year simply because one contract falls inside IR35. Always calculate your expected net income before accepting a contract — the advertised day rate rarely tells you what you'll actually keep.

Compare your own IR35 take-home in seconds

Plug your day rate, expenses and pension into our IR35 comparison calculator and see the reconciled numbers for your contract.

Open IR35 Comparison Calculator

Umbrella companies and IR35

Umbrella companies are the default solution for inside IR35 contracts. The umbrella employs the contractor, runs PAYE payroll, handles holiday pay and pension auto-enrolment, and pays a net salary each week or month.

Required for most inside IR35 assignments
Simple — no accountant, no company admin
Compliant by design (PAYE handled at source)
Employer costs and umbrella margin reduce take-home pay

See our full Umbrella vs PAYE guide or run the numbers in the Umbrella Company Calculator.

Limited companies and IR35

A limited company (PSC) is the most tax-efficient structure when a contract is genuinely outside IR35. You become a director, pay yourself a small salary, and take the rest as dividends after Corporation Tax — with optional employer pension contributions from the company.

Best suited to outside IR35 contracts
Bookkeeping, VAT and payroll responsibilities
Specialist contractor accountant typically £80–£150/month
Profits can be retained in the company for future years

Try our Contractor Calculator to model your own outside IR35 take-home.

Who determines IR35 status?

Since the 2021 reforms, responsibility for deciding IR35 status depends on the size of the end client.

Medium and large private-sector clients: the client decides and issues a Status Determination Statement (SDS).
Public-sector clients: always responsible for determining status.
Small private-sector clients: the contractor's own company makes the determination (the small company exemption).

Common IR35 tests

HMRC and tribunals look at the working relationship as a whole. These factors carry the most weight:

Control: who decides what, how, when and where the work is done?
Substitution: can you genuinely send a substitute?
Mutuality of obligation: is the client obliged to offer work and you to accept?
Financial risk: do you risk your own money, equipment, or fixing defects?
Business independence: multiple clients, marketing, insurance, own tools?

HMRC risks and penalties

IR35 enquiries can be expensive. If HMRC successfully challenges a status determination, the fee-payer (or the contractor's company in small-client situations) can face significant liabilities.

Back taxes and employee/employer National Insurance
Interest on unpaid amounts
Penalties depend on behaviour — an ordinary careless mistake, a deliberate error and a concealed error each attract very different penalty ranges under HMRC's rules, and reasonable care with clear contemporaneous evidence can reduce or remove them altogether
Multi-year reviews going back several tax years

Compliance matters

Always keep written contracts, an SDS where applicable, and evidence that your working practices match the contract. Status and contract reviews from a specialist are inexpensive insurance.

Common contractor mistakes

Assuming every limited company contract is automatically outside IR35
Using a PSC for an inside IR35 contract with no tax benefit
Ignoring or not challenging an SDS issued by the client
Forgetting employer NI is deducted from the assignment rate inside IR35
Comparing gross day rates rather than net take-home pay

Estimate your own contractor income

Run the numbers for both routes with your own day rate, expenses and pension.

Umbrella Calculator Contractor Calculator

Editorial standards & sources

Reviewed by the Money Tools UK editorial team. Last reviewed 21 July 2026 for the 2025/26 UK tax year.

HMRC: Understanding off-payroll working (IR35) (ESM10000 series)
HMRC: Rates and thresholds for employers 2025 to 2026
HMRC: Corporation Tax rates and reliefs (marginal relief 2025/26)
GOV.UK: Dividend tax and Student Loan repayment thresholds

Figures are estimates for a generic contractor in England on tax code 1257L. Your actual take-home depends on your specific circumstances, expenses and pension arrangements.