Inside IR35 vs Outside IR35: The Basics
A clear explanation of the differences between inside and outside IR35, outlining what each means for contractors' tax and employment status, and why it matters for UK contract workers.
Introduction: Understanding IR35 in a Nutshell
IR35 is a set of tax rules in the UK designed to identify workers who are effectively employees for tax purposes, even if they operate through a limited company. It primarily targets contractors and freelancers. The difference between being 'inside IR35' and 'outside IR35' determines how you are taxed and what rights you might have.
What Does 'Inside IR35' Mean?
If a contract is classed as inside IR35:
- The HMRC (tax office) considers you an employee in the eyes of tax law.
- You must pay income tax and National Insurance as if you were directly employed.
- Your take-home pay is usually less than if you were outside IR35.
Key Consequences:
- You can't claim the same tax reliefs on travel, subsistence, or certain company expenses.
- The business hiring you or your agency may need to deduct tax from your pay before you get it.
What Does 'Outside IR35' Mean?
If a contract is outside IR35:
- HMRC considers you genuinely self-employed for that job.
- You pay yourself via your limited company, giving you more flexibility in how you draw income (salary/dividends).
- You can deduct more expenses from your company’s income before tax.
Key Consequences:
- You generally keep more of your pay.
- You’re responsible for your taxes (not the client or agency).
- You have fewer employment benefits and protections compared to permanent employees.
Quick Comparison Table
| Inside IR35 | Outside IR35 | |
|---|---|---|
| Tax Treatment | Like an employee | Like a business |
| Expenses | Limited tax relief | More expenses can be claimed |
| Pay | Usually less take-home | More take-home possible |
| Rights | May get worker rights (pensions etc) | Fewer/no employment rights |
| Who pays taxes | Client or agency (mostly) | The contractor pays themselves |
Why Does This Matter?
The distinction affects a contractor’s real income, benefits, and legal obligations. HMRC can fine or demand back-taxes if you get it wrong. Understanding where you stand allows for better financial planning and compliance.
'Being inside IR35 means higher taxes but perhaps more job security, while outside IR35 allows more flexibility but comes with greater tax responsibility.'
Practical Example
Imagine Sam, an IT contractor:
- If Sam’s contract is inside IR35, she receives tax-deducted pay, has fewer expenses she can claim, but may get some workplace protections.
- If Sam’s contract is outside IR35, she pays herself from her company, claims more expenses, and manages her own tax submissions.
How to Tell Where You Stand
To decide if a contract falls inside or outside IR35, HMRC looks at:
- Control: Does the client dictate your daily work and how you do it?
- Substitution: Can you send someone else to do your job?
- Mutuality of Obligation: Are you expected to keep working past the project?
Help is available from employment specialists and online IR35 calculators; however, complex cases often require legal advice.
If in doubt, consult an expert. The rules can be nuanced and mistakes are costly.
Final Thoughts
IR35 is about how much you’re like an employee vs. a business owner in the eyes of the law. The difference between being inside or outside matters for your tax bill, your rights, and your working flexibility. Make sure you know your status before signing any contract.
