Quick Answer
Inside IR35 means HMRC treats you as an employee for tax purposes, so you pay income tax and National Insurance on your contract income, just like a permanent employee. Outside IR35 means you operate as a genuine business, taking income through a mix of salary and dividends. On a £500/day contract in 2026/27, outside IR35 take-home is about £70,057 versus about £65,222 inside, an advantage of roughly £5,000–£6,000 a year (around 8–10% of take-home).
What does IR35 actually mean?
IR35 is HMRC's legislation designed to prevent "disguised employment." It targets contractors who work through limited companies but whose working arrangements look, in practice, like employment.
If HMRC decides your contract falls inside IR35, you pay tax as though you were an employee: income tax and National Insurance on your gross contract income. None of the tax efficiency of operating through a limited company applies.
The legislation takes its name from the Inland Revenue press release that introduced it in 2000: IR35. The current rules are set out in Chapter 10 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003).
What is the difference between inside and outside IR35?
The distinction comes down to whether HMRC considers you a genuine independent business or a disguised employee.
Outside IR35: You are treated as a legitimate business. You invoice your client through your limited company, pay yourself a small salary, and take the rest as dividends. You pay corporation tax on profits, dividend tax on distributions, and significantly less National Insurance than an employee.
Inside IR35: Your client (or the agency they use) deducts income tax and National Insurance at source before paying you. You receive the equivalent of a net wage. The limited company structure provides minimal tax benefit.
The key factors HMRC and the courts examine include: whether you have to do the work personally, whether your client controls how and when you work, and whether you could send a substitute in your place.
How is take-home pay calculated inside IR35?
Take a contractor billing £500 per day, working 220 days per year. Gross contract income: £110,000.
Inside IR35, the full £110,000 is treated as employment income, but first the umbrella or fee-payer deducts employer National Insurance from the contract income. Employer NI is 15% above the £5,000 secondary threshold, so (£110,000 − £5,000) × 15% = £15,750, leaving a deemed salary of £94,250. Income tax and employee NI are then applied to that figure exactly as for any employee:
- Income tax (personal allowance £12,570, 20% up to £50,270, 40% above): £25,132
- Employee NI (8% between the thresholds, then 2%): £3,895.60
- Take-home pay: ≈ £65,222 (2026/27 rates)
A typical umbrella company margin of £25 per week (roughly £1,300 a year) reduces this to approximately £63,922.
Use our IR35 calculator to model your specific day rate and working days.
Should you take an inside IR35 contract?
This is usually the real question contractors are trying to answer once the tax mechanics are clear, and it depends on more than the headline day rate.
Start with the net day rate, not the gross one. A £600/day contract that's inside IR35 might net out to roughly the same as a £570–£580/day contract outside IR35, once the tax difference is stripped out, so comparing two offers purely on the advertised day rate can be misleading. Run both figures through the calculator above before comparing offers, rather than doing the maths in your head.
It's also worth weighing what you're giving up beyond tax. Inside IR35 usually means no flexibility to take on other clients during the contract, no ability to send a substitute, and none of the tax planning options, pension contributions via salary sacrifice, dividend timing, income splitting with a spouse, that make outside IR35 contracting genuinely more efficient over a full tax year, not just on a single invoice.
How is take-home pay calculated outside IR35?
The same contractor, outside IR35, pays themselves a salary of £12,570 (the personal allowance, so no income tax). They take the remaining profit as dividends, after paying corporation tax.
Gross contract income: £110,000 Less salary: £12,570 Less employer NI on salary: £1,135.50 (15% above the £5,000 threshold) Profit before corporation tax: £96,294.50 Less corporation tax: £21,768.04 Available for dividends: £74,526.46
Note that corporation tax here is not the 19% small profits rate, that rate only applies to profits of £50,000 or less. Profits of £96,294.50 fall in the marginal relief band, so tax is charged at the 25% main rate with marginal relief of (£250,000 − £96,294.50) × 3/200, deducted. We walk through that calculation in our guide to how corporation tax is calculated, and HMRC publishes the current Corporation Tax rates and allowances on GOV.UK.
The dividend allowance for 2026/27 is £500. Dividend tax is charged at 10.75% on dividends falling in the basic rate band (£37,700) and 35.75% above it. The rates rose from 6 April 2026 (up from 8.75%/33.75% in 2025/26):
- £37,700 × 10.75% = £4,052.75
- £36,326.46 × 35.75% = £12,986.71
- Total dividend tax: £17,039.46
Effective take-home outside IR35: approximately £70,057 (£12,570 salary plus £57,487 of dividends after dividend tax), a total tax take of around 36% of gross income.
The real take-home difference
At £500 per day across 220 days, the gap between inside and outside IR35 is roughly £5,000–£6,000 per year (around 8–10% of take-home) after all taxes, about £70,057 outside versus £65,222 inside, widening to around £6,100 once a typical umbrella margin is deducted.
| Inside IR35 (umbrella) | Outside IR35 (salary + dividends) | |
|---|---|---|
| Gross contract income | £110,000 | £110,000 |
| Employer NI (15% above £5,000) | £15,750 | £1,135.50 (on salary only) |
| Deemed pay / profit | £94,250 | £96,294.50 |
| Income tax | £25,132 | £0 (salary within personal allowance) |
| Employee NI | £3,895.60 | £0 |
| Corporation tax | n/a | £21,768.04 (25% with marginal relief) |
| Dividend tax | n/a | £17,039.46 |
| Take-home | ≈ £65,222 (≈ £63,922 after umbrella margin) | ≈ £70,057 |
That is still a substantial sum. It explains why the IR35 status of contracts matters so much, and why the 2017 and 2021 reforms (which shifted the responsibility for determination from contractor to client) caused such disruption in the contracting market.
For the dividend tax picture on your outside-IR35 income, see how GOV.UK taxes dividends, or use our dividend tax calculator.
What is an umbrella company?
If you operate inside IR35, many contractors use an umbrella company rather than their own limited company. The umbrella company employs you directly, handles PAYE and NI, and passes your net pay to you.
Umbrella companies charge a weekly or monthly margin, typically £15–£30 per week. They provide employment rights including holiday pay and a payslip. For a long-term inside-IR35 contract, they can be administratively simpler than running your own company for no tax advantage.
However, be alert to non-compliant umbrella companies that claim to offer higher take-home through loan schemes or other arrangements. HMRC pursues these aggressively and the contractor bears the liability.
How do I know if my contract is inside or outside IR35?
Start with the three primary tests used by the courts: personal service, control, and mutuality of obligation.
If you must personally do the work (no right of substitution), the client controls your working hours and methods, and the client expects to give you more work and you expect to take it, these point firmly inside IR35.
If you can send a substitute, set your own hours, use your own equipment, work for multiple clients simultaneously, and take on genuine financial risk, these point outside IR35.
What is the HMRC CEST tool?
CEST (Check Employment Status for Tax) is HMRC's online tool for assessing IR35 status. You can work through it on GOV.UK, where HMRC sets out how the Check Employment Status for Tax tool should be used and who it applies to. HMRC states it will stand behind the result if you answer accurately and the facts do not change.
CEST has limitations, it cannot reach a determination in around 20% of cases, and it does not address all the relevant legal tests. Many contractors and clients use specialist IR35 status review services alongside CEST.
For limited company directors thinking about related tax planning, our corporation tax calculator shows the effective tax rate at different profit levels.
Can you challenge an IR35 determination?
Yes. If your client issues a Status Determination Statement that puts you inside IR35 and you disagree, you're entitled to challenge it through the client's status disagreement process, which they're required to have under the off-payroll rules. Set out clearly why the determination doesn't reflect your actual working arrangement, point to specific facts around substitution, control or mutuality of obligation carries far more weight than a general objection.
If the client doesn't respond or maintains the same determination without a reasoned explanation, the dispute can escalate, though in practice many contractors find it more productive to negotiate the day rate to reflect the inside-IR35 tax position rather than fight the determination itself, particularly for shorter contracts.
Frequently asked questions
Does inside IR35 mean I pay more tax?
Yes, significantly more. Inside IR35, your contract income is treated as employment income and taxed accordingly. Outside IR35, you can use the corporation tax and dividend tax structure, which is materially more efficient for most contractors.
Can I be inside IR35 for one contract and outside for another?
Yes. IR35 status is determined contract by contract, not per contractor. You can simultaneously hold one inside-IR35 contract and one outside-IR35 contract, provided you report each correctly.
Who is responsible for determining IR35 status?
For contracts in the private sector with a medium or large client (since April 2021), the client is responsible for the status determination and must provide a Status Determination Statement. For contracts with small private-sector clients, and for all public sector contracts, the rules also require client-side determination. Self-assessment of status applies only to contracts with genuinely small businesses.
What happens if HMRC disagrees with my IR35 determination?
HMRC can investigate and issue a tax bill for unpaid income tax and National Insurance, plus interest and potentially penalties. The liability falls on the fee-payer in the chain, typically the client or agency, under the 2021 rules. Contractors using their own limited company for contracts that were not properly assessed by the client can face personal exposure in some circumstances.
Does IR35 affect my state pension?
If you are inside IR35 and paying NI through deemed employment, your NI record is credited in the same way as for an employee. Outside IR35, your NI contributions depend on how much salary you pay yourself from your limited company. Most contractors pay a salary at least at the lower earnings limit to protect their state pension record.
Does IR35 apply to sole traders?
No. IR35 only applies to individuals working through their own intermediary, typically a personal service company (limited company), not to sole traders, who are taxed under self-employment rules instead.
Is take-home pay always worse inside IR35?
Almost always, yes, for a like-for-like day rate, but the gap narrows the lower the day rate, since the tax advantages of dividends matter less at lower income levels. Always run your actual numbers through the calculator above rather than relying on a rule of thumb.
Use our free IR35 Calculator
Free, instant, no sign-up required