Fee-Payer Liability Under IR35: Who Pays if the Status Is Wrong

The off-payroll chain: client, agency and fee-payer

Most contractors working through a limited company (a personal service company, or PSC) sit inside a contractual chain that runs: end client at the top, one or more recruitment agencies in the middle, and the contractor's PSC at the bottom. Under Chapter 10 of ITEPA 2003, the off-payroll working rules that have applied to medium and large private-sector clients since 6 April 2021, each party in that chain has specific obligations.

The end client determines employment status and issues a Status Determination Statement (SDS). The fee-payer operates PAYE and National Insurance on the payment to the PSC. Those two functions belong to different parties, and understanding which is which matters because liability follows the function. When either party fails, liability can shift upward.

For a detailed walkthrough of how the off-payroll reform was constructed, how the chain operates and what the SDS process requires, see our guide to the off-payroll working rules for private-sector contractors. This page focuses specifically on what happens to the PAYE liability when something in the chain goes wrong.

Who exactly is the fee-payer?

The fee-payer is the party that makes the direct payment to the contractor's PSC. In practice that is usually the agency that has a contract with the PSC (the "agency closest to the PSC" in the chain). Where a client engages a PSC directly with no agency in between, the client is both the determining party and the fee-payer.

In a longer chain with two agencies (say, a managed service provider layered between the end client and a staffing agency, which in turn pays the PSC), the fee-payer is the staffing agency that writes the cheque to the PSC. The managed service provider is in the middle of the chain but is not the fee-payer. Each intermediary must pass the SDS downward so that the fee-payer knows whether to operate PAYE.

The fee-payer's duties under Chapter 10 where the SDS says inside IR35 are:

• Treat the payment to the PSC (after deducting VAT and the direct cost of any materials) as a deemed direct payment.
• Operate PAYE and employee Class 1 NIC on that deemed payment before remitting the net to the PSC.
• Pay employer Class 1 NIC at 15% (above the secondary threshold of £5,000 for 2026/27) on top of the payment, from its own funds.
• Account for the Apprenticeship Levy if applicable.

There is no 5% administrative expenses allowance under Chapter 10 (that allowance was retained only for Chapter 8, where the PSC self-assesses under the original IR35 rules). The fee-payer operates on the gross payment to the PSC as the starting point, which is why an inside-IR35 engagement through a PSC under Chapter 10 is so costly compared with an outside one.

Normal operation: liability sitting with the fee-payer

When everything in the chain works as it should, liability sits with the fee-payer. The end client issues a valid SDS with a conclusion and reasons, passes it to the next party in the chain and directly to the worker, and the fee-payer receives it and operates PAYE accordingly. Provided all of that is done correctly, the fee-payer is the entity HMRC would pursue for any shortfall in PAYE on that engagement.

This is a deliberate design feature of Chapter 10: it moves responsibility away from the worker (who under the original Chapter 8 rules bore the assessment and payment risk through the PSC) and places it on better-capitalised entities in the chain. But that only works if the chain operates correctly from top to bottom.

When liability moves: the four triggers

1. The client fails to issue an SDS

If the end client makes no status determination at all, there is no SDS in the chain. In that case the liability does not fall to the fee-payer; it sits with the client itself. The client that fails to issue any SDS is treated as the deemed employer and is personally on the hook for the PAYE and NIC. The statutory basis is ITEPA 2003 s.61NA: the obligation to determine status and issue the SDS is the client's, and until it is fulfilled the client remains liable.

The practical implication for contractors: if an agency has been paying you without deducting PAYE and you have never seen an SDS from the client, either the engagement was assessed as outside IR35 (in which case an SDS should still exist confirming that) or no determination was made. In the latter case the exposure sits with the client, not the agency, but HMRC may still inquire into the PSC if it suspects the engagement should have been inside.

2. The SDS is invalid because reasonable care was not taken

A valid SDS requires not just a conclusion but the reasons for that conclusion, and it must be made with reasonable care. HMRC's guidance at ESM10013 and ESM10014 sets out what reasonable care means in this context: a genuine, individual assessment of the engagement against the employment status tests, not a rubber-stamp exercise.

The most common failure here is the blanket determination: a client that sends a single inside-IR35 ruling covering an entire category of contractors ("all contractors in this team are inside IR35") without assessing each engagement individually. That is very likely a failure of reasonable care. As our guide to the SDS and the disagreement process explains, a blanket determination is legally risky for the client and gives affected contractors solid grounds to challenge it.

Where reasonable care was not taken, the effect is that the SDS is invalid and the client becomes the deemed employer, even if an agency below it has been operating PAYE in good faith on the basis of that SDS. The agency's exposure is extinguished (it was acting on what it received); the client's is not.

3. The client fails to pass the SDS down the chain

Even a valid, carefully-made SDS does not discharge the client's liability until it is passed to both the worker and the next party in the chain (ITEPA 2003 s.61NA). Where the client determines status but keeps the SDS to itself, the liability stays with the client. It only moves to the fee-payer once the SDS has been properly transmitted down to the paying party.

This matters in practice where there is a long chain. A client that issues an SDS and sends it to its direct contractor (a master vendor, say) but where that SDS never reaches the agency actually paying the PSC has not fulfilled the pass-down requirement for the whole chain. Each link must receive the SDS before the relevant part of the liability moves on.

4. Debt transfer: a party cannot or will not pay

The fourth route by which liability moves up the chain is the debt-transfer mechanism in the off-payroll rules. Even where a valid SDS was in place and the fee-payer was correctly identified, if that fee-payer fails to remit the PAYE and NIC (because it has become insolvent, or because it is a non-compliant entity set up to avoid payment), HMRC can recover the debt from another party higher in the chain.

The statutory basis is the Income Tax (PAYE) Regulations 2003 as amended for Chapter 10, with HMRC's manual guidance from ESM10025 onwards. The chain of recovery runs upward: HMRC will first look to the fee-payer, then to the next party above it (an intermediate agency), and ultimately to the end client. In practice this means end clients can face a PAYE bill they thought they had delegated to an agency, simply because that agency stopped trading or was shown to be a vehicle for avoiding payroll obligations.

This is one of the main reasons the off-payroll rules introduced a preferred-supplier-list culture among large clients: engaging PSCs through unvetted agencies whose PAYE compliance is unknown creates a real liability risk that sits dormant until HMRC begins an inquiry.

The 2024 set-off: how it changes the cost of getting it wrong

Before 6 April 2024, if HMRC determined that a client or fee-payer had incorrectly treated an engagement as outside IR35, the assessed PAYE liability took no account of tax the worker and PSC had already paid on the same income. That produced potential double taxation: the client paid a full PAYE assessment, and the worker had also paid income tax on dividends and the PSC had paid corporation tax on profits, all on the same underlying income. There was no mechanism to net one against the other.

From 6 April 2024, a statutory set-off (offset) changes that. Where HMRC raises a Regulation 80 determination on or after 6 April 2024, the deemed employer's PAYE liability is reduced by an estimate of the taxes the worker and PSC had already paid on the relevant income. The taxes that can be offset include:

• Corporation tax paid by the PSC on the profits in question.
• Income tax and employee NIC paid by the worker on any salary the PSC paid from those profits.
• Income tax paid by the worker on dividends from the relevant PSC profits.

The offset applies to errors arising from 6 April 2017 (for public-sector engagements) or 6 April 2021 (for private-sector engagements), even though the offset mechanism itself only became operative from 6 April 2024. The statutory basis is the Income Tax (PAYE) Regulations 2003 as amended (the off-payroll set-off regulations), and the HMRC manual guidance is at ESM10036 onwards.

What the set-off does not cover

The set-off reduces the PAYE assessment but does not eliminate it. Two important gaps remain.

First, employer NIC is never offset. Employer NIC at 15% (above the secondary threshold of £5,000 in 2026/27) was never paid by the worker or the PSC; it would have been the fee-payer's cost had PAYE been operated correctly. Because no-one has already paid it, there is nothing to credit against it. A client found to have incorrectly assessed an engagement as outside IR35 will still face the full employer NIC charge on the deemed payment, even after the set-off reduces the income-tax element.

Second, the set-off is HMRC-operated on a trigger-event basis, not an automatic netting the deemed employer can calculate itself. HMRC must be able to identify the worker and the intermediary and confirm that returns were filed and tax assessed or paid before it can apply the offset. It is a credit mechanism in HMRC's hands, not a self-service reduction.

What this means in practice for 2026/27

The set-off makes a wrongly-outside determination less catastrophic than it was before April 2024, but it does not make it safe. A client or fee-payer that incorrectly assesses an engagement as outside IR35 and is later challenged by HMRC will face at minimum the full employer NIC bill on the deemed payment, plus interest and potentially penalties. The PAYE and employee NIC element will be partially offset by what was paid, but the quantum of that offset depends on what the worker and PSC actually did with the income (a contractor who took most income as dividends will have a different offset profile from one who paid a larger salary).

The immediate effect of the set-off on contractors is that the personal financial risk of a status challenge has not grown since 2024. HMRC cannot simultaneously recover full PAYE from the client and leave the worker and PSC with the tax they already paid. The risk that fell on the worker under the old double-taxation exposure has been substantially removed, and the liability that remains sits with the client and fee-payer.

The disagreement process: the contractor's route to challenge

Liability in the chain and the worker's ability to push back on a determination are separate questions, but they are connected. A contractor who believes their engagement is outside IR35 but has been given an inside determination has a statutory right to use the client-led disagreement process under ITEPA 2003 s.61T.

The process works like this. The worker (or the PSC) makes written representations to the end client setting out why the determination should be different. The client must consider those representations and respond within 45 days, either confirming the original SDS with its reasons or issuing a revised SDS. The client decides the outcome; this is not an appeal to HMRC or to a tribunal.

The process matters for liability in a secondary way. If a client receives representations and ignores them (gives no response within 45 days, or refuses to engage), that conduct is relevant to whether the client took reasonable care with its determination in the first place. A client that blanket-assessed an entire contractor population as inside IR35 and then refuses to consider individual representations is accumulating evidence of reasonable-care failure.

Our detailed guide on how to challenge an inside IR35 determination covers the disagreement process and how to prepare representations that carry weight.

Liability in a two-party chain (no agency)

Where the end client engages the PSC directly, with no recruitment agency in the contractual structure, the client is simultaneously the determining party and the fee-payer. That means all of the obligations sit with the client: it must determine status, issue the SDS, pass the SDS to the worker, operate PAYE and pay employer NIC. There is no entity below it to hold the fee-payer liability.

In practice many technology and professional-services clients engage PSCs directly, particularly for senior or specialist roles. Those clients carry the full Chapter 10 compliance burden. Where they get it wrong (invalid SDS, reasonable-care failure, or a simple failure to operate PAYE), HMRC's inquiry is directed entirely at the client and there is no intermediary agency to create any diffusion of liability.

Liability in the public sector from April 2017

The off-payroll rules came to the public sector first, on 6 April 2017. The same chain mechanics apply (end client determines status; fee-payer operates PAYE), and the debt-transfer provisions and the 2024 set-off both cover public-sector engagements as well as private-sector ones. Where HMRC pursues a historic public-sector engagement that was incorrectly treated as outside IR35, the set-off credit applies from 6 April 2017 onward (with the offset itself operative from 6 April 2024).

Those who held public-sector engagements between April 2017 and April 2021 assessed as outside IR35, and who are now being revisited by HMRC, will find the 2024 set-off potentially significant. Any corporation tax paid by the PSC and income tax paid on dividends in those years would reduce a Regulation 80 assessment raised now, even though the set-off rules were not in force at the time of the original engagement.

Avoiding the liability traps: what clients and contractors should do

The lesson from the liability chain is that the personal financial risk under Chapter 10 is smaller than under Chapter 8: the PAYE and employer NIC burden falls on the fee-payer and the client, not on the PSC. The PSC still faces the economic consequence (an inside-IR35 engagement leaves less money in the company), but it is not directly assessed for the PAYE that the fee-payer failed to operate.

That said, contractors do not sit entirely outside the risk. Where a PSC received payments that should have had PAYE operated and did not, and where the PSC's CT returns and the worker's self-assessment do not reflect the correct treatment, HMRC may inquire into the PSC directly, even if its primary recovery action is against the client or fee-payer. Keeping clear records of the SDS received, the payments made and the tax actually paid on PSC income is important.

For clients and agencies, the hierarchy of risk reduction is straightforward in principle, if demanding in execution:

• Make individual assessments for each engagement, documented and supported by a genuine analysis of the working practices against the status tests.
• Issue an SDS that sets out the conclusion and the reasons in enough detail that it can withstand challenge.
• Pass the SDS to the worker and to the next party in the chain promptly and keep records of having done so.
• Engage agencies and umbrella companies on an approved, vetted basis where PAYE compliance can be confirmed.
• Respond to any disagreement representations within the 45-day window with proper reasons.

A client that does all of those things has substantially discharged its Chapter 10 obligations. The liability chain then operates as designed, with the fee-payer holding the paying responsibility and the client holding the determination responsibility, each documented and defensible.

Where this page ends and where to go next

The fee-payer liability rules are one part of a larger Chapter 10 framework. This page has focused on who holds the PAYE liability, when it moves and what the 2024 set-off does to the cost of getting it wrong. The full reform mechanics, including how the SDS is structured, the complete deemed-payment calculation and the small-company exemption, are covered in our guide to the off-payroll working rules for the private sector.

Contractors who want to understand the deemed-payment calculation in detail, including what deductions the fee-payer can make from the payment to the PSC before operating PAYE, should read our companion page on the deemed employment payment.

For the status determination itself, including how clients are supposed to use CEST and what makes a determination valid, see our guide to the Status Determination Statement. And if you have received a determination you disagree with, our guide on how to challenge an IR35 determination covers the disagreement process in full.

If you are a contractor with an upcoming engagement and you are uncertain whether your status has been assessed correctly, or if you are a client or agency reviewing your Chapter 10 processes, our IR35 status review service is the fastest way to get a defensible, expert-led assessment. You can also speak with the team through our contractor accountancy services page.