Inside IR35: What It Means and How It Affects Your Pay

What being inside IR35 actually does to your income

Being caught inside IR35 means the taxman views your contract income as equivalent to employment pay. You do not become an employee in law, and your personal service company (PSC) does not disappear, but the income from that engagement is taxed as if you were on the client's payroll. That single fact has cascading consequences for your take-home pay, your expense claims, your company's cash position, and the decisions you need to make about whether running a PSC still makes sense for that contract.

This guide is about those consequences. For the underlying question of what IR35 is, which chapter applies to your engagement, and how the three employment-status tests work, see our what is IR35 guide. For the steps you can take to protect an outside-IR35 position, see our outside IR35 guide. Here the focus is on what happens when the determination goes the other way.

Two regimes, two very different mechanics

The term "inside IR35" covers two distinct legislative regimes that work differently and affect your PSC differently. Which one applies depends on the size of your end client.

Chapter 10: medium and large clients (the common case)

For contractors working with medium or large end clients, Chapter 10 of Part 2 ITEPA 2003 applies. This is the off-payroll working regime that was extended to the private sector from 6 April 2021. Under Chapter 10, the end client determines your status (by issuing a Status Determination Statement, or SDS), and the fee-payer, typically the agency that sits between you and the client, operates PAYE and National Insurance on the payments it makes to your PSC.

The fee-payer takes the gross payment due to your PSC, deducts any VAT and direct materials cost, and treats the remainder as a deemed direct payment. From that deemed payment it deducts employee NIC (8% between the primary threshold of £12,570 and the upper earnings limit of £50,270 for 2026/27, then 2% above) and PAYE income tax at the applicable rates. It also pays employer NIC at 15% on earnings above the secondary threshold of £5,000 (2026/27 rate), and the Apprenticeship Levy where applicable. These costs are funded from the assignment rate agreed with your PSC, not added on top of it.

The net amount after all those deductions is what arrives in your PSC's bank account. The money has already been taxed. There is no 5% administrative expenses allowance under Chapter 10; that was abolished when the off-payroll rules shifted responsibility to the client side. And because status determination now sits with the client, your PSC has no role in calculating whether the engagement is inside IR35: the SDS tells you the answer and the fee-payer acts on it automatically.

Chapter 8: small or overseas clients

Where your end client is small, or is a wholly overseas entity with no UK connection, Chapter 10 does not apply. Your PSC remains responsible under Chapter 8, the original IR35 intermediaries legislation (in force since 6 April 2000). Here your PSC must assess status itself, and if it concludes the engagement is inside IR35, it must calculate and operate a deemed employment payment.

The Chapter 8 calculation works on an annual basis. At the end of the tax year your PSC totals all the income from the inside-IR35 engagement, then deducts in sequence: a flat 5% of that income as an administrative expenses allowance (still retained under Chapter 8), actual allowable employment-type expenses, employer pension contributions made during the year, and any salary already put through payroll. It then grosses down the remainder for employer NIC at 15% (above the £5,000 secondary threshold) and treats the balance as a deemed employment payment: salary subject to PAYE and Class 1 NIC, reported and paid via your PSC's payroll.

The 5% allowance is the most significant practical difference between the two regimes. On a £100,000 inside-IR35 engagement under Chapter 8 you can deduct £5,000 before the deemed payment calculation starts. Under Chapter 10, every pound of the assignment rate is in scope.

The small-company thresholds that determine which regime applies were raised for financial years beginning on or after 6 April 2025 (two of three conditions: turnover up to £15m, balance sheet up to £7.5m, no more than 50 employees). But because of the relevant-financial-year lag and the two-consecutive-years rule, the earliest a previously medium client can drop out of Chapter 10 scope is 6 April 2027. For 2026/27, most contractors working with medium or larger businesses should assume Chapter 10 still applies unless the client has confirmed its size status in writing.

The employer NIC problem: why inside IR35 costs more than PAYE alone

The single most misunderstood financial impact of being inside IR35 is employer NIC. When a permanent employee is hired, the employer pays their gross salary and then writes a separate cheque to HMRC for employer NIC on top: 15% on earnings above £5,000 for 2026/27. That employer NIC is a cost the employer absorbs, above and beyond what the employee receives.

Inside IR35 under Chapter 10, the economics work the other way around. The assignment rate agreed between your PSC and the fee-payer is the total pot. Employer NIC, the fee-payer's own costs, and your net pay all come out of that same pot. In practice, the day rate a contractor negotiates has to absorb the 15% employer NIC charge, which means a contractor billing £600 a day is effectively receiving less in take-home terms than a permanent employee on the same annualised gross.

Consider a concrete illustration using 2026/27 figures. A contractor billing £600 a day for 220 days generates approximately £132,000 in gross fees. Under Chapter 10, before income tax and employee NIC are even applied, employer NIC at 15% on earnings above £5,000 takes roughly £19,050 (on the portion above the secondary threshold). Employee NIC at 8% on earnings between £12,570 and £50,270 takes a further £3,016, and at 2% on earnings above £50,270 takes roughly £1,635. Income tax at 20% on the basic-rate band and 40% on earnings above £50,270 takes the largest slice. The personal allowance of £12,570 (2026/27) still applies, but there is no dividend allowance, no corporation tax saving, and no salary/dividend split to exploit.

The contrast with an efficiently structured outside-IR35 engagement, where the same £132,000 flows into the PSC as company income, is stark. Outside IR35, the contractor pays corporation tax at 19% to 25% on profits, extracts a low salary (commonly to the lower earnings limit of £6,708 to protect a qualifying NI year), and takes the balance as dividends taxed at 10.75% (basic rate) or 35.75% (upper rate) for 2026/27, rather than income tax at 20% to 45%. The gap in annual take-home between the two positions, across a full year on a mid-tier day rate, commonly runs to £15,000 to £25,000.

What you can still claim inside IR35

The inside-IR35 tax treatment closes off many of the extraction advantages available to an outside-IR35 contractor, but it does not eliminate all legitimate deductions. The key is understanding which expenses survive the rules and which ones fall away.

Expenses that remain deductible

Professional indemnity and business insurance. Premiums for PI cover, public liability, and other business-critical insurance remain deductible as genuine business costs, provided they relate to the work and not to personal liabilities.

Professional subscriptions and memberships. Subscriptions to professional bodies that are recognised by HMRC (a relevant list exists for employment-status purposes) and that are genuinely required for the work are still deductible. This includes bodies like the BCS, RICS, CIMA, or sector-specific institutes where membership is a professional requirement.

Training directly relevant to the engagement. Training costs that directly update or extend the skills used in the contract can still be claimed, though the bar is closer to the employed-worker "necessarily incurred" test than the broader "wholly and exclusively" test available outside IR35.

Equipment purchased wholly for the work. A laptop, specialist software, or tools bought exclusively for the inside-IR35 engagement can still be deducted, via capital allowances or the Annual Investment Allowance. The "wholly and exclusively" condition matters: dual-use items that also serve personal purposes require apportionment.

Accountancy fees. The cost of your PSC's accountant, Companies House filing, and tax compliance remains a legitimate business expense of the company, not subject to the inside-IR35 restriction (which applies to the employment-type expenses of the deemed salary calculation, not to the company's own running costs).

Employer pension contributions. This is the largest lever that survives intact. Covered in detail below.

What you lose inside IR35

Home-to-client travel. This is the most significant loss. Inside IR35, each separate engagement is treated like a separate employment, which means the client site is a permanent workplace for that contract. Travel from home to that site is ordinary commuting, not deductible under ITEPA 2003 ss.338A and 339A. The temporary-workplace relief that lets outside-IR35 contractors deduct travel to a client site for up to 24 months (under the 24-month/40% rule) does not apply.

The mileage rate for genuinely business-related travel that does qualify, such as driving to a different site from your usual client location for a specific project meeting, remains 55p per mile for the first 10,000 business miles from 6 April 2026 (up from 45p), then 25p. Ordinary commuting miles do not count against that threshold.

Salary and dividend extraction advantages. The income taxed through the deemed payment has already been taxed as employment income. You cannot draw that same income again as a dividend without a double charge. Under Chapter 10, the net arrives in the PSC having already had PAYE and NIC applied; drawing it as salary or dividend does not reset the tax position.

The 5% administrative allowance (Chapter 10 only). As noted above, abolished entirely for off-payroll engagements with medium and large clients.

The employer pension contribution: your biggest surviving lever

Inside IR35, the employer pension contribution made from your PSC is the most powerful tax-efficient tool that remains fully available. It works in the same way whether your contract is inside or outside IR35, and its advantages are substantial.

An employer pension contribution is deductible against your PSC's corporation tax (on a paid basis, wholly and exclusively incurred for the purposes of the trade). It carries no employer NIC and no employee NIC. The director does not pay income tax on it when the company makes it into the pension. It does not count as relevant UK earnings for personal contribution limits because it is the company making the payment, not the individual.

The annual allowance for 2026/27 is £60,000. This covers all contributions across employer and personal sources combined. It tapers where your threshold income exceeds £200,000 and your adjusted income exceeds £260,000, reducing by £1 for every £2 above £260,000 down to a minimum floor of £10,000. If you have not used your full allowance in the previous three tax years, you can carry that unused allowance forward and make a larger one-off contribution in the current year.

The employer contribution is not limited by the director's salary level, unlike a personal contribution (which is capped at 100% of relevant UK earnings). This means a director drawing a low salary (say £6,708 to the lower earnings limit) can still make an employer contribution of up to £60,000 in 2026/27 (subject to the wholly-and-exclusively and annual-allowance tests), regardless of the salary figure.

One caution: if you have flexibly accessed a defined-contribution pension (by drawing a flexible income from a drawdown pot, for example), the money purchase annual allowance (MPAA) of £10,000 is triggered. This significantly restricts future contributions and removes the carry-forward facility for DC contributions, so take advice before crystallising any benefits.

Even on a fully inside-IR35 contract, a well-timed employer pension contribution from the PSC can recover a substantial portion of the tax lost to the deemed payment calculation. For a higher-rate taxpayer, the corporation-tax saving on the contribution (19% to 25%), combined with avoiding income tax and NIC at effective combined rates of 48% to 63% on alternative extraction, makes the pension the dominant financial planning lever inside IR35.

Inside IR35 and the umbrella question

Once a contract is firmly inside IR35, the question of whether to keep operating through your PSC or move to an umbrella company becomes genuinely live. The tax outcome of the two routes is broadly similar, but the costs and practicalities differ meaningfully.

Why an umbrella is often the right choice for a purely inside-IR35 contract

Under an umbrella arrangement, you become an employee of the umbrella company. The umbrella operates PAYE and NIC on your assignment income and pays you a salary. The mechanism produces a similar tax position to being inside IR35 through your PSC, because in both cases PAYE and NIC apply to the income at equivalent rates.

What the umbrella removes is the PSC overhead. A limited company costs money to maintain: accountancy fees (typically £1,000 to £2,500 a year for a modest PSC), registered office, Companies House filing, payroll software, and directors' responsibilities. If all your contracts are inside IR35, the PSC provides none of the tax advantages (no salary/dividend split, no low corporation tax rate on retained profit, no dividend-led extraction) that would justify those costs. The umbrella is a simpler, lower-overhead vehicle for the same net outcome.

The umbrella's own margin comes out of the assignment rate, alongside employer NIC and the Apprenticeship Levy. A compliant umbrella must set this out in a Key Information Document (KID) before your assignment starts. Expect the umbrella to show the gross assignment rate, its deductions (employer NIC, Apprenticeship Levy, margin), the resulting gross salary, and the estimated net pay. Any umbrella that cannot or will not produce a clear KID is a warning sign.

When keeping the PSC makes sense inside IR35

Keeping the PSC is the better choice where your contract mix is genuinely mixed: some engagements inside IR35, others outside. The outside-IR35 contracts retain all the tax advantages of PSC operation (salary/dividend split, retained profit, employer pension, corporation tax at 19%). Collapsing the company entirely because one contract is inside IR35 loses those advantages on the contracts where you could legitimately keep them.

A PSC also makes sense if you have meaningful retained profit to keep building, want to use the company as a vehicle for large employer pension contributions across multiple years, or value the separate legal entity for reasons beyond tax (professional indemnity, client contracts, future business development). The decision is not purely about the current inside-IR35 engagement.

For detailed analysis of the inside-versus-umbrella trade-off, see our guide on limited company vs umbrella contractor.

The April 2026 umbrella reform: what it means in practice

From 6 April 2026, Finance Act 2026 s.24 introduced new Chapter 11 (ss.61Y to 61Z2) into ITEPA 2003. This creates a joint and several liability (JSL): where a contractor is supplied through an umbrella, the recruitment agency that contracts with the end client (or the end client itself where there is no agency) becomes jointly and severally liable for PAYE and NIC that the umbrella fails to remit to HMRC.

The umbrella remains your legal employer. The employment relationship does not change. What changes is that HMRC now has a direct line to pursue the agency or end client if the umbrella goes rogue and fails to pay over the tax it deducted from your wages. This provision was introduced to combat an estimated £1 billion of avoidance through non-compliant umbrella arrangements.

The practical effect on contractors is significant. Agencies and end clients now have skin in the game: they face liability for umbrella non-compliance, which means they are applying much tighter preferred-supplier-list controls. Many agencies will only place contractors with FCSA-accredited or Professional Passport-approved umbrellas. If you are using an umbrella, choose one on a major PSL. If an umbrella is promising you take-home pay materially above what a straight PAYE calculation would suggest, treat that as a serious warning sign of a tax-avoidance scheme: the firm's position is an unequivocal do-not-use. HMRC will pursue the worker for any unpaid tax, often years later, with interest and penalties on top.

Challenging an inside IR35 determination

Being told your contract is inside IR35 is not the end of the matter. Under Chapter 10, the end client has a legal obligation to issue a Status Determination Statement setting out its conclusion and the reasons for it, taken with reasonable care. If the SDS does not explain the reasoning, or if you believe the working practices of your engagement point to outside IR35, you have a formal right of challenge.

The client-led disagreement process (ITEPA 2003 s.61T) requires the client to consider your representations and respond within 45 days. It must either confirm the original SDS (with reasons) or issue a revised one. If it does neither within 45 days, the liability shifts to the client. The process is client-led, meaning the client decides, but it must engage and give a substantive response.

Two specific situations where a challenge is especially worth pursuing: first, where the client issued a blanket determination across all contractors in a role category without assessing your engagement individually. This almost certainly fails the reasonable-care requirement (ESM10013 and ESM10014), making the SDS invalid and shifting liability to the client. Second, where the SDS simply states "inside IR35" without explaining which status factors drove the conclusion. A bare conclusion without reasons does not satisfy s.61NA.

For detail on the evidence and working-practices steps needed to protect an outside-IR35 position through a disagreement process, see our outside IR35 guide. For the mechanics of the SDS chain and how liability transfers between parties, see our guide to off-payroll working rules in the private sector.

What the set-off rules mean for historic errors

HMRC can and does open enquiries into historic contracts, arguing that engagements treated as outside IR35 were actually inside. If HMRC succeeds, a PAYE liability arises on the deemed employer (the client or fee-payer under Chapter 10, your PSC under Chapter 8).

Since 6 April 2024, a statutory set-off mechanism applies. When HMRC raises a deemed-employer PAYE liability (typically via a Reg 80 determination or on a trigger event from 6 April 2024), it must reduce that liability by an estimate of the taxes already paid by the worker and PSC on the same income: corporation tax on PSC profits, income tax and employee NIC on any salary drawn, and income tax on dividends from those profits. The offset applies to errors from 6 April 2017 (public sector) and 6 April 2021 (private sector), with the offset mechanism available from 6 April 2024.

This is a material improvement on the pre-2024 position, where HMRC could assess the full deemed PAYE liability without crediting taxes already paid, creating genuine double taxation in some cases. The set-off reduces but does not eliminate the exposure: employer NIC that was never paid is not credited by the offset, because it was never paid by anyone. And the offset is an HMRC-operated estimate on a trigger event, not an automatic netting that you can plan around.

The lesson is not that historic compliance matters less; it is that a properly documented status assessment, contract review, and working-practices audit reduce the risk of HMRC finding an incorrect outside determination in the first place. For contractors who have historic engagements that were treated as outside IR35 on uncertain grounds, a review with a specialist before HMRC opens an enquiry is far cheaper than responding to one.

Trivial benefits: a small surviving perk

One minor but genuine perk that survives inside IR35 is the trivial benefits exemption for director shareholders of close companies. Under ITEPA 2003 s.323A and s.323B, a director of a close company can receive benefits free of income tax and NIC where each benefit costs £50 or less, is not cash or a cash voucher, is not a reward for services, and is not contractual. A director-specific annual cap of £300 (s.323B) limits how much can be received this way in a year. Small gifts, a bottle of wine, a team lunch within the cost limit, and similar perks can fall within the exemption. It is not a planning vehicle, but it is a surviving legitimate concession worth knowing about.

Practical steps once a contract is confirmed inside IR35

When a contract is confirmed inside IR35, either by an SDS from the client or by your own PSC's self-assessment under Chapter 8, there are several immediate practical steps worth taking.

First, review whether to maintain the PSC or move to an umbrella. Run the numbers on your full contract mix, not just the inside-IR35 engagement. If all current work is inside IR35, the PSC costs may not be recoverable. If you have outside-IR35 work alongside it, the PSC likely remains worthwhile. Our IR35 status service can walk through the analysis.

Second, review your pension position. An employer pension contribution from the PSC is often the most significant tax-planning lever available on inside-IR35 income. Understand your remaining annual allowance, carry-forward capacity from the previous three years, and the interaction with any pension you have already accessed. Our contractor pension employer contributions guide covers the mechanics in detail.

Third, get clarity on expenses. Audit what you have been claiming. The short list of deductible expenses inside IR35 is significantly narrower than outside, and the most common error is continuing to claim home-to-client travel. Correct that quickly to avoid HMRC interest and penalties on incorrect claims.

Fourth, if you are using an umbrella, verify it appears on a major agency or client PSL and that it is FCSA or Professional Passport accredited. The April 2026 JSL reform means your agency and end client are now actively monitoring this; be ahead of them rather than behind.

Fifth, if you believe the inside-IR35 determination is wrong, use the disagreement process promptly. The 45-day response window is the client's obligation, but you need to put your representations in before the process can start. Keep all written working practices and engagement records that support an outside position.

A note on the overlap with managed service company rules

Inside IR35 is not the only legislative risk for PSC contractors. Chapter 9 ITEPA 2003 (the managed service company legislation, in force from 6 April 2007) is a separate regime that does not depend on an employment-status test. If your company is an MSC, all payments to you are treated as employment income with no "outside" determination to win, and unpaid PAYE can be transferred as a personal debt to you, your company's directors, and potentially the MSC provider. The accountancy-services carve-out in s.61B(3) protects genuine independent advisers from MSC-provider status, but the distinction matters when choosing how your company is run and structured. For a genuinely inside-IR35 contractor who is already absorbing PAYE and NIC, an inadvertent MSC characterisation would compound that position. Choosing an accountant who clearly advises rather than one selling a packaged, finances-controlled product is the risk-management answer.

Working with a specialist accountant

Inside IR35 is a position many contractors find themselves in, at least on some contracts, particularly since the 2021 extension of Chapter 10 to the private sector. The rules are not punishing in the way a penalty for evasion would be, but they do require careful financial planning to avoid leaving money on the table.

The employer pension contribution, the correct handling of the Chapter 8 deemed payment, the expenses that do and do not survive, the umbrella decision, and the disagreement process are all areas where a specialist accountant adds real value. These are not questions with universal answers: the right approach depends on your day rate, your full contract mix, your pension position, your salary history, and whether you have other income sources.

If you want a structured review of your current inside-IR35 position, or help assessing whether a new contract determination is correct, get in touch. Our IR35 status service covers both the status assessment and the financial planning that follows from it. Contractor-specialist services are available for PSC directors, umbrella workers, and the growing population of contractors with mixed inside-and-outside contract portfolios.