What Is Inside IR35 and Who Actually Decides It?

April 2017 changed everything for public sector contractors. April 2021 changed it again for the private sector. And yet, thousands of contractors still don't fully understand who actually decides whether they are inside IR35, or what happens when that person gets it wrong.

This post is not another walkthrough of what IR35 means in broad strokes. If you want that, What Does Inside IR35 Mean for Your Take-Home Pay? covers the financial hit in detail. This post is about accountability: who makes the call, what tools they use, why they often get it wrong, and what recourse you actually have when they do.

Who Actually Makes the Decision?

Before April 2017, the contractor's own personal service company (PSC) decided its IR35 status. This was, predictably, a system that invited optimism. Most contractors concluded they were outside IR35 and paid themselves accordingly.

HMRC didn't like that. So it shifted the responsibility to the end-client for public sector engagements in 2017, and extended that rule to medium and large private sector clients in April 2021 via the off-payroll working rules (Chapter 10 of ITEPA 2003).

The result: your client now issues a Status Determination Statement (SDS) before your contract begins. That document declares whether you are inside or outside IR35. If they say inside, the fee-payer (usually a recruitment agency sitting between you and the client) deducts Income Tax and employee NICs from your rate before you see a penny. The client also pays employer NICs on top of your rate, which is why so many clients now reduce day rates for inside IR35 engagements.

Small clients, those meeting at least two of these criteria: fewer than 50 employees, annual turnover under £10.2 million, or a balance sheet under £5.1 million, are exempt. In those cases, responsibility reverts to your PSC under the old Chapter 8 rules. But "small" is deceptively narrow. Most businesses large enough to engage specialist contractors regularly will clear at least one of these thresholds.

The CEST Problem

HMRC built a tool to help clients make status determinations: Check Employment Status for Tax, known as CEST. In theory, a client answers a series of questions about the working relationship, substitution clauses, control, and mutuality of obligation, and the tool returns a verdict.

In practice, CEST has been criticised extensively, including in evidence submitted to the House of Lords Economic Affairs Committee. The tool does not test mutuality of obligation, one of the three key tests established in case law since the 1968 Ready Mixed Concrete ruling. The Lords committee's 2020 report described CEST as "not fit for purpose."

None of this stopped HMRC from telling clients to use it. And when a client uses CEST and follows the result in good faith, HMRC provides a degree of protection from retrospective liability. The perverse incentive is clear: clients use a flawed tool because it offers legal cover, not because it gives the right answer.

For the contractor sitting at the other end of that determination, a "we ran it through CEST" SDS that says inside IR35 can be impossible to overturn in practice, regardless of how your actual working relationship looks.

What "Inside" Actually Costs, in Real Numbers

If you are a contractor operating through a limited company, billing a client at £400 per day, and working 220 days a year, your gross contract value is £88,000.

Outside IR35, you pay yourself a small salary (say £12,570 to use your Personal Allowance), take dividends on the rest, and pay Corporation Tax at 19-25% on profits retained in the company. Your effective overall tax rate, handled efficiently, typically falls in the range of 25-30%.

Inside IR35, the fee-payer runs your £88,000 through payroll. You pay Income Tax at 20% on income between £12,571 and £50,270, then 40% on the rest. You pay employee NICs at 8% up to £50,270 and 2% above. The fee-payer also pays employer NICs of 13.8% on your earnings above the secondary threshold, which typically comes off your headline rate rather than appearing as a bonus on top.

The difference between outside and inside IR35 on a £88,000 contract is often £15,000 to £20,000 per year in additional tax. That is not a rounding error. For a detailed breakdown of those figures, What Does Inside IR35 Mean for Your Take-Home Pay? walks through the exact arithmetic.

The Three Tests That Actually Matter

Status determinations, whether made by a client, their HR team, or CEST, should reflect three foundational employment law tests developed through decades of case law.

Control

Does the client control how you do your work, not just what the end result should be? A contractor who sets their own working methods, chooses their own tools, and decides how to solve problems independently scores towards outside IR35. One who is told exactly how to work, when to be present, and must follow the client's internal processes looks more like an employee.

Substitution

Could you send someone else to do the work in your place, without the client's specific approval? A genuine right of substitution suggests a business-to-business relationship rather than personal service. But HMRC scrutinises whether this right has actually been exercised in practice. A substitution clause that exists only on paper is unlikely to impress a tribunal.

Mutuality of Obligation

Is the client obliged to offer you work, and are you obliged to accept it? Employment typically involves ongoing mutual obligations: the employer offers work, the employee turns up. A contractor engaged for a discrete project, with no expectation of continued work beyond that project, looks more independent. This test is the one CEST famously ignores.

Your Right to Challenge: How It Works in Practice

Since April 2021, you have a statutory right to disagree with an SDS. The client must operate a client-led disagreement process and respond to your challenge within 45 days. If they fail to respond in time, responsibility for the tax liability shifts back to them.

In theory, this is meaningful. In practice, most clients simply reaffirm their original determination. Unless you have overwhelming evidence that the working relationship has been mischaracterised, the 45-day review typically produces the same answer with slightly more detailed justification.

Your nuclear option is an employment tribunal or tax tribunal challenge. These are slow, expensive, and uncertain. The case law around IR35 is genuinely complex: IR35 cases such as HMRC v Christa Ackroyd Media (2019) and HMRC v Lorraine Kelly (2019) reached opposite conclusions on superficially similar facts, which tells you something about how difficult status determination actually is.

The practical lesson is that if you are about to sign a contract with a client who has issued an inside IR35 SDS and you believe it is wrong, the moment to push back is before you sign, not after six months of deducted tax.

Sole Traders: Why This Still Matters to You

IR35 in its strict legislative form targets workers using personal service companies or other intermediaries. If you are a sole trader, you cannot technically be caught by IR35 because there is no intermediary in the structure.

But that does not mean you are immune from the underlying concern. HMRC applies the same employment status tests to sole traders through the broader tax law on self-employment. If you work for a single client, follow their instructions closely, work set hours on their premises, and have done so for three years, HMRC may argue you are a disguised employee under general tax principles rather than IR35 specifically.

The risk is different in character but similar in consequence: back taxes, penalties, and interest on underpaid Income Tax and NICs. And unlike limited company contractors who now have a client-led process to navigate, sole traders face this challenge from HMRC directly, without an SDS process or formal disagreement mechanism.

If you are a sole trader taking on longer-term contracts with a single client and want to understand how your working arrangements hold up to scrutiny, IR35 Advice: What Sole Traders Get Wrong Every Time is worth reading before your next contract renewal.

The Broader Context: MTD and Contractors

From April 2026, Making Tax Digital for Income Tax will require sole traders and landlords with income above £50,000 to file quarterly digital updates to HMRC rather than a single annual Self Assessment return. Contractors who have been operating as sole traders, especially those doing multiple short engagements per year, will face a significant administrative change.

If you have been delaying MTD preparation, the overlap with IR35 pressures makes this a sensible moment to consolidate your record-keeping. A decent MTD-ready app that automatically categorises income and expenses reduces both the quarterly compliance burden and the risk that HMRC spots a discrepancy in your working pattern that triggers an employment status enquiry.

For a plain-English breakdown of what MTD means for sole traders specifically, Tax App for Self Employed: What Changes After April 2026 lays out the timeline and practical steps.

The Accountability Gap

Here is the honest summary. HMRC designed a system where a client uses a flawed government tool to make a determination that can cost you £15,000 or more per year, and your formal right to challenge that determination almost never produces a different result. The client is protected from liability if they follow the tool. You bear the financial consequence if they get it wrong.

That is not a glitch in the system. It is the system. HMRC shifted the compliance burden to clients precisely because it could not effectively police thousands of individual contractors. What it did not build into the design was a meaningful appeals process that contractors could actually win.

Knowing this does not change the rules. But it does change how you should approach any new contract. Understand the three tests, scrutinise every SDS before you sign, and push back in writing before the engagement begins. Once the first payslip arrives with deductions applied, the leverage shifts sharply to the other side.

The question at the top of this post was who actually decides if you are inside IR35. The honest answer is: your client decides, HMRC's tool nudges that decision, and you pay the bill if the answer is wrong.