When IR35 applies, HMRC does not make you an employee, it simply taxes you as if you were one. That fiction is called deemed employment, and it changes how every pound you earn is treated.
IR35 produces a strange result: you can be taxed as an employee without ever becoming one. When an engagement is found to be inside the off-payroll rules, HMRC does not rewrite your contract or hand you a staff badge. It simply deems your fee to be employment income and taxes it accordingly. That tax fiction has a name, deemed employment, and understanding it explains why an inside-IR35 contractor can pay employee-level tax while getting none of the employee benefits.
The word that matters is "deemed", meaning treated as, but not actually. A real employee has an employment contract, statutory rights and a salary. A deemed employee is a contractor whose engagement is inside IR35: they are taxed as though employed, but their legal relationship is still a contract for services. This is why deemed employment is the direct consequence of disguised employment being caught, the off-payroll rules close the tax gap without granting the worker employee status.
The practical sting is the imbalance. The contractor pays Income Tax and employee National Insurance like a member of staff, yet has no entitlement to holiday pay, sick pay, pension auto-enrolment or redundancy. Employment rights are decided under employment law, separately from tax, so a person can sit on the wrong side of both lines.
Under the rules in force since April 2021, the fee-payer, the client or the agency paying the contractor's company, handles the calculation:
The old regime, where the contractor's own company calculated the deemed payment and could subtract a flat 5% administration allowance, still applies only to small-client engagements where the contractor remains responsible for assessing status. For client-led assessments, that 5% allowance was withdrawn.
Take Maria, a project manager inside IR35, whose company is paid a £6,000 fee for a month's work in 2025/26 with no separate materials.
| Step | Amount |
|---|---|
| Fee for services | £6,000 |
| Less allowable direct costs | £0 |
| Deemed employment payment | £6,000 |
| Income Tax + employee NI (deducted via PAYE) | charged as if salary |
| Net reaching Maria's company | reduced accordingly |
The £6,000 is taxed exactly as a £6,000 monthly salary would be, at 20% and 40% Income Tax (45% above £125,140) plus employee National Insurance, all withheld by the fee-payer before Maria's company is paid. The employer National Insurance is funded by the fee-payer on top. Compared with an outside-IR35 engagement, where Maria could take dividends, the deemed-employment treatment leaves her materially worse off. The IR35 calculator quantifies that gap for any fee.
Contractors often assume that being deemed employed means they have "become an employee" and can claim holiday pay or a workplace pension. They cannot, not automatically. Deemed employment is a tax label only. The mismatch, employee taxation without employee rights, is one of the most criticised features of the off-payroll regime, and it is why some contractors negotiate a higher day rate when forced inside IR35 to offset the extra tax and the lack of benefits.
Deemed employment means HMRC taxes you as an employee while employment law still treats you as a contractor. You get the tax bill of a job without the safety net of one.
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