How it works
What IR35 (off-payroll working) actually is
IR35 — officially the off-payroll working rules — is HMRC's test of whether a contractor working through their own limited company is, in substance, an employee of the client. If the relationship looks like employment, the engagement is "inside IR35" and the income must be taxed like a salary (PAYE Income Tax plus National Insurance). If it is a genuine business-to-business arrangement, it is "outside IR35" and the contractor can pay themselves through a mix of salary and dividends.
Since April 2021, for medium and large private-sector clients (and all public bodies), it is the client — not the contractor — who determines status and must issue a Status Determination Statement. Only when the end client is a small company does the contractor's own company still decide. HMRC's free CEST tool (Check Employment Status for Tax) gives a determination HMRC says it will stand behind if the inputs are accurate.
Three tests dominate every status decision. Substitution: could you send a suitably qualified replacement, or must you personally do the work? Control: does the client dictate how, when and where you work, or only the outcome? Mutuality of obligation: is the client obliged to keep offering work and you obliged to accept it? Genuine substitution rights, autonomy over method, and project-by-project engagement all point outside IR35; a named individual working fixed hours under a manager points inside.
Inside IR35 via umbrella: the full deduction chain on £500 a day
Inside IR35 you are usually paid through an umbrella company, which employs you and runs PAYE. The single most misunderstood point: the assignment rate the agency quotes is *not* your gross salary. Employment costs — employer National Insurance at 15% above £96 a week, the 0.5% apprenticeship levy (rebranded the Growth and Skills Levy from April 2026) and the umbrella's margin of roughly £25 a week — all come out of the assignment rate *before* your gross pay is even calculated.
Here is the complete weekly chain on £500 a day (£2,500 a week). The umbrella margin comes off first, then gross pay is reverse-solved so that gross + employer NI + levy exactly exhausts what is left. Your own PAYE tax and employee NI are then deducted from that gross. Over a 48-week year the gross works out at about £103,455 — which tips over £100,000 and starts tapering the Personal Allowance, one reason inside-IR35 retention drops sharply at higher day rates.
Net result: roughly £1,456 a week in your bank — about 58% of the assignment rate. Nothing here is the umbrella "taking" 42%; almost all of the difference is tax that HMRC collects on any employment income of this size. Compare a permanent salary with the PAYE take-home calculator or convert the day rate itself with the day rate to salary calculator.
| Step | Weekly | Annual (48 wks) |
|---|---|---|
| Assignment rate (£500 × 5 days) | £2,500.00 | £120,000.00 |
| Umbrella margin | −£25.00 | −£1,200.00 |
| Employer NI (15% above £96/wk) | −£308.90 | −£14,827.20 |
| Apprenticeship levy (0.5% of gross) | −£10.78 | −£517.44 |
| Your gross pay | £2,155.32 | £103,455.36 |
| Income Tax (PA tapered to £10,842) | −£614.69 | −£29,505.22 |
| Employee NI (8% / 2%) | −£85.00 | −£4,079.71 |
| Net take-home | £1,455.63 | £69,870.43 |
Outside IR35 via limited company: £500 a day worked example
Outside IR35 the classic structure is a £12,570 director salary (matching the Personal Allowance, deductible against Corporation Tax) with the rest of the profit paid as dividends, which carry no National Insurance. On £500 a day for 48 weeks the company turns over £120,000; after £4,000 of typical running costs (accountancy, insurance, software), the salary, and £1,136 employer NI on that salary, taxable profit is about £102,295.
Corporation Tax for 2026/27 is 19% on profits up to £50,000 and 25% above £250,000, with marginal relief (fraction 3/200) blending the two in between. On £102,295 the bill is about £23,358 — an effective 22.8%. The £78,936 left can all be drawn as dividends: £500 is covered by the dividend allowance, £37,200 falls in the basic band at 8.75% (£3,255) and £41,236 in the higher band at 33.75% (£13,917) — £17,172 of dividend tax, payable through Self Assessment. Full band detail is on the dividend tax page.
Personal take-home: £12,570 salary + £78,936 dividends − £17,172 tax = £74,334, about 62% of turnover. That assumes you extract everything; leaving profit in the company, pension contributions paid by the company, or a lower-earning spouse holding shares can push retention meaningfully higher. Company pension contributions are especially efficient — see the pension contribution calculator.
| Step | Amount |
|---|---|
| Company turnover (£500 × 240 days) | £120,000.00 |
| Running costs (accountancy, insurance, etc.) | −£4,000.00 |
| Director salary | −£12,570.00 |
| Employer NI on salary (15% above £5,000) | −£1,135.50 |
| Taxable profit | £102,294.50 |
| Corporation Tax (25% less marginal relief) | −£23,358.05 |
| Profit available as dividends | £78,936.45 |
| Dividend tax (£500 @ 0%, 8.75%, 33.75%) | −£17,172.30 |
| Personal take-home (salary + net dividends) | £74,334.15 |
Inside vs outside IR35: side-by-side at £400, £500 and £600 a day
The retention gap between the two routes is real but smaller than folklore suggests — typically 4 to 6 percentage points once employer costs, Corporation Tax and dividend tax are all counted honestly. It widens if you retain profit in the company or run genuine business expenses, and shrinks to nearly nothing once umbrella pension salary sacrifice is used aggressively inside IR35.
All figures below use the same assumptions as the worked examples: 48 paid weeks, £25 a week umbrella margin, £4,000 limited-company running costs, £12,570 salary, full dividend extraction, England, no student loan, no pension.
| Day rate | Annual billing | Inside IR35 net (umbrella) | Retention | Outside IR35 net (ltd co) | Retention |
|---|---|---|---|---|---|
| £400 | £96,000 | £58,510 | 61% | £62,648 | 65% |
| £500 | £120,000 | £69,870 | 58% | £74,334 | 62% |
| £600 | £144,000 | £77,767 | 54% | £83,963 | 58% |
Expenses: what changes when you go inside IR35
Outside IR35, your limited company deducts genuine business costs — travel, equipment, training, home-office costs, accountancy — before Corporation Tax, so every £1 of allowable expense saves 19p–25p of tax.
Inside IR35 the position flips. Since 2016, workers caught by supervision, direction or control — which describes almost every inside-IR35 umbrella engagement — cannot claim tax relief on ordinary travel and subsistence (T&S) between home and the client site. Each assignment is treated as a permanent workplace, so the commute is just a commute. Only expenses the client agrees to reimburse, or the narrow category of costs wholly and exclusively for the job that survive the T&S restriction, escape tax.
This is worth hard cash when comparing rates: a contractor commuting weekly to a distant client can easily spend £8,000–£12,000 a year on trains and hotels out of taxed income inside IR35, while the same spend outside IR35 would have been pre-tax. Always compare *net of travel*, not just net of tax.
The April 2026 umbrella reform: agencies now carry the tax risk
From 6 April 2026, following the Autumn Budget 2025, the rules changed fundamentally: where an umbrella company sits in a labour supply chain, the recruitment agency that holds the contract with the end client becomes jointly and severally liable for any unpaid PAYE and NIC. If there is no agency in the chain, that liability lands on the end client itself. HMRC can now pursue the agency or client directly for tax a non-compliant umbrella failed to remit — the measure is forecast to protect around £2.8 billion of revenue by 2030.
For contractors this is broadly good news. Agencies now have a direct financial reason to vet every umbrella on their preferred-supplier lists, so disguised-remuneration schemes and mini-umbrella structures have far fewer routes to market. Expect agencies to insist you use an accredited umbrella from a short list, and expect more consolidation among compliant providers. Note what the reform is not: it is a tax-liability measure, not full regulation of umbrella conduct — a separate regulatory regime for umbrellas remains planned for 2027.
Nothing about the reform changes your own payslip arithmetic. The deduction chain above still applies; what changes is who HMRC chases if the umbrella pockets the money instead of paying it over.
Umbrella red flags: schemes that end in a tax bill
Even after the 2026 reform, the person who ultimately owes tax on disguised remuneration is usually the worker. A few minutes of due diligence protects years of income.
Walk away if you see any of these
- Take-home promises above ~70% on a mid-range day rate. Legitimate PAYE arithmetic cannot produce 80–85% retention; only loan schemes, "annuities" or offshore trusts can, and HMRC taxes them retrospectively (the Loan Charge is the cautionary tale).
- Part of your pay arriving as a "loan", "advance", "grant" or from a second company. Classic disguised remuneration.
- Mini umbrella company (MUC) fraud — your employer name changes every few months to a string of tiny companies, often with overseas directors, exploiting the Employment Allowance and VAT flat-rate scheme. Check your employer's name on each payslip against Companies House.
- No employer NI or apprenticeship levy visible on your reconciliation statement. Compliant umbrellas itemise every employment cost.
- Fees for "compliance", joining or leaving, or a margin quoted as a percentage of the rate rather than a flat weekly amount.
- No accreditation. FCSA or SafeRec membership is not a legal guarantee, but its absence from a large umbrella is a signal.
Holiday pay, pensions and the rest of the umbrella package
Umbrella employees are legally employees, with 5.6 weeks of statutory paid holiday, auto-enrolment pension rights, statutory sick pay and maternity/paternity rights. Holiday pay is funded from your assignment rate and either paid rolled up (an extra 12.07% on each payslip, itemised separately) or accrued and paid when you take leave. Check which model applies — with accrual, unclaimed holiday pay that lapses back to the umbrella has historically been a quiet profit centre; a compliant umbrella pays out any accrued balance when you leave.
Pension salary sacrifice is the one genuinely powerful lever inside IR35: contributions sacrificed from the pre-tax pot avoid Income Tax, employee NI *and* employer NI, so £1 into the pension costs well under 50p of net pay for a higher-rate contractor. On the £500/day example, sacrificing £20,000 a year would claw back most of the tapered Personal Allowance too. Model it with the pension contribution calculator, and check any student loan effect with the student loan calculator — Plan 2 repayments (9% above £29,385) apply to umbrella gross pay like any other salary.