What is IR35?
IR35 is UK tax legislation designed to identify contractors who work in a similar way to employees but operate through their own limited company. The rules determine whether you should pay tax like an employee or can benefit from the tax efficiencies of running your own business.
Inside vs Outside IR35
Inside IR35 means HMRC considers the engagement to be one of employment for tax purposes. You'll pay similar taxes to an employee, including Income Tax and National Insurance at employee rates.
Outside IR35 means the engagement is genuinely a business-to-business relationship. You can take advantage of the tax efficiencies of operating through a limited company, including paying yourself through a combination of salary and dividends.
Key Factors Determining IR35 Status
- Substitution: Can you send a substitute to do the work? Genuine right of substitution suggests outside IR35.
- Control: Does the client control how, when, and where you work? High control suggests inside IR35.
- Mutuality of Obligation: Is the client obliged to offer work and are you obliged to accept it? Ongoing obligation suggests employment.
- Part and Parcel: Are you integrated into the client's organisation like an employee? Integration suggests inside IR35.
- Financial Risk: Do you bear business risk, such as having to correct work at your own expense? Business risk suggests outside IR35.
IR35 for Fractional Executives
Fractional executives often have strong arguments for being outside IR35:
- Multiple clients: Working with 2-4 clients simultaneously demonstrates genuine business operation
- Strategic rather than operational: Providing high-level guidance rather than day-to-day task work
- Own equipment and premises: Using your own laptop, phone, and home office
- Business development: Actively marketing services and building your own client base
- Project-based work: Defined deliverables rather than ongoing indefinite engagements
The CEST Tool
HMRC's Check Employment Status for Tax (CEST) tool helps determine IR35 status. While not legally binding, it's widely used by clients and contractors. Access it at gov.uk/guidance/check-employment-status-for-tax.
Who Determines Status?
Since April 2021, medium and large private sector clients are responsible for determining the IR35 status of contractors. Small companies (fewer than 50 employees, turnover under £10.2m, balance sheet under £5.1m) leave the determination to the contractor.
Practical Steps for Fractional Executives
- Maintain multiple client relationships where possible
- Use written contracts that reflect the actual working arrangement
- Keep records of business expenses, marketing activities, and client acquisition
- Consider professional indemnity insurance and other business insurances
- Ensure genuine substitution rights are included in contracts
- Maintain clear separation between your business and client organisations
Tax Implications
Outside IR35 (typical):
- Corporation Tax on company profits (25% main rate)
- Small salary (typically up to NI threshold)
- Dividends taxed at 8.75% (basic), 33.75% (higher), 39.35% (additional)
- Effective rate often 25-35% on moderate income
Inside IR35:
- Income Tax at marginal rates (20%, 40%, 45%)
- Employee and Employer National Insurance
- Effective rate typically 45-50% on higher income
Getting Professional Advice
IR35 is complex and case-specific. We recommend:
- Consulting an accountant experienced with contractor taxation
- Consider IR35 contract reviews from specialist firms
- Stay updated on legislative changes