In brief: If a contractor working through a personal service company (PSC) is inside IR35, their payments are taxed as employment income. The fee payer (either the end client or an agency in the chain) runs those payments through payroll. That means deducting Pay As You Earn (PAYE) income tax and employee National Insurance contributions (NICs) before paying the PSC, paying employer NICs and any Apprenticeship Levy on top, and reporting the payment to HMRC on your Full Payment Submission (FPS). The end client must also issue a status determination statement (SDS) on or before the first payment. Small end clients are the exception, because the PSC stays responsible instead.
Last updated: October 2026.
Since the off-payroll working rules reached the private sector in April 2021, medium and large organisations have had to decide whether the contractors they engage through personal service companies are inside or outside IR35. Making that call is only half the job. When a contractor is inside IR35, someone has to run their payments through payroll, and that’s where a lot of organisations get stuck.
Who’s responsible? What needs deducting? And how do you report it to HMRC? The answers depend on where you sit in the contract chain, and a couple of recent changes (higher company size thresholds and new rules for umbrella companies) mean it’s worth checking your position, even if you’ve had a process in place for years.
To make things easier for you, this guide covers whether IR35 applies to you, who the fee payer is and what they need to do, how to process an inside-IR35 contractor step by step, and what’s changed for 2026/27.
Employed or self-employed for tax?
Before IR35 comes into it, you need to know whether the work counts as employment or self-employment for tax. It’s not always clear-cut. Employment status depends on the facts of the working relationship, so neither you nor the worker can simply choose it.
A few things to keep in mind:
- Each contract is assessed separately: one person can be employed under one contract and self-employed under another.
- Employment means payroll: if the work is employment, all payments go through payroll with PAYE deductions applied as usual.
- Self-employment means gross payments: if the work is genuinely self-employed, you can keep paying the worker gross.
If you’re unsure, HMRC’s Check Employment Status for Tax (CEST) tool is a good place to start.
When does IR35 apply?
IR35 applies when you pay an intermediary (usually the worker’s own PSC) for work that would count as employment if you paid the worker directly. For example, a contractor invoices you through their limited company, but works much like one of your employees.
In that case, the worker isn’t legally your employee. They’re treated as one for tax, National Insurance and Apprenticeship Levy purposes only, which is why they’re often called “deemed employees”.
Who handles the tax depends on the client’s size. If you’re a medium or large organisation (or in the public sector), you decide the worker’s status and the fee payer runs the payments through payroll. If you’re small, the PSC stays responsible, just as it was before the 2021 reforms.
Does IR35 apply to you?
Work through these in order:
- Do you pay intermediaries? For example, contractors who invoice you through their own limited company.
- Would the work be employment if the worker were engaged directly? Apply the employment status test to each contract.
- Are you a medium or large organisation, or in the public sector? Check against the size thresholds covered later in this guide (public sector clients apply the rules whatever their size).
If all three answers are yes: issue an SDS to the worker and any agency, and let your payroll team know before the first payment.
If you answer no to question 1 or 2, IR35 doesn’t apply to that engagement. If you’re a small private sector client, the off-payroll working rules don’t place any duties on you, but the contractor’s PSC still needs to check IR35 itself. Either way, it’s worth re-checking whenever a contract changes.
Who is the fee payer?
The fee payer is usually the party that pays the PSC. (HMRC’s guidance now calls this the “deemed employer”.) If the end client pays the PSC directly, it’s the end client. If there’s an agency involved, it’s normally the UK agency sitting directly above the PSC in the contract chain.
Be aware, though, that responsibility only moves down the chain once each party has received the SDS. Until then, whoever’s holding it keeps the liability. And if no one in the chain qualifies (for example, because the only agency is based overseas), the end client stays responsible.
| Situation | Who decides status | Who runs the deemed payment through payroll |
|---|---|---|
| Medium or large end client, pays the PSC directly | End client | End client |
| Medium or large end client, via an agency | End client (must pass the SDS down the chain) | The agency or other fee payer |
| Small end client | The PSC | The PSC, under the original IR35 rules |
Here’s how that looks in practice. A medium-sized retailer takes on a developer through a recruitment agency. The retailer decides the role is inside IR35 and sends the SDS to the developer and the agency. The agency, as fee payer, then runs each payment through its payroll.
What the fee payer must do
Here’s each duty, what it means, and where it sits in your payroll process.
| Duty | What it means | Where it happens in payroll |
|---|---|---|
| Deduct PAYE | Income tax is deducted from the deemed payment (the tax code is often BR, set using a new starter checklist) | [VERIFY with Cintra support] |
| Deduct employee NICs | Employee National Insurance is deducted at the normal rates and thresholds | [VERIFY] |
| Pay employer NICs | You pay employer National Insurance on top. It can't be deducted from the PSC's payment, and Employment Allowance can't be used against it | [VERIFY] |
| Pay Apprenticeship Levy | Paid on top, where you're liable for the levy | [VERIFY] |
| Report to HMRC | Report the payment on your FPS, using the "off-payroll worker subject to the rules" indicator | [VERIFY Cintra field name] |
| Issue an SDS (end client) | Give the contractor and any agency a statement with reasons, on or before the first payment | Outside payroll, but must be in place first |
| Take reasonable care (end client) | Assess each engagement, keep evidence, and run a disagreement process (responding within 45 days) | Outside payroll |
If the end client doesn’t issue an SDS or doesn’t take reasonable care, liability for the tax, NICs and Apprenticeship Levy stays with them. The same goes for any agency that receives the SDS but doesn’t pass it on.
There’s some good news on the admin side. You’re not responsible for student or postgraduate loan deductions, statutory payments or auto-enrolment for deemed employees. They aren’t your employees, so they get these through their own company instead.
How to run an inside-IR35 contractor through payroll
Here’s the process, step by step.
- Confirm the determination: assess the engagement using both the contract and the real working practices. HMRC’s CEST tool can help. If you enter accurate information and use the tool in line with HMRC’s guidance, HMRC will stand by the result. It doesn’t always reach a determination, though, so keep your own reasoning on file.
- Issue the SDS: send it to the contractor and any agency on or before the first payment, and keep a record of when you sent it. There’s no set format, but putting it in writing (an email or letter, for example) is best practice.
- Get the payment details: collect the gross fee, the invoice reference and the contractor’s details.
- Set the worker up in payroll: you can add deemed employees to your existing payroll or run them under a separate PAYE scheme. Keeping them in their own category stops deemed payments getting mixed up with ordinary employees.
- Calculate the deemed payment: start with the payment to the PSC, then take off value added tax (VAT), the direct cost of any materials, and expenses that would’ve been tax-deductible for an employee. Work out PAYE and employee NICs on what’s left, plus the employer NICs and any Apprenticeship Levy due from you.
- Pay the PSC and HMRC: pay the PSC the net amount, and pay the deducted tax and NICs to HMRC on your normal payroll schedule.
- Report through payroll: include the payment in your FPS, flagged with the off-payroll worker indicator.
- Review regularly: check the determination whenever the contract or working practices change, and at least once a year. A new or changed contract usually needs a new SDS.
This process works well when a role is clearly inside or outside IR35. Borderline roles are different. Take extra care at step 1 and keep more detailed evidence of your reasoning.
What's changed for 2026/27?
Higher small company thresholds
The Companies Act thresholds that decide whether an end client is “small” rose for financial years beginning on or after 6 April 2025, and HMRC applies them to IR35. A company is small if it meets at least two of these:
| Test | Previous threshold | Financial years from 6 April 2025 |
|---|---|---|
| Annual turnover | £10.2 million | £15 million |
| Balance sheet total | £5.1 million | £7.5 million |
| Employees | 50 | 50 |
Don’t expect an overnight change, though. Size is based on the last financial year whose accounts filing deadline fell before the tax year starts. A company also usually has to meet the tests for two consecutive years before its size changes. So for most businesses, the earliest practical effect is the 2027/28 tax year.
A few other rules to bear in mind:
- New companies: a company counts as small in its first financial year, even if it’s part of a group. If it’s small in that first year, it only becomes medium or large after meeting two of the tests for two consecutive years.
- Groups: if the parent company is medium or large (using figures from the whole group), its subsidiaries have to apply the rules too.
Some businesses will drop out of the 2021 rules and stop running deemed payments. Work out your position before April 2027, so you’ve got time to change your payroll set-up.
Umbrella company liability
From 6 April 2026, if an umbrella company fails to account for PAYE and NICs correctly, HMRC can recover the shortfall from others in the supply chain. Who that falls on depends on how the chain is set up:
- There’s an agency in the chain: the agency that contracts with the end client shares the liability with the umbrella.
- There’s no agency: if you contract directly with the umbrella, you share the liability as the end client.
- The agency is based outside the UK: the end client shares the liability with the umbrella.
- The agency is connected to the umbrella: the end client, the agency and the umbrella are all jointly liable.
This applies to payments made on or after 6 April 2026. Be aware that checking your suppliers won’t remove the liability, because there’s no “reasonable care” defence. But choosing compliant umbrella companies and reviewing them regularly makes a shortfall much less likely, so it’s worth building into your IR35 processes.
Official sources: ESM2420: Umbrella companies legislation, joint and several liability (HMRC manual).
Employees and workers: what’s the difference?
You’ll often hear about “employees” and “workers”, especially in conversations about the gig economy. This distinction comes from employment law and affects people’s rights. For example, a worker has the same minimum wage and holiday rights as an employee, but isn’t usually entitled to statutory redundancy pay or protection against unfair dismissal.
Tax law works differently. There’s no separate “worker” status for PAYE, so you’re either employed or self-employed. That means someone classed as a worker for employment rights could still be treated as an employee for tax.
It’s also worth knowing that HMRC’s CEST tool only looks at tax status. It won’t tell you whether someone is a worker or an employee for employment rights, so you’ll need to assess that separately.
IR35 payroll checklist
Use this to check you’ve covered the essentials:
- Every contractor paid through a PSC has a recorded status determination.
- The SDS is issued before the first payment, with a disagreement process in place.
- Inside-IR35 workers are set up in payroll, with PAYE, NICs and levy handled.
- Employer costs are budgeted for inside-IR35 engagements.
- Company size has been tested against the current thresholds.
- Umbrella suppliers have been reviewed for the April 2026 liability rules.
- Contracts with PSCs and agencies are updated for tax deductions and indemnities.
- Hiring managers know what makes an engagement inside IR35.
Cintra has you covered
IR35 follows a clear sequence. Work out whether the work is employment for tax, check whether IR35 applies and whose responsibility it is, then run any deemed payments through payroll like any other pay run. Most problems happen before payroll gets involved, though. A missing SDS or an out-of-date determination can leave liability with you, even when your payroll process is spot on.
With the higher size thresholds and new umbrella company rules in play, check your position each year. With a clear process and the right payroll software behind you, IR35 becomes a routine part of running payroll. If you’d like to see how Cintra handles off-payroll workers, we’re happy to walk you through a demo.
Payroll Legislation Guide
The facts, figures, thresholds and allowances for 2026/27 spanning tax, National Insurance, pensions, statutory payments and more.
Frequently asked questions
Q. How do I manage IR35 compliance through my payroll system?
A. Record the status determination, then set inside-IR35 contractors up as deemed employees, so PAYE and NICs are calculated and reported with your normal payroll. Keep the SDS and your reasoning on file.
Q. Do I deduct tax from a PSC?
A. Yes, if the engagement is inside IR35 and you’re the fee payer. If the end client is small, the PSC stays responsible instead.
Q. Who’s responsible if the status is wrong?
A. The end client has to take reasonable care. If it doesn’t, or doesn’t issue an SDS, liability for the tax and NICs stays with it.
Q. Does IR35 change someone’s employment rights?
A. No. IR35 applies for tax purposes only. Deemed employees aren’t entitled to employment rights (such as holiday pay) from you.
Q. Do the recent changes apply now?
A. Partly. The higher size thresholds apply to financial years beginning on or after 6 April 2025, but because of how size is tested, the practical effect arrives from 2027/28 at the earliest. The umbrella rules apply to payments made from 6 April 2026.
