IR35 and Invoicing — What Contractors Need to Know

IR35 is one of the most misunderstood pieces of tax legislation in the UK — and one of the most important for contractors and freelancers working through a limited company. Getting it wrong can result in a significant unexpected tax bill, so understanding how it affects your invoicing and business structure is essential.

This guide explains what IR35 is, how to determine whether it applies to you, and what it means practically for how you invoice your clients.

What is IR35?

IR35 — formally known as the off-payroll working rules — is legislation designed to prevent what HMRC calls "disguised employment." The idea is straightforward: if you work through a limited company but your working relationship with a client looks and feels like employment (same hours, same desk, same manager, same work as an employee), HMRC believes you should pay roughly the same tax as an employee would.

Without IR35, a contractor working in this way could pay themselves a small salary and take the rest as dividends — a significantly lower tax burden than an employee doing equivalent work. IR35 is HMRC's mechanism to close that gap where the working relationship is effectively employment regardless of the contractual structure.

Inside IR35 vs outside IR35

Every contractor engagement is either "inside IR35" or "outside IR35." This distinction determines how your income from that engagement is taxed.

Outside IR35

Your engagement is genuinely self-employed. You have control over how, when, and where you work. You take on financial risk. You could send a substitute to do the work if needed. You invoice the client through your limited company, receive payment into the company, and pay yourself through the usual salary and dividends structure. The tax efficiency of operating through a limited company is available to you.

Inside IR35

Your engagement looks more like employment — even though you're working through a limited company. HMRC considers the income from this engagement to be "deemed employment income." You must pay Income Tax and National Insurance on it as if you were an employee, removing most of the tax advantage of the limited company structure for that contract.

The three tests HMRC uses

IR35 status is determined by the substance of the working relationship, not the wording of the contract alone. HMRC looks at three primary factors:

1. Substitution

Can you send someone else to do the work in your place, without the client's approval being required? A genuine contractor can substitute — an employee cannot. If your contract says you must personally provide the services, this points toward inside IR35. If you have a genuine right of substitution (and have exercised it, or could realistically do so), this points outside.

2. Control

Who controls how, when, and where the work is done? If the client dictates your working hours, tells you where to work, and supervises how you carry out tasks — that looks like employment. If you have genuine autonomy over your working methods, this points outside IR35.

3. Mutuality of obligation

Is the client obliged to offer you work, and are you obliged to accept it? An employment relationship typically has this mutuality — you show up, they pay you. A genuine contractor relationship doesn't: the client engages you for a specific piece of work, and when it's done, there's no ongoing obligation on either side. If you're automatically rolled onto the next project without discussion, that looks more like employment.

HMRC also considers other factors including financial risk, provision of equipment, integration into the client's organisation, and exclusivity. No single factor is decisive — it's the overall picture that matters.

Who decides IR35 status?

This changed significantly in 2017 (public sector) and 2021 (private sector). Prior to these changes, contractors largely determined their own IR35 status. Now:

1. Large and medium-sized private sector clients are responsible for determining the IR35 status of contractors they engage, and for deducting tax at source if the engagement is inside IR35
2. Public sector clients have been responsible for determining status since 2017
3. Small private sector clients (companies meeting at least two of: under 50 employees, under £10.2m turnover, under £5.1m balance sheet total) — the contractor's own limited company is still responsible for determining status

When the client is responsible for the determination, they must issue a Status Determination Statement (SDS) to the contractor. If you disagree with the determination, you have the right to challenge it through the client's formal disagreement process.

What IR35 means for your invoicing

This is where it gets practically important. How you invoice — and what happens to that invoice — differs significantly depending on your IR35 status.

Outside IR35 — invoicing as normal

If your engagement is outside IR35, you invoice the client (or their agency, if one is involved) through your limited company in the normal way. You issue a VAT invoice, receive payment into the company account, and manage your own tax through your company's accounts. Your invoice looks exactly like any other business-to-business invoice.

Inside IR35 — the deemed payment mechanism

If your engagement is inside IR35 and you're working for a small client who has left status determination to you, you still invoice normally — but at the end of the tax year you must calculate a "deemed employment payment" and pay the appropriate Income Tax and NICs on it through your company's payroll. You effectively pay yourself as if you were an employee for that income, removing the tax benefit.

Inside IR35 with a medium/large client — off-payroll working

If a medium or large client (or public sector body) has determined you're inside IR35, the tax is deducted at source before you even receive payment. The fee-payer (the client, or an agency in the chain) deducts Income Tax and Employee NICs and pays them directly to HMRC. You receive the net amount. The client also pays Employer NICs on top.

In this situation, your invoice is still issued by your limited company for the full contract amount — but the payment you receive will be reduced by the tax deducted at source. You should ensure your invoice clearly references the contract and the gross amount, and keep records of the tax deducted.

Working through an umbrella company

Many contractors working inside IR35 choose to operate through an umbrella company rather than their own limited company. An umbrella company employs you directly, handles payroll, deducts tax and NICs, and pays you a net salary. You don't invoice the client yourself — the umbrella company does, and you raise a timesheet or similar record instead.

If you're consistently working inside IR35, an umbrella company often simplifies the administration significantly — you give up the limited company structure in exchange for someone else handling all the compliance. The tax position is broadly the same either way.

HMRC's CEST tool

HMRC provides a free online tool called Check Employment Status for Tax (CEST) to help determine IR35 status. You answer a series of questions about the working relationship and CEST gives a determination of employed, self-employed, or unable to determine.

CEST is useful as a starting point, but it has limitations — it doesn't always reflect the full nuance of case law, and HMRC has acknowledged it cannot cover every situation. For higher-value contracts or any situation where the status isn't clear-cut, professional advice from an accountant or IR35 specialist is strongly recommended. The cost of specialist advice is almost always less than the cost of getting it wrong.

Common IR35 mistakes contractors make

1. Relying on the contract wording alone — HMRC looks at the actual working relationship, not just what the contract says. A contract can say "right of substitution" but if you've never exercised it and the client would never accept a substitute, it won't protect you
2. Assuming all contracts with the same client have the same status — each engagement should be assessed independently. A new project with a new scope may have a different status to the previous one
3. Not keeping evidence — if HMRC investigates, you'll need to demonstrate that your working practices matched your outside IR35 determination. Keep records of how you actually worked, any substitutions, any financial risk you took on
4. Ignoring a client's inside IR35 determination — if a medium or large client has determined you're inside IR35 and you disagree, challenge it formally. Don't simply continue as if the determination doesn't apply
5. Not accounting for IR35 in your rate negotiation — if you're going to be inside IR35, your effective take-home is lower than an outside IR35 engagement at the same day rate. Factor this into your pricing

IR35 and your invoice checklist

Getting professional advice

IR35 is complex, the penalties for getting it wrong are significant, and the rules continue to evolve through case law and HMRC guidance. If you're a contractor earning meaningful income through a limited company, it's worth having your contracts and working practices reviewed by an accountant or IR35 specialist — ideally before you sign rather than after.

Many IR35 specialist firms offer contract reviews for a fixed fee of £100–£300. For a contract worth tens of thousands of pounds, that's a sensible investment.

Keep your invoicing clean regardless of IR35 status

Whatever your IR35 position, clean and consistent invoicing is essential. HMRC investigations often start with a review of financial records — and invoices that are incomplete, inconsistent, or don't match bank records create unnecessary risk.

Invoice Kwik generates HMRC-compliant limited company invoices automatically — correct fields, sequential numbering, VAT calculations — so your invoicing records are always in order if HMRC comes asking.

Try Invoice Kwik free — no credit card required.