Understanding IR35 for Construction Contractors
TL;DR
IR35 — also called the off-payroll working rules — is HMRC's framework for deciding whether someone working through a personal service company (PSC) is genuinely self-employed or is really an employee in disguise. Since April 2021, medium and large private-sector clients (and all public-sector bodies) decide your IR35 status, not you. If you're "inside IR35" you're taxed broadly as an employee. CIS does not override IR35. Use HMRC's CEST tool, get a Status Determination Statement (SDS), and challenge it through the client-led disagreement process if you disagree.
Table of Contents
1. What IR35 Actually Is
IR35 was introduced by HMRC in 2000 to tackle "disguised employment" — situations where someone works through a limited company but, in reality, looks and behaves like an employee of the end client. The rules now sit in Chapter 8 and (since April 2017 for the public sector and April 2021 for the private sector) Chapter 10 of the Income Tax (Earnings and Pensions) Act 2003.
If your engagement is "inside IR35", PAYE income tax and Class 1 National Insurance must be deducted at source from your fees, broadly as if you were an employee. You won't usually get the benefits of employment such as holiday pay or sick pay, which is why it is often described as the worst of both worlds.
If your engagement is "outside IR35", you can continue to operate through your limited company in the normal way, paying yourself a mix of salary and dividends in line with HMRC rules, and the engagement is treated as a B2B contract.
IR35 only applies if you operate through an intermediary — usually a personal service company. If you're a sole trader paid through CIS, IR35 does not directly apply to you, but employment status still does, which is covered in the next section.
2. Who Decides Your Status
Since 6 April 2021, in the private sector, medium and large clients are responsible for determining the IR35 status of any contractor working through a PSC. Small clients (those that meet at least two of: turnover below £10.2m, balance sheet below £5.1m, fewer than 50 employees) are exempt — in those cases the contractor decides their own status under the older Chapter 8 rules.
In the public sector, the public body (or fee-payer in the chain) has been responsible for determining status since April 2017. HMRC has dedicated guidance on this in its Employment Status Manual on GOV.UK.
For sole traders paid under CIS, employment status is decided using HMRC's general employment status framework rather than IR35 itself. HMRC's CEST tool can be used by either party to test that status, and the principles are very similar to those used for IR35.
Whoever decides, they must use "reasonable care" in reaching the determination. Just blanket-classifying everyone as inside IR35 is not reasonable care — HMRC has explicitly said so in its compliance guidance.
3. The Status Tests HMRC Uses
There is no single statutory test. HMRC and the courts look at the whole picture, but three factors carry the most weight: personal service (can you send a substitute?), control (does the client decide what, how, when and where you work?) and mutuality of obligation (is the client obliged to offer work, and are you obliged to accept it?).
Other factors include financial risk (do you have to put right defective work at your own cost?), provision of equipment (do you supply your own tools and materials?), exclusivity, integration into the client's organisation and the contractual right to refuse work. HMRC's Employment Status Manual sets out the case law in detail.
In construction this can be more nuanced. Many genuine subbies provide their own tools and materials, work for multiple clients in a single year and can send a substitute — strong indicators of self-employment. But long-running engagements where you work full-time on one site, under direct supervision, often look more like employment.
The leading cases — including Ready Mixed Concrete (1968), Hall v Lorimer (1994) and more recently the Supreme Court's PGMOL decision (2024) — make clear that the labels in the contract do not decide the issue. What actually happens day to day is what matters.
4. How IR35 Interacts with CIS
CIS and IR35 are separate regimes. CIS is HMRC's payment-deduction system for construction; IR35 is HMRC's rule on whether you are really an employee. You can be CIS-registered and still fall inside IR35 if you operate through a limited company.
If you operate through a PSC and the engagement is determined inside IR35, the fee-payer must deduct PAYE and NICs before you ever touch the money. CIS deductions do not apply to that payment because PAYE is being operated instead — HMRC guidance is clear that you can't be subject to both at the same time.
If you operate as a sole trader under CIS, IR35 itself does not apply, but employment status does. If HMRC concludes you are really an employee of the contractor, the contractor — not you — is usually liable for unpaid PAYE and NICs, plus interest and penalties. That makes contractors very cautious about long, exclusive engagements.
Umbrella companies are a third option that has grown rapidly since 2021. Umbrellas employ you and run PAYE on every payment, so IR35 doesn't bite. They charge a margin and the take-home is usually lower than a genuine outside-IR35 engagement, but they remove a lot of admin.
5. CEST, SDS and the Disagreement Process
HMRC's Check Employment Status for Tax (CEST) tool is the main free tool for testing IR35 status. HMRC says it will stand by a CEST result if the answers given are accurate and reflect the actual working arrangements. CEST is not perfect — it has been criticised for not properly weighing mutuality of obligation — but it is the official starting point.
Where the off-payroll rules apply, the client must issue a Status Determination Statement (SDS) to both you and the next party in the contract chain, before payment, explaining the decision and the reasons for it. Until they do, the client can be on the hook for the tax themselves.
If you disagree with the SDS, you have a statutory right to use the client's client-led disagreement process. The client must respond within 45 days, either confirming or changing the determination, and explaining their reasoning. Many SDSs are overturned at this stage when contractors push back with evidence.
If you remain unhappy, you can complain to HMRC. HMRC will not arbitrate individual SDSs but will investigate clients who appear to be applying blanket determinations or failing to take reasonable care.
6. Practical Steps for Construction Contractors
Before you sign any contract, ask the client for their IR35 position. If they say "inside", ask for the SDS in writing and the reasons. If they say "outside", make sure your contract reflects that — substitution clauses, no obligation to accept further work, a right to refuse work — and that day-to-day reality matches.
Keep evidence. Save quotes you've prepared, jobs you've turned down, multiple clients you've worked for in the same period, your own insurance, your own tools, and any correspondence showing you control how you do the work. This is the evidence base if HMRC ever opens an enquiry.
Consider professional advice. A specialist accountant or IR35 contract reviewer typically charges a few hundred pounds for a contract review, and that is small compared with the tax exposure of getting it wrong. HMRC enquiries can go back years.
Finally, don't panic. Many genuine construction subcontractors are clearly outside IR35 by any sensible reading of the case law. The rules exist to catch people pretending to be in business — not to catch real businesses doing real work for multiple clients.