If your company is medium or large and you hire a contract developer who works through their own limited company, you decide whether IR35 applies, and if you get it wrong the tax bill can land on you. If you buy a defined piece of software from a company that employs its own engineers, the off-payroll rules generally do not apply. Most IR35 trouble in software projects comes from arrangements that sit between those two and are labelled as the second while working like the first.
This guide is for UK founders, CTOs and finance leads deciding how to resource a software build. It explains when the off-payroll working rules apply to developers, what a client must do, how the company size test is changing, and how agency and offshore models compare. It is general information, not tax advice, and it does not cover the public sector rules in depth or the position of contractors themselves.
What is IR35?
IR35, formally the off-payroll working rules, makes a contractor working through their own limited company pay broadly the same tax as an employee if they would be one when engaged directly. For medium and large private companies and all public sector bodies, the client decides the contractor's status and issues a status determination statement.
The rules work contract by contract. The same developer can be inside IR35 on one engagement and outside on another (HMRC: Understanding off-payroll working).
Does IR35 apply to your company?
Who decides status depends on the client, not on the contractor.
| Client type | Who decides the contractor's status |
|---|---|
| Public sector body (including NHS bodies and universities) | The client |
| Medium or large private or voluntary sector company | The client |
| Small private sector company | The contractor's own intermediary |
| Client wholly overseas, with no UK residence or permanent establishment | The contractor's intermediary; the client rules do not apply |
A company is medium or large if it meets two or more of these for two consecutive financial years: turnover above £10.2 million, balance sheet total above £5.1 million, more than 50 employees. A newly incorporated company is treated as small in its first financial year (HMRC ESM10006). Group rules apply, and the worldwide group counts.
The thresholds are rising, but not yet
From 6 April 2025 the Companies Act thresholds rose to £15 million turnover and £7.5 million balance sheet total, with the 50-employee limit unchanged. They apply to financial years beginning on or after 6 April 2025. HMRC says that for a usual 12-month financial year the earliest tax year the change can affect a client's size for off-payroll purposes is 2027/28 (HMRC ESM10006A). A scale-up that expects to drop back to "small" should not stop issuing determinations early.
Five ways to resource a software build, compared
| Model | IR35 position | Who carries status risk | What you control |
|---|---|---|---|
| Employee | Not relevant; normal PAYE | You, as employer | Everything |
| Contractor via own company, inside IR35 | Rules apply; fees taxed like employment | You or the fee-payer in the chain | How, when and where they work |
| Contractor via own company, outside IR35 | Rules do not apply to that engagement | You, if your determination lacked reasonable care | The outcome, not the method |
| UK agency delivering a defined scope with its own employees | Generally outside; contracted-out service | The agency, unless it is really labour supply | Scope, acceptance and priorities |
| Offshore company whose engineers are its own salaried staff | The engineers are not working through their own intermediaries | The supplier, for its own employment obligations | Scope, acceptance and priorities |
What pushes a developer inside or outside IR35
Status is decided on normal employment principles, looking at both the contract and the working practices. For software contractors the same few factors decide most cases.
- Control. If your engineering manager decides how, when and where the contractor works, allocates tickets daily and reviews their method, that points inside. A contractor who owns a defined deliverable and decides how to build it points outside.
- Substitution. A genuine, usable right to send a suitably skilled substitute points outside. A clause nobody would ever accept in practice carries little weight.
- Obligations to offer and accept work. Rolling extensions with new work assigned as it arises look like employment.
- Part and parcel. Line management of permanent staff, company email signatures, performance reviews and team rotas all point inside.
- Financial risk. Fixing defects at their own cost and pricing by deliverable rather than by day points outside.
A typical embedded contractor in a Scrum team, attending standups, picking tickets from your board and working to your manager's direction, often ends up inside IR35. That is not a problem in itself. It is a cost to plan for.
Your obligations as the client
- Make a determination for each engagement. HMRC's Check Employment Status for Tax (CEST) tool can help, and HMRC says it will stand by an accurate CEST result that is followed (HMRC ESM10013).
- Issue a status determination statement. It must state your conclusion, give reasons, and reflect reasonable care. Advertising a role as "outside IR35" is not an SDS.
- Pass it down the chain. Give the SDS to the contractor and to the party you contract with, such as a recruitment agency.
- Run a disagreement process. If the contractor or deemed employer disagrees, you must respond within 45 days, or the tax liability becomes yours (HMRC: Off-payroll working for clients).
- Keep records and re-check. Record each determination and its reasons, and reassess when the working arrangement or contract changes.
What an inside-IR35 developer really costs
If a contractor is inside IR35, the deemed employer deducts Income Tax and employee National Insurance from the fees and pays employer National Insurance at 15%, plus Apprenticeship Levy where it applies. Take 120 days at £525, the median UK senior software engineer contract rate in the six months to 17 September 2026 (ITJobsWatch). The fees are £63,000 and employer National Insurance adds close to £9,500 on top, unless the rate was agreed on a basis that already absorbs it. Many contractors also quote higher rates for inside engagements, so ask for both figures before you choose.
When is an agency engagement really outside IR35?
HMRC's guidance says an organisation receiving contracted-out services from a third party, like an outsourcing company, does not have to apply the off-payroll rules; that responsibility sits with the supplier. It also warns clients to make sure a contract has not been relabelled to avoid the rules (HMRC: Off-payroll working for clients). Relabelling usually looks like a named individual on a day rate, embedded in your team, taking daily direction from your manager, with the "agency" doing little more than invoicing.
A genuine contracted-out service in software tends to look like this:
- A statement of work with defined deliverables, acceptance criteria and a price or capped budget per phase.
- The supplier chooses and manages the team, and can change who does the work.
- The supplier runs delivery: its own lead, its own QA, its own process.
- Defects in accepted work are fixed at the supplier's cost within a warranty period.
- You set priorities and accept outcomes; you do not line-manage individuals.
Our staff augmentation vs dedicated team vs fixed price comparison maps these structures, and the contract checklist covers the clauses. Staff augmentation, where you direct a supplied engineer day to day, is the model that needs the most IR35 care if the individual works through their own company.
Offshore teams and IR35
The off-payroll rules are aimed at individuals providing services through their own intermediaries. Engineers who are salaried employees of an offshore development company are not doing that, so the client-side rules are not the mechanism that applies to them. The offshore company handles its own employment and tax obligations where it employs people.
Two cautions. First, an individual freelancer abroad who works through their own company raises separate questions about residence and UK tax, so take advice rather than assuming "overseas means outside". Second, moving work offshore changes other UK rules even when IR35 drops away: R&D relief on overseas work is generally restricted, and engineer access to personal data is a restricted transfer under UK GDPR. We covered both in London vs offshore vs nearshore development and R&D tax relief for software development.
Frequently asked questions
Does IR35 apply to small companies?
Small private sector clients do not decide their contractors' status; the contractor's own intermediary does. A company is small unless it meets two or more of: turnover above £10.2 million, balance sheet above £5.1 million, more than 50 employees, for two consecutive years. Higher thresholds of £15 million and £7.5 million apply to financial years beginning on or after 6 April 2025, with effect for off-payroll purposes from 2027/28 at the earliest.
Does IR35 apply if I outsource development to an agency?
Generally not, if the agency delivers a defined service with its own employees and manages the work. HMRC treats that as a contracted-out service and puts any off-payroll responsibility on the supplier. If the "agency" simply supplies a named contractor who works under your direction through their own company, the rules can apply and a status determination is needed.
Do offshore developers fall under IR35?
Engineers employed on the payroll of an offshore development company are not working through their own intermediaries, so the client-side off-payroll rules are not the relevant regime. Individual overseas freelancers with their own companies are more complex and depend on residence and where the work is done, so take specific advice.
Who pays if an IR35 determination is wrong?
If the client fails to issue a valid status determination statement, fails to take reasonable care, or misses the 45-day disagreement deadline, the Income Tax and National Insurance liability can move to the client. Otherwise the fee-payer, usually the party paying the contractor's company, operates PAYE as the deemed employer.
What is a status determination statement?
A status determination statement is the client's written conclusion on whether a contractor would be an employee if engaged directly, with reasons, made with reasonable care. It must be given to the contractor and the party the client contracts with. An accurate CEST output that meets those conditions can serve as a valid statement.
Key takeaways
- Medium and large companies decide IR35 status for contract developers and can carry the tax if they get it wrong.
- The size test is still £10.2 million turnover, £5.1 million balance sheet and 50 employees; the higher thresholds affect off-payroll status from 2027/28 at the earliest.
- Embedded contractors directed like staff often fall inside IR35; plan for about 15% employer National Insurance on their fees.
- A defined scope delivered by a supplier's own employees is generally a contracted-out service, but HMRC looks through relabelled labour supply.
- Offshore salaried teams sidestep the client-side rules, while R&D relief and UK GDPR transfers still need attention.
Take IR35 off the table for your build
If you want a software build without determinations, SDS paperwork and inside-IR35 costs, tell us what you need built. You contract with our UK company for a defined scope, our London office at 2-7 Clerkenwell Green, EC1R 0DE, is your point of contact, and our employed engineering team delivers and fixes defects in accepted work at our cost. If your situation genuinely calls for an embedded contractor instead, we will say so. See our custom software development service for how we scope work.
Sources
- HMRC: Understanding off-payroll working (IR35), updated 26 February 2026
- HMRC: Off-payroll working for clients
- HMRC ESM10006: Medium or large-sized organisations and wholly overseas clients
- HMRC ESM10006A: Size threshold changes from 6 April 2025
- HMRC ESM10013: What constitutes a valid status determination statement
- HMRC: Check employment status for tax (CEST)
- ITJobsWatch: Senior software engineer contract rates, UK