The off-payroll working rules (Chapter 10 ITEPA 2003) shifted the IR35 compliance burden from contractors to engagers. Understanding who bears the liability and when, is the foundation of any defence against an HMRC compliance action.
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History: from IR35 to off-payroll
When IR35 was introduced in April 2000, it placed the compliance burden squarely on the personal service company (PSC). The PSC was required to determine whether each engagement would, absent the intermediary, constitute employment and if so, to account for PAYE income tax and National Insurance contributions on a deemed payment at the end of the tax year. This was Chapter 8 of the Income Tax (Earnings and Pensions) Act 2003.
Two decades of enforcement revealed a fundamental problem: HMRC lacked the resources to investigate the hundreds of thousands of individual PSCs that might be non-compliant and many contractors simply ignored the rules or took optimistic positions on their status. Voluntary compliance rates were low, and the administrative burden of investigation was high.
The government’s response was structural reform. From April 2017, public-sector engagers were made responsible for determining the IR35 status of contractors they engaged and for operating PAYE on inside-IR35 payments. This reform was then extended to medium and large private-sector engagers from 6 April 2021, creating the current off-payroll working regime under Chapter 10 ITEPA 2003.
The effect of this shift was significant: rather than HMRC pursuing individual PSCs, it can now hold large organisations, with far greater compliance resources, responsible for getting determinations right across their entire contractor population.
Chapter 10: who it applies to
Chapter 10 applies where all of the following conditions are met:
- Services are provided by an individual (the worker) to a client (the end-client);
- those services are provided through an intermediary, most commonly a PSC controlled by the worker, but also a partnership or individual acting through a managed service company;
- the end-client is a medium or large private-sector company, a public-sector body or a non-UK entity with a UK connection; and
- the engagement would be employment if contracted directly between the worker and the end-client (applying the employment status tests).
The public sector (central and local government, NHS, universities, most charities) has been within Chapter 10 since April 2017. Medium and large private companies joined from April 2021. Small private-sector companies are exempt (see below).
The small company exemption
A private-sector company that qualifies as “small” under section 382 of the Companies Act 2006 is exempt from the Chapter 10 off-payroll obligations. To qualify as small, a company must satisfy at least two of the following three conditions in its most recent financial year:
- Annual turnover not more than £10.2 million;
- Balance sheet total not more than £5.1 million;
- Average number of employees not more than 50.
Where the small company exemption applies, the contractor’s PSC remains responsible for determining its own IR35 status under Chapter 8, the “old IR35” rules. This means HMRC will pursue the PSC directly for any PAYE and NIC shortfall, not the engager.
Importantly, the small company test is applied to the immediate engager (or the end-client in the chain), not to any group structure. However, HMRC will scrutinise arrangements where a small company may be part of a larger group, and the group test may apply in certain circumstances. Companies close to the thresholds should take advice on whether they are genuinely within the exemption.
The responsibility and liability chain
Chapter 10 creates a chain of obligation that flows from the end-client downwards:
- End-client: must determine employment status for each engagement and issue a Status Determination Statement (SDS). If it does not or issues a negligent SDS without adequate reasons, the liability for PAYE and NICs stays with the end-client regardless of what happens further down the chain.
- Agency (or intermediary in the chain): receives the SDS from the end-client and passes it on to the next party (and ultimately the worker). If an agency passes fraudulent information about employment status, the liability may jump to it even if the end-client issued a correct SDS.
- Fee-payer: the entity immediately above the PSC in the contractual chain, often an agency, but may be another intermediary. Where an inside-IR35 SDS has been issued, the fee-payer must deduct income tax under PAYE and employee’s NICs from payments to the PSC and account for employer’s NICs. This is the fee-payer’s primary liability.
- PSC (the worker’s personal service company): receives the net payment after PAYE deductions. Where Chapter 10 applies and the fee-payer has operated PAYE correctly, the PSC does not need to apply IR35 rules itself for that engagement.
The practical consequence of this structure is that in any HMRC investigation, the first question is always: where in the chain did the failure occur? An engager that issued a properly reasoned SDS but whose agency then failed to pass it on or failed to operate PAYE correctly, may have a defence; an engager that issued an inside-IR35 determination but where the fee-payer has collapsed or disappeared faces the prospect of bearing the liability itself.
SDS obligations
The Status Determination Statement is the documentary lynchpin of the off-payroll regime. It must:
- State whether the worker would be an employee or office-holder if the intermediary were not involved;
- give the reasons for that conclusion (not merely a conclusion without reasoning, HMRC has confirmed that a bare “inside IR35” or “outside IR35” without explanation is insufficient); and
- be provided to the worker and to the next party in the contractual chain before the engagement commences or, where the engagement is already running, as soon as practicable.
Workers and agencies have the right to formally disagree with an SDS within 45 days of receiving it. The engager must respond within 45 days of receiving the challenge, either confirming the original determination with further reasons or issuing a revised SDS. Failure to respond within 45 days means the SDS is treated as made without reasonable care, and the end-client liability position is restored. For a full analysis of the challenge process, see our SDS guide.
HMRC’s compliance approach for engagers
HMRC’s Large Business directorate leads compliance activity for organisations within the off-payroll rules. Its approach includes:
- Bulk CEST assessment reviews: HMRC requests sight of the CEST outputs used to prepare SDS determinations for an engager’s entire contractor population, looking for patterns of error in the answers given, particularly around the mutuality of obligation and control questions. See our CEST tool guide for the tool’s known limitations.
- End-to-end chain reviews: HMRC traces the SDS from end-client to fee-payer to confirm it was transmitted correctly and that PAYE was operated on inside-IR35 determinations.
- RTI and payroll cross-matching: Where an agency has not deducted PAYE on payments to a PSC but the SDS records an inside determination, HMRC identifies the gap via Real Time Information submissions.
- Sector campaigns: HMRC has run targeted campaigns in financial services and IT, industries where large contractor populations are common and where compliance rates have historically been lower than HMRC considers acceptable.
Engagers facing HMRC compliance scrutiny should take specialist advice early. The PAYE audits and income tax investigation services we offer extend to off-payroll compliance work for both engagers and contractors.
Key cases post-2021
Two cases decided after the private-sector reform illustrate how tribunals continue to approach employment status questions:
Eamonn Holmes v HMRC [2020] UT 0017
Although decided just before the April 2021 reform, the Upper Tribunal’s decision in Eamonn Holmes v HMRC (under the public-sector Chapter 10 rules from 2017) is instructive. The Upper Tribunal upheld the FTT’s finding that Mr Holmes’ engagement with ITV was inside IR35, emphasising the degree of integration into ITV’s programming operation and the limited financial risk borne by the PSC. The case is widely cited for the proposition that the tribunal will look beyond the label the parties apply to the relationship.
Kickabout Productions Ltd v HMRC [2022] EWCA Civ 29
The Court of Appeal upheld the Upper Tribunal’s finding that a radio presenter’s engagement was inside IR35. The court confirmed that the correct approach is to consider the hypothetical direct contract between the worker and the end-client, applying the full employment status tests. The substitution clause was found to be of limited practical weight where it had never been exercised and where the engager’s evidence was that it would have been unwilling to accept a substitute. The case reinforces that a contract must be genuine and that working practices will be examined closely.
Frequently asked questions
Does IR35 apply to sole traders?
Chapter 10 ITEPA 2003 (the off-payroll working rules) applies where services are provided through an intermediary, most commonly a PSC. A sole trader operating without a corporate intermediary does not fall within Chapter 10. However, sole traders can still be caught by other employment status rules and HMRC may challenge whether a purported self-employment arrangement is genuine employment.
What is a small company for off-payroll purposes?
For Chapter 10 off-payroll purposes, the small company test follows the Companies Act 2006 (s382) criteria: a company qualifies as small if it meets at least two of three conditions, annual turnover not more than £10.2 million; balance sheet total not more than £5.1 million; average number of employees not more than 50. Small private-sector companies are exempt from the off-payroll rules, meaning contractors engaged by them fall under Chapter 8 (old IR35) and must self-determine their status.
Can engagers be liable for historic IR35 failures before April 2021?
Not directly under Chapter 10, which applies from April 2021 for the private sector. For the period before April 2021, private-sector IR35 liability sits with the PSC under Chapter 8. However, public-sector bodies have been within Chapter 10 since April 2017, so historic failures from April 2017 onwards can fall on those engagers. Post-2021, if an engager issued a negligent or absent SDS, it remains liable for the period of its failure.
What happens if an agency does not pass the SDS on to the worker?
The SDS must be passed down the entire contractual chain to the worker. If an agency fails to pass the SDS on, the liability for PAYE and NICs may revert to the end-client rather than the fee-payer. Engagers and agencies should maintain records demonstrating that SDS documentation was issued and transmitted throughout the chain, as HMRC compliance teams will request this evidence in an investigation.