Contractors, freelancers and the IR35 rules for UK startups

This guide covers employment status, the off-payroll working rules known as IR35, paying freelancers in the UK and abroad, and what a contractor costs compared with an employee.
By Buzz Accounting · Updated 16 September 2026

Using contractors and freelancers in a startup

Contractors and freelancers let a startup bring in a specialist for a defined piece of work, pay only for the days it uses and put off committing to a salary until the business can support one.

If a contractor works like an employee, HMRC can treat them as one for tax, and the person may be able to claim employment rights such as paid holiday and the minimum wage. For contractors who work through their own limited company, the off-payroll working rules, usually called IR35, decide whether income tax and National Insurance should come out of their fees. If your startup counts as small, the contractor's own company makes that decision and carries the tax risk. Once your company is medium or large, the decision and the risk move to you, so you need to know where the size limits sit, including the higher limits for financial years beginning on or after 6 April 2025.

The guide also covers who owns the code and designs a freelancer produces for you, how VAT works on their invoices, what changes when the contractor lives abroad, and a worked comparison of a year's cost for a contractor and an employee doing the same job.

What this guide covers

Employment status and why it matters
The IR35 rules, who decides and the small company exemption
Paying freelancers, VAT and overseas contractors
A cost comparison of a contractor and an employee

Why employment status matters

Employment status answers two separate questions. For tax, it decides whether the person is employed, so the company runs PAYE on their pay, or self-employed, so they pay their own tax. For employment rights, it decides whether they are an employee, a worker or self-employed. The two answers can differ, and courts and tribunals make the final decision on employment rights.

HMRC and tribunals look at how the work is really done. A person is probably an employee if most of these are true:

they have to do the work themselves and cannot send someone else
a manager decides what work they do, when it is due and how it is done
they are expected to work regularly and are paid for their time
the business provides their equipment and decides where they work
they work only for you, or any other job they have is completely different

A person is probably self-employed if they quote for work, invoice for it, work without direct supervision, pay their own tax and National Insurance, get no holiday or sick pay and work under a contract for services. Using their own equipment, being free to send a substitute and working for other clients all point the same way.

If you pay someone as self-employed who should have been an employee, the company may have to pay the income tax and National Insurance it should have deducted, plus interest and a penalty. The person may also bring a claim for rights such as the minimum wage and holiday pay.

Who owns the work

Status also affects who owns what the person creates. Copyright in work an employee makes in the course of their employment belongs to the employer. A freelancer who writes code, designs a brand or produces content for you owns the copyright unless they assign it to you in writing, and computer programs are protected as literary works. Put a written assignment of copyright and other intellectual property into every contractor agreement before work starts, so the company owns its product when investors carry out due diligence.

The off-payroll working rules (IR35)

Some contractors work through their own limited company, often called a personal service company. The off-payroll working rules apply where that contractor would be an employee of the client if they were engaged directly. When the rules apply, the contractor ends up paying broadly the same income tax and National Insurance as an employee. The rules work contract by contract, so the same person can be inside the rules for one client and outside them for another.

Who applies the rules depends on the client:

A small private sector client. The contractor's own company decides whether the rules apply and accounts for any tax and National Insurance itself.
A medium or large private sector client, since 6 April 2021, or any public sector client, since 6 April 2017. The client decides and gives its decision, with reasons, to the contractor and to the party it contracts with. If the rules apply, whoever pays the contractor's company deducts income tax and employee National Insurance from the fee and pays employer National Insurance on top.

When your company is that payer, it cannot set the employer National Insurance against the Employment Allowance, and it does not have to enrol the contractor in a workplace pension. The rules decide the tax position, and the contractor's employment rights are decided separately.

Whether your startup counts as small

A company is medium or large for these rules if it meets at least two of the following conditions for two consecutive financial years:

turnover of more than £15 million
a balance sheet total, meaning its gross assets before deducting liabilities, of more than £7.5 million
an average of more than 50 employees

The turnover and balance sheet limits were £10.2 million and £5.1 million before they rose for financial years beginning on or after 6 April 2025. Size is judged on accounts whose filing deadline passed before the tax year began, so for a normal 12-month financial year HMRC expects the higher limits to affect a company's position from the 2027/28 tax year at the earliest.

A new company is small in its first financial year. After that, a company in a group is judged on the combined figures of the whole worldwide group, so a UK subsidiary of a large overseas group is treated as medium or large. A client with no UK residence and no permanent establishment in the UK is outside the rules, and the contractor's company decides status. If a contractor or agency asks, you must confirm your company's size. HMRC's Employment Status Manual sets out the size tests and the April 2025 change.

Checking status with HMRC's online tool

HMRC's Check Employment Status for Tax tool asks about the contract, the person's responsibilities, who decides what work is done and when, where and how it is done, how they are paid and whether they get benefits or expenses. It then gives HMRC's view of whether they are employed or self-employed for tax, and whether the off-payroll working rules apply.

HMRC stands by the result as long as the information you give is accurate and follows its guidance. HMRC will not stand by a result reached through an arrangement set up to get a particular answer, and the result no longer holds if the contract or working practices change materially, so run the tool again when they do. The tool is anonymous and does not store your answers, so save the result. In finely balanced cases it can say it is unable to determine status, and you then have to decide using the guidance in HMRC's Employment Status Manual.

Status determination statements

A medium or large client must give a status determination statement for each contractor who works through their own company. The statement must say whether the contractor would be an employee if engaged directly, give the reasons, and go to the contractor and to whoever the client contracts with, such as an agency. The client must also take reasonable care in reaching the decision, and treating every contractor as inside the rules without looking at the facts of each case does not count as reasonable care. An accurate result from HMRC's online tool can be used as the statement.

Until a valid statement has been given, the client is responsible for the income tax and National Insurance on the fees. A statement without reasons, or one reached without reasonable care, is invalid and leaves the liability with the client. A contractor can disagree with the decision at any point up to the last payment, and the client must respond within 45 days, either confirming the decision with reasons or giving a new one. Keep records of each decision, the reasons for it, the fees paid and any disagreement.

If a contractor's status turns out to be wrong

Who pays depends on how the contractor was engaged:

A sole trader engaged directly by your company. The company can be asked for the income tax and National Insurance it should have deducted, plus interest and a penalty.
A contractor's company, where your startup is a small client. The contractor's company is responsible for applying the rules and for any tax it should have paid.
A contractor's company, where your company is a medium or large client. The deemed employer, usually your company or an agency, owes the tax and National Insurance, and your company takes on the liability if its statement was missing or careless. For liabilities assessed from 6 April 2024, HMRC can reduce the bill by tax and National Insurance the contractor and their company have already paid on the same income.

Whichever applies, the person may also bring an employment tribunal claim for rights such as holiday pay if they were really a worker or an employee.

Paying freelancers and contractors

Agree a written contract before work starts. Set out the work, the price and when it is paid, who owns what is produced, confidentiality and how either side can end the arrangement. Contract terms that match how the work is really done also support self-employed status.

Pay against an invoice. An invoice must show a unique number, the supplier's name, address and contact details, your company's name and address, a description of the work, the date the work was done, the invoice date, the amount, any VAT and the total owed. A sole trader using a business name must also show their own name and an address where legal documents can be delivered, and a limited company must use its full registered name.

Freelancers must register for VAT once their taxable turnover passes £90,000 in any rolling 12 months. When both you and the freelancer are VAT-registered, they must give you a VAT invoice, usually charging VAT at 20%. Your startup can reclaim that VAT on its VAT return if it holds a valid VAT invoice, and you can confirm the freelancer's VAT number with HMRC's VAT number checker. If your startup is not VAT-registered, the VAT is a cost to the business. Our guide to VAT for startups covers when to register.

Unless you agree a payment date, a business invoice becomes late 30 days after you receive it or the work is delivered, whichever is later. The freelancer can then claim statutory interest at 8% plus the Bank of England base rate, and a fixed recovery charge of £40, £70 or £100 depending on the size of the debt.

Contractors based overseas

A contractor who is not UK resident and works outside the UK is unlikely to be within the charge to UK income tax or National Insurance. In that case you pay their invoice without deductions and the off-payroll working rules do not apply. Work they carry out in the UK is normally within the UK tax charge. Check the tax and employment rules in their own country as well. If you want them as an employee there, you will need to register as an employer in that country or use a local business that employs them on your behalf.

For most business services bought from a supplier outside the UK, such as software development or legal services, the reverse charge applies, meaning the UK customer accounts for any UK VAT in place of the supplier. If your startup is VAT-registered, you enter the VAT on your return as both VAT due and VAT reclaimed, which costs nothing overall if you can reclaim all your VAT. If your startup is not VAT-registered, the value of these services counts towards the £90,000 registration threshold, so a large offshore development bill can make you register before your own sales reach that level.

Overseas work can also reduce research and development relief. For accounting periods beginning on or after 1 April 2024, payments to contractors for R&D carried out outside the UK, and payments for workers supplied through a third party whose pay is not subject to UK PAYE, are generally excluded from R&D relief. There is a narrow exception for conditions the research needs that are not present in the UK, such as geographical, environmental, legal or regulatory requirements, and the cost of the work and the availability of staff do not count as conditions. If R&D relief is part of your funding plan, read our R&D tax credits page before moving development offshore.

A cost comparison of a contractor and an employee

The figures in this example are illustrative. A small startup needs a developer for a year. It can employ someone on £60,000 or use a contractor who works through their own company at £375 a day. An employee is paid for 52 weeks, including 28 days of paid holiday, so a five-day week gives 260 − 28 = 232 working days.

Employee salary: £60,000.00
Employer National Insurance: 15% × (£60,000 − £5,000) = £8,250.00
Minimum employer pension contribution: 3% × (£50,270 − £6,240) = 3% × £44,030 = £1,320.90
Total employee cost: £60,000.00 + £8,250.00 + £1,320.90 = £69,570.90, which is £69,570.90 ÷ 232 = £299.87 a working day
Total employee cost if the full Employment Allowance is available: £60,000.00 + £1,320.90 = £61,320.90, which is £264.31 a working day
Contractor fees for the same 232 days: 232 × £375 = £87,000.00
VAT if the contractor is VAT-registered: 20% × £87,000 = £17,400.00, which a VAT-registered startup reclaims and which takes the total to £104,400.00 for a startup that is not registered

Before VAT, the contractor costs £87,000.00 − £69,570.90 = £17,429.10 more than the employee, or £87,000.00 − £61,320.90 = £25,679.10 more if the allowance covers the employee's National Insurance. At this salary, a contractor charging less than £299.87 a day costs the company less than the employee.

The contractor bills only for the days they work, can be released at the end of the contract and sits outside your payroll and pension scheme, but needs a written assignment of intellectual property. The employee is entitled to statutory sick pay and notice and, for dismissals from 1 January 2027, to unfair dismissal protection after six months. Only an employee can receive EMI share options, and they must work for the company for at least 25 hours a week or, if less, 75% of their working time. If your company were medium or large and the contract fell inside IR35, you would also deduct tax from the fees and pay employer National Insurance on top, with no Employment Allowance to set against it. Compare other salaries with our cost of hiring calculator, and read our guide to hiring your first employee for the payroll steps.

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Common questions

Who decides whether IR35 applies to a contractor?

The size of your company decides who makes the decision. If your startup is small, the contractor's own limited company decides whether the off-payroll working rules apply and accounts for any tax. If your company is medium or large, or in the public sector, your company decides, gives a status determination statement with reasons to the contractor and to the party it contracts with, and must take reasonable care. Until a valid statement is given, the tax and National Insurance on the fees are your company's responsibility.

What are the IR35 small company limits after April 2025?

For financial years beginning on or after 6 April 2025, a company is medium or large for the off-payroll working rules if it meets two or more of three conditions in two consecutive financial years. The conditions are turnover above £15 million, a balance sheet total above £7.5 million and more than 50 employees. The earlier turnover and balance sheet limits were £10.2 million and £5.1 million. HMRC expects the higher limits to affect a company's size for these rules from 2027/28 at the earliest, and group figures are combined worldwide.

Will HMRC accept the result of its Check Employment Status for Tax tool?

HMRC says it will stand by the result as long as the information you entered is accurate and the tool was used in line with its guidance. HMRC will not stand by a result reached through an arrangement designed to get a particular answer. If the contract or the way the work is done changes materially, run the tool again. The tool does not keep your answers, so save a copy of the result. Medium and large clients can use an accurate result as their status determination statement.

How does VAT work when I pay an overseas freelancer?

For most business services bought from a supplier outside the UK, the reverse charge applies, so your company accounts for any UK VAT in place of the supplier. If you are VAT-registered, you enter the VAT on your return as both VAT due and VAT reclaimed, which costs nothing overall if you can reclaim all your VAT. If you are not registered, the value of those services counts towards the £90,000 VAT registration threshold, so a large offshore development bill can mean you have to register.

Can a contractor be given EMI share options?

A contractor cannot be given EMI options, because EMI options can only be granted to employees. Each employee must also work for the company for at least 25 hours a week or, if less, 75% of their working time. A contractor who invoices as a sole trader or through their own company does not meet that test. If offering equity matters for recruiting someone, that is a reason to consider bringing them onto payroll as an employee.

What happens if HMRC decides my contractor should have been an employee?

If you engaged the person directly as a sole trader, HMRC can ask your company for the income tax and National Insurance it should have deducted, plus interest and a penalty. If they worked through their own company and your startup is small, the responsibility sits with their company. If your company is medium or large, the deemed employer owes the tax, and HMRC can reduce the bill by tax the contractor and their company have already paid. The person may also claim employment rights such as holiday pay.