PSC Rules & IR35: How to Stay Compliant as a Contractor

What Is a Personal Service Company?

A Personal Service Company (PSC) is typically a limited company through which an individual — usually the sole or majority shareholder and director — provides their professional services to end clients. HMRC views PSCs with scrutiny because they can be used to take income as dividends rather than salary, reducing National Insurance Contributions (NICs) and income tax compared to being directly employed.

What Is IR35 and Why Does It Matter?

IR35 is the off-payroll working legislation designed to combat disguised employment — where a contractor operates through a PSC but works in a manner that is functionally the same as being an employee. If HMRC determines your engagement falls inside IR35, you are treated as an employee for tax purposes on that income, meaning income tax and NICs are due as if you were on a payroll.

Who Decides Your IR35 Status?

Since April 2021, responsibility for determining IR35 status shifted depending on the size of the client:

• Large and medium-sized private sector clients (and all public sector clients): The end client must issue a Status Determination Statement (SDS) and, if inside IR35, the fee-payer deducts tax and NICs before paying your PSC.
• Small private sector clients (meeting two of: turnover under £10.2m, balance sheet under £5.1m, fewer than 50 employees): Your PSC remains responsible for assessing and paying the correct tax.

The Key Tests HMRC Uses to Identify Disguised Employment

HMRC applies a combination of case law tests to determine whether a contractor is genuinely self-employed or effectively employed. The main factors are:

• Substitution: Can you send a suitably qualified substitute to do the work without the client's approval? A genuine right of substitution strongly points toward self-employment.
• Control: Does the client dictate how, when, and where you work? High levels of client control suggest employment.
• Mutuality of Obligation (MOO): Is the client obliged to offer work and are you obliged to accept it? If yes, this points toward employment.
• Financial Risk: Do you risk your own money — for example, correcting faulty work at your own cost? Genuine contractors bear financial risk.
• Integration: Are you embedded in the client's organisation — using their equipment, attending staff meetings, or listed in internal directories? Deep integration indicates employment.
• Exclusivity: Working for only one client over a long period can raise red flags, though it is not conclusive on its own.

HMRC's CEST Tool: Useful But Not Foolproof

HMRC offers the Check Employment Status for Tax (CEST) tool online. It provides a status indication based on your answers, and HMRC has stated it will stand by results produced accurately. However, CEST has been criticised for not properly accounting for Mutuality of Obligation. Use it as a guide, but consider a specialist review for higher-value or longer-term contracts.

Practical Steps to Protect Your IR35 Position

• Get a contract review: Before signing, have a specialist IR35 solicitor or tax adviser review your contract to ensure it reflects genuine self-employment in both wording and working practices.
• Keep evidence of working practices: Document how you actually work — substitution attempts, multiple clients, use of your own equipment, and invoicing arrangements all support outside-IR35 status.
• Avoid being treated like an employee on site: Decline staff benefits, avoid being given a permanent desk or internal email address, and ensure your contract has a defined deliverable rather than open-ended availability.
• Review status at contract renewal: IR35 status is assessed engagement by engagement. A change in working practices or client size can change your status.
• Consider IR35 insurance: Specialist tax investigation insurance can cover the cost of professional representation if HMRC opens an enquiry.

Penalties for Getting It Wrong

If HMRC finds you have been operating inside IR35 but treating income as outside, you could face unpaid income tax, employee and employer NICs, interest, and penalties of up to 100% of the tax owed in cases of deliberate non-compliance. Acting now — rather than waiting for an enquiry — is always the more cost-effective approach.