If your agency engages contractors who work through their own limited company, you are responsible for determining their IR35 status. This is not optional. Since April 2021, medium and large agencies in the UK have been legally required to issue a Status Determination Statement (SDS) to every contractor before they start work. Get it wrong, and HMRC can come after you for the unpaid tax and National Insurance, not the contractor.
This article is written specifically for IR35 agency founders who need to understand the process from the agency side. Not from the contractor's side. Not from a generic employer perspective. From your position as the intermediary that engages the contractor and pays their limited company.
Why IR35 Matters for Your Agency
IR35 is tax legislation designed to catch what HMRC calls "disguised employment". A contractor who works like an employee but takes income through a limited company to pay less tax and NI. When IR35 applies, the contractor's limited company pays roughly the same tax as if the contractor were on payroll.
For agencies, the risk is financial. If HMRC determines a contractor was inside IR35 and you did not operate PAYE and deduct employer NI, you become liable for the full amount. Backdated. With interest and penalties.
We have seen cases where a single contractor engaged for two years generated a six-figure HMRC bill for the agency. That is not a theoretical risk. It happens.
The Legal Framework: What You Must Do
Under the off-payroll working rules (commonly called IR35), your agency is the "fee-payer". That means you are responsible for:
- Determining the contractor's employment status before work begins
- Issuing a Status Determination Statement (SDS) to the contractor and the client
- Operating PAYE and deducting tax and NI if the contractor is inside IR35
- Keeping records of your determination and the reasoning behind it
These rules apply if your agency meets two or more of these criteria: turnover over £10.2 million, balance sheet over £5.1 million, or more than 50 employees. Most agencies reading this will qualify. If you are smaller, the responsibility shifts to the end client, but you still need to know the rules because the client will ask you for information.
The Three Factors That Determine IR35 Status
HMRC looks at three main areas when deciding if a contractor is inside or outside IR35. These are not a checklist you tick. They are a holistic assessment of the working relationship.
Substitution and Personal Service
Can the contractor send someone else to do the work? A genuine right of substitution is the strongest indicator that the contractor is outside IR35. If the contract says the contractor must personally perform the work, that points towards inside IR35.
We see agency founders get this wrong by including a substitution clause in the contract but never intending to allow it. HMRC will look at what happens in practice, not just what the contract says. If your contractor has never substituted and you would not allow it, the clause is meaningless.
Control
Who decides what work gets done, when, where, and how? If your agency or the end client controls these things, the contractor looks like an employee. If the contractor decides their own methods, hours, and location, that points towards self-employment.
For agency contractors, control is often blurred. A contractor might work on your premises, use your equipment, and attend your team meetings. That looks like control. But if they also work for other clients, set their own schedule, and use their own tools for parts of the work, that weakens the control argument.
Mutuality of Obligation (MOO)
Is your agency obliged to offer work, and is the contractor obliged to accept it? If yes, that is an employment relationship. If the contractor can turn down work and you can stop offering it without penalty, that points towards outside IR35.
MOO is often the deciding factor. A contractor on a rolling monthly retainer with no end date and no right to refuse work is almost certainly inside IR35. A contractor engaged for a specific six-week project with a fixed scope and no expectation of further work is likely outside.
How to Issue a Status Determination Statement
The SDS is a formal document you must provide before the contractor starts. It must state:
- Whether the contractor is inside or outside IR35
- The reasons for that determination
- The key facts that led to the decision
You can use HMRC's Check Employment Status for Tax (CEST) tool to help, but be careful. CEST gives directional guidance only. It is notoriously unreliable for complex arrangements, especially where the contractor works across multiple clients or has a genuine substitution right.
We recommend using CEST as a starting point, not a final answer. For any borderline case, take professional advice from an accountant or employment tax specialist. Working exclusively with agency founders, we handle IR35 determinations for agency clients regularly. The cost of advice is small compared to the cost of getting it wrong.
Common Mistakes Agency Founders Make
We see the same errors repeatedly. Here are the ones that cause the most damage.
Relying on the Contract Alone
HMRC ignores contracts that do not reflect reality. If the contract says the contractor has control but they actually take direction from your account manager every day, the contract is worthless. HMRC will look at what happens on the ground.
Review your working practices alongside your contracts. If they do not match, fix the practices or change the contracts. Do not leave a mismatch.
Treating All Contractors the Same
Every contractor relationship is different. A graphic designer who works from home, uses their own software, and takes briefs from multiple clients is different from a developer who sits in your office 40 hours a week using your equipment and attending your standups. You cannot apply a blanket determination to all contractors.
Not Keeping Records
HMRC can ask for your IR35 determinations up to six years after the engagement ends. If you cannot produce the SDS and the reasoning behind it, HMRC will assume you did not do the work. That presumption works against you.
Keep a file for each contractor with the SDS, the working practices review, and any correspondence about the determination. Store it securely and keep it for at least six years after the contractor leaves.