Your Agency, Your Freelancers, and IR35
If your agency engages freelancers who work through their own limited company, IR35 applies to you. This is not optional. It is a legal obligation that has been in force for medium and large agencies since April 2021, and for all agencies regardless of size where the end client is a public authority.
The rules are straightforward in principle. In practice, they create real compliance work for agency founders who rely on freelance talent. Get it wrong and you face the tax bill, plus penalties and interest.
This guide covers exactly what you need to do when engaging freelancers through your agency, written for agency founders who need the practical steps, not the theory.
Does IR35 Apply to Your Agency?
IR35 applies where a contractor (the freelancer) provides services through their own limited company (often called a Personal Service Company or PSC) and would otherwise be classed as an employee for tax purposes.
For agencies, there are two common scenarios:
- You are the end client. The freelancer works directly for your agency, on your projects, under your direction. You are responsible for determining their IR35 status and issuing a Status Determination Statement (SDS).
- You are the intermediary. You supply the freelancer to a third-party end client. In this case, the end client is responsible for the IR35 determination, but you must pass the SDS to the freelancer and ensure the correct tax treatment is applied.
Most agency founders reading this will fall into the first category. You hire a freelance designer, developer, or copywriter who operates through their own limited company. They work from your office (or remotely), on your projects, using your processes. That is where the risk sits.
Which Agencies Are Caught by the Rules
The off-payroll working rules (the legislation that makes agencies responsible for IR35 determinations) apply to:
- All public sector end clients (since April 2017)
- Medium and large private sector end clients (since April 2021)
- Small private sector end clients are exempt from making the determination themselves, but the freelancer remains responsible for their own IR35 status
How do you know if your agency is medium or large? You meet two of the following three criteria in the current or previous financial year:
- Annual turnover over £10.2 million
- Balance sheet total over £5.1 million
- More than 50 employees
If your agency is below these thresholds, you are small. The freelancer must determine their own IR35 status. But here is the catch: HMRC can still challenge the freelancer's determination, and if they find it wrong, the freelancer pays the tax. That does not mean you are off the hook entirely. If HMRC believes you knowingly facilitated tax avoidance, they can come after you.
What Happens When IR35 Applies
If the freelancer is deemed inside IR35, the agency (or end client) must treat the payments as employment income. This means:
- You deduct PAYE income tax and employee National Insurance from the freelancer's payments
- You pay employer National Insurance at 15% on top
- You may need to make pension contributions (auto-enrolment rules apply if the freelancer would otherwise be classed as a worker)
- The freelancer cannot draw dividends from their limited company for that engagement; they receive a salary net of tax and NI
This changes the economics of engaging a freelancer significantly. A freelancer charging £500 per day inside IR35 costs you more than £500 per day once employer NI is added. And the freelancer receives less net of tax, so they may want a higher day rate to compensate.
A Worked Example
Take a 12-person digital agency in Manchester's Northern Quarter. They engage a freelance developer through their limited company at £450 per day, three days per week. The engagement lasts six months.
If the developer is inside IR35, the agency must:
- Process the £450 per day through payroll
- Deduct employee NI (approx £45 per day at 2025/26 rates)
- Deduct income tax (approx £130 per day, assuming basic rate)
- Pay employer NI of 15% on top (approx £67 per day)
- Pay the developer the net amount of roughly £275 per day
Over six months (78 working days), that is:
- Total cost to agency: £39,390 (£450 + £55 employer NI x 78 days)
- Net pay to developer: £21,450
- Tax and NI to HMRC: £17,940
The developer's limited company receives nothing. The developer pays themselves through the agency payroll, not through their own company. This is why many freelancers push back on inside IR35 determinations. They lose the tax advantages of operating through their own company.
How to Determine IR35 Status
You cannot guess. You must make a reasonable determination based on the specific facts of the engagement. HMRC provides the CEST tool (Check Employment Status for Tax) which gives you a directional answer. It is not perfect, but using it in good faith provides some protection if HMRC later challenges your determination.
The key factors that point towards inside IR35 (employment) include:
- Substitution. Can the freelancer send a substitute? If the contract says no, or the reality is that no substitute would ever be acceptable, that points towards employment.
- Control. Does the agency control what the freelancer does, when they do it, and how they do it? The more control, the more likely inside IR35.
- Mutuality of obligation. Is the agency obliged to offer work, and the freelancer obliged to accept it? Ongoing engagements with regular hours point towards employment.
- Financial risk. Does the freelancer bear any financial risk? Do they invoice for completed work only? Do they have to rectify mistakes at their own cost? If not, that points towards employment.
- Part and parcel. Is the freelancer integrated into the agency's business? Do they attend team meetings, use agency equipment, have an agency email address? The more integrated, the more likely inside IR35.
For agency founders, the reality is that many freelancers who work regularly on your projects, using your systems, under your direction, will be inside IR35. The days of blanket outside IR35 determinations ended in April 2021.
Issuing a Status Determination Statement
If you are a medium or large agency, you must issue an SDS to the freelancer before the engagement begins. The SDS must state:
- Whether the engagement is inside or outside IR35
- The reasons for that determination
- Details of how the freelancer can challenge the determination
You must also keep a record of the SDS for at least six years. HMRC can ask to see it.