How Does IR35 Apply When Your Agency Engages Freelancers?

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 13.8% 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 13.8% on top (approx £55 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.

If the freelancer challenges your determination, you must respond within 45 days. If you do not respond, or if you reject their challenge without reasonable grounds, the responsibility for the correct tax treatment shifts back to you.

What Happens If You Get It Wrong

HMRC can investigate your IR35 compliance at any time. If they find that a freelancer should have been inside IR35 but was treated as outside, they will issue a tax bill for:

• The unpaid income tax and employee NI that should have been deducted
• The employer NI that should have been paid
• Interest on the late payments
• Penalties, which can be up to 100% of the tax due in cases of deliberate non-compliance

For a six-month engagement at £450 per day, that could easily be a £17,000 bill plus penalties. For multiple freelancers over multiple years, the numbers become significant.

HMRC also has the power to transfer the liability down the chain. If the end client fails to pay, HMRC can come to you as the agency. If you fail to pay, they can go to the freelancer. Someone will pay. It is better that it is you, correctly, from the start.

Practical Steps for Agency Founders

1. Review Every Freelancer Engagement

Do not assume that because someone works through a limited company, they are automatically outside IR35. Review each engagement on its own facts. Use the CEST tool as a starting point, but get professional advice for borderline cases.

2. Use Proper Contracts

Your contract with the freelancer should reflect the reality of the working relationship. If you say the freelancer can send a substitute but never accept one, the contract is misleading. HMRC will look at what happens in practice, not what the contract says.

If you genuinely want the freelancer to be outside IR35, the contract and the working practices must align. That means no control over hours or methods, genuine substitution rights, and the freelancer bearing financial risk.

3. Keep Records

For each freelancer, keep:

• The SDS you issued
• The CEST output or other evidence supporting your determination
• The contract
• Any correspondence about the determination
• Payroll records showing tax and NI deducted (if inside IR35)

HMRC can ask for these records up to six years after the engagement ends.

4. Consider Umbrella Companies

Some agencies prefer to use umbrella companies for freelancers who are inside IR35. The umbrella company becomes the employer, handles payroll, and takes on the compliance burden. This can be simpler, but you need to choose a reputable umbrella company. There are many bad actors in this space who do not operate compliantly.

If you use an umbrella company, you still need to issue an SDS to the freelancer. The umbrella company does not remove your obligation to make a reasonable determination.

5. Get Professional Advice

IR35 is not a set-and-forget area. The rules change, HMRC's interpretation evolves, and your freelancer arrangements change as your agency grows. Working with an ICAEW qualified accountant who understands agency finances and IR35 compliance is essential.

At Agency Founder Finance, we work exclusively with agency founders. We know the IR35 freelancers agency landscape because we deal with it daily. If your contractor mix has changed in the last 12 months, ask your accountant before year-end. If you do not have an accountant who understands agency IR35, speak to us.

Common Questions Agency Founders Ask

Can I engage a freelancer through an agency to avoid IR35?

No. Using an agency as an intermediary does not remove your responsibility. If you are the end client and the freelancer is inside IR35, you are responsible for the determination and the tax treatment, regardless of how the freelancer was introduced to you.

What if the freelancer insists they are outside IR35?

That is their opinion. Your legal obligation is to make a reasonable determination based on the facts. If you determine they are inside IR35, you must treat them as such. The freelancer cannot override your determination. If they disagree, they can challenge the SDS, but the tax treatment applies from day one.

Do I need to issue an SDS for every freelancer?

Yes, if your agency is medium or large. For every freelancer who works through their own limited company, you must issue an SDS before the engagement begins. This applies even for short engagements. A two-week freelance project still requires an SDS.

What about overseas freelancers?

IR35 applies to engagements where the work is performed in the UK or where the end client is UK-based. If you engage a freelancer based overseas who works entirely outside the UK, IR35 may not apply. But if that freelancer works on UK projects, from a UK location, or under UK direction, IR35 likely applies. This is a complex area. Take specific advice.

The Bottom Line on IR35 Freelancers Agency Compliance

IR35 is not going away. HMRC is actively investigating agencies, and the penalties for non-compliance are significant. The days of treating all freelancers as outside IR35 are over.

The good news is that compliance is straightforward once you have a process in place. Review each engagement, issue the SDS, deduct the correct tax, and keep records. Do that consistently, and you will have no issues.

If you are unsure about any aspect of IR35 compliance for your agency, get in touch. We help agency founders across the UK, from Shoreditch to Bristol Harbourside to Manchester's Northern Quarter, get their contractor compliance right.