IR35 shapes your corporation tax bill by deciding whether contract income stays inside your personal service company as taxable profit or gets pushed through payroll as employment earnings before corporation tax is calculated. A contract outside IR35 leaves the full invoice in the company, where normal profit rules apply. A contract inside IR35 strips most of that income out as deemed or actual employment pay, so the corporation tax on it drops to near zero, and the salary-and-dividend planning that makes a limited company attractive stops working on that revenue.
How Corporation Tax Works on Outside-IR35 Income
When a contract sits outside IR35, your PSC trades as a normal company. The client pays the invoice gross, and the company works out taxable profit by subtracting allowable expenses from turnover. Allowable costs include professional indemnity insurance, equipment, software subscriptions, employer pension contributions, and any salary paid to you or other staff.
For the financial year starting April 2026, the main rate of corporation tax is 25% on profits above £250,000, and the small profits rate is 19% on profits below £50,000. Between those thresholds, marginal relief applies using a fraction of 3/200, tapering the effective rate.1GOV.UK. Corporation Tax Rates and Allowances Most single-contractor PSCs sit well under £50,000, so 19% is the working rate.
The tax advantage of an outside-IR35 contract is really about extraction. Many contractors take a modest salary near the personal allowance of £12,570 and draw the rest as dividends. Dividends carry no National Insurance, and from April 2026 the first £500 is tax-free, with the basic rate at 10.75%, the higher rate at 35.75%, and the additional rate at 39.35%.2GOV.UK. Changes to Tax Rates for Property, Savings and Dividend Income That combination is what produces the gap between a contractor’s total tax and an equivalent employee’s, and it is the gap IR35 exists to close.
One practical trap for single-director PSCs: the Employment Allowance is not available where the director is the only employee earning above the secondary threshold, so the employer National Insurance saving that other small companies get does not apply.3GOV.UK. Single-Director Companies and Employment Allowance
Inside IR35 Under Chapter 8: The Deemed Payment
Chapter 8 of ITEPA 2003 applies where your PSC is providing services to a small private sector client or a client with no UK connection. In these situations the PSC itself decides whether IR35 applies.4HM Revenue & Customs. Employment Status Manual – ESM10006 If the contract is inside, the company has to work out a “deemed employment payment” and put it through payroll before the tax year ends.
HMRC sets out a nine-step calculation.5GOV.UK. How to Calculate the Deemed Employment Payment The starting figure is the inside-IR35 income the PSC received during the year. A flat 5% allowance for general running costs comes off first, and no receipts are needed for it.6HM Revenue & Customs. Employment Status Manual – ESM8135 Then you deduct expenses a direct employee could have claimed, capital allowances for equipment required by the engagement, employer pension contributions, employer Class 1 NI already paid on salary, and salary and benefits already taxed as employment income. Whatever is left is the deemed payment. Employer NI at 15% is calculated on top of that and also deducted, and the remainder becomes the worker’s taxable pay.7GOV.UK. Rates and Thresholds for Employers 2026 to 2027
The corporation tax effect is large. The deemed payment and the employer NI on it are deductible business expenses, so almost all of the inside-IR35 income leaves the company as payroll cost. What is left as taxable profit is usually the 5% allowance minus what the company actually spent on administration. On £100,000 of inside-IR35 billings, the corporation tax attributable to that income may be only a few hundred pounds.
Inside IR35 Under Chapter 10: When the Client Deducts the Tax
Chapter 10 of ITEPA 2003 applies where the end client is a public sector body or a medium or large private sector organisation. The reformed rules were introduced for the public sector in 2017 and extended to medium and large private sector clients in 2021.8HM Revenue & Customs. Help to Comply with the Reformed Off-Payroll Working Rules (IR35) – Purpose, Scope and Background Under Chapter 10 the client, or the fee-payer in the chain, deducts income tax and NI before paying your PSC. Your company receives a net amount that has already been taxed as employment income.
That changes the corporation tax picture entirely. The gross invoice value still appears in the accounts, but the tax withheld by the fee-payer sits alongside it as a credit. Because the income has already been taxed as earnings, the company has effectively no taxable profit on that contract, and the Chapter 8 deemed payment calculation does not apply.
Keeping the CT600 Clean So You Don’t Pay Twice
The biggest live risk for a PSC that runs a mix of inside and outside contracts is paying corporation tax on income that has already been taxed through payroll. It happens when the CT600 doesn’t properly exclude inside-IR35 income from the profit calculation.
On the return, the company reports total turnover and then makes an adjustment in the tax computation to remove income already taxed under the off-payroll rules. For Chapter 10 contracts, the fee-payer’s payslips or payment summaries show the PAYE and NI deducted. For Chapter 8 contracts where the PSC ran its own deemed payment, the RTI submissions are the evidence, and on the final Full Payment Submission of the tax year the PSC has to indicate it is a service company operating the intermediaries legislation.9GOV.UK. File Your Accounts and Company Tax Return
For Chapter 10 engagements, keep the Status Determination Statement the client issues. A valid SDS has to state whether the worker would be employed or self-employed for tax if engaged directly, give reasons, and show reasonable care.10HM Revenue & Customs. Status Determination Statements (Part 9) Missing any of those three, the SDS is invalid and responsibility for deducting tax stays with the client. Either way, holding copies of every SDS is how you defend your corporation tax position if HMRC opens a check.
Funds left in the company after PAYE and NI have been settled are treated as already taxed for corporate purposes. They can be paid out as dividends or retained without a further corporation tax charge.
The Offset Mechanism If HMRC Reclassifies a Contract
Before April 2024, an HMRC investigation that reclassified an outside-IR35 contract as inside could produce genuine double taxation. The client or fee-payer owed the PAYE and NI that should have been deducted, while the PSC had already paid corporation tax and the contractor had already paid income tax on dividends drawn from those profits. The same money was taxed twice, and unwinding it was slow.
The IR35 offset, which took effect on 6 April 2024, lets HMRC credit taxes the contractor has already paid against what the client or fee-payer now owes. The offset covers corporation tax paid by the PSC, income tax paid by the contractor on salary and dividends from the engagement, and employee NI contributions (Class 1 employee, Class 2, and Class 4). It does not cover employer NI or VAT.
To use the offset, the client or fee-payer gives HMRC the contractor’s name, National Insurance number, and company details so records can be matched. Both parties receive a direction notice confirming the years affected and the offset amount, and the contractor can appeal the figures. It applies to engagements going back to 2017 for the public sector and 2021 for the private sector, provided the case was still open in April 2024, but not to cases already settled before that date.
For corporation tax planning this changes the shape of the downside. Where a reclassification once meant employment taxes stacked on top of corporation tax and dividend tax already paid, the previously paid amounts now come off the new liability. What is left is mainly the employer NI that was never paid in the first place.
Penalties, Interest, and Using CEST
An incorrect deemed payment or a failure to operate PAYE on an inside-IR35 contract falls under HMRC’s inaccuracy penalty framework. The percentage depends on the behaviour:
- Careless errors (lack of reasonable care): 0% to 30% of the additional tax due
- Deliberate errors: 20% to 70% of the additional tax due
- Deliberate and concealed errors: 30% to 100% of the additional tax due
Within each band the exact figure turns on whether the disclosure was unprompted or prompted and on the quality of the disclosure.11HM Revenue & Customs. Penalties – An Overview for Agents and Advisers An unprompted disclosure of a careless error can drop the penalty to zero. A deliberate error found during an investigation, with an uncooperative taxpayer, pushes toward the top of the range.
On top of penalties, late payment interest runs daily from the statutory due date. Corporation tax is due nine months and one day after the end of the accounting period. If PAYE and NI from an unprocessed deemed payment are also owed, interest on those runs from the date they should have gone through payroll.
HMRC’s Check Employment Status for Tax tool supports an IR35 determination. HMRC commits to standing by the CEST result provided the information entered is accurate, so running it and saving the output gives you a defensible position if the status decision is later challenged.12GOV.UK. Check Employment Status for Tax
Records You Have to Keep
Your PSC must keep business records for at least six years from the end of the financial year they relate to. You keep them longer for transactions spanning more than one accounting period, for assets expected to last more than six years, where the return was filed late, or where HMRC has opened a compliance check.13GOV.UK. Running a Limited Company – Your Responsibilities
For IR35, the records that matter most sit alongside normal bookkeeping: every contract and statement of work, every SDS received from a client, the output from any CEST checks, deemed payment calculations for Chapter 8 contracts, payslips and PAYE records for both regular salary and deemed payments, and evidence of expenses claimed against inside-IR35 income. Failing to keep adequate accounting records can bring a £3,000 fine or director disqualification.13GOV.UK. Running a Limited Company – Your Responsibilities
If the PSC runs both inside and outside IR35 contracts, keeping separate accounting streams for each is what keeps the year-end filing straightforward. Mixed ledgers are where most errors start, and reconstructing them for HMRC is slow and expensive.
Winding Up the PSC: Watch the TAAR
One boundary worth flagging. If you close your PSC and extract retained profits as a capital distribution, the Targeted Anti-Avoidance Rule can reclassify that distribution as a dividend taxed at income tax rates. Capital Gains Tax with Business Asset Disposal Relief can be as low as 10%, while dividend rates from April 2026 start at 10.75% and rise to 39.35%.
TAAR bites when three conditions are met: the company was a close company (almost every PSC is), the person receiving the distribution continues to carry on the same or a similar trade personally, through a connected person, or through another company they control, and it is reasonable to assume the winding up was part of arrangements to secure a tax advantage. If you are genuinely retiring, changing career, or moving into employment, TAAR is unlikely to apply. If you liquidate the PSC and set up a new one doing similar work, HMRC will treat the distributions as dividends.