IR35 explained for contractors
IR35 sounds complicated, but the core idea is simple: are you genuinely in business for yourself, or working like an employee? Here's what that means for your pay.
In short: Outside IR35, a limited company usually leaves you with more take-home than an umbrella, because profit can be drawn as dividends that avoid National Insurance. Inside IR35, that advantage largely disappears and an umbrella is often the simpler, similarly-priced choice.
Ask two contractors on identical day rates what they take home and you can get two very different answers. The reason usually isn’t the rate — it’s how they’re set up. The two common routes, an umbrella company and your own limited company, are taxed in fundamentally different ways, and the gap between them can run into thousands a year.
The two setups
Through an umbrella company, you become their employee. They receive your assignment rate, take out the employer’s costs and their margin, run PAYE, and pay you a net salary. You get payslips, holiday pay handling and zero company admin.
Through your own limited company, you’re a director and shareholder. The company invoices clients, pays corporation tax on its profit, and you draw money out as a mix of salary and dividends. More control, more admin, and — when you’re allowed to use it — a more tax-efficient way of being paid.
Where the difference comes from
The limited-company advantage is mostly about dividends. A tax-efficient setup pays a modest salary and takes the rest as dividends, which are taxed at lower rates than salary and crucially aren’t subject to National Insurance. That NI saving is the bulk of the gap.
The umbrella route, by contrast, runs everything through PAYE. On top of that, the assignment rate has to absorb employer National Insurance and the apprenticeship levy before your salary is even calculated — which is why your take-home from a given rate feels lower than you’d expect.
You can see the rough size of the gap for your own rate with the Umbrella vs Limited Company Calculator.
The catch: IR35
Here’s the part that decides everything. IR35 is the rule that asks whether you’re genuinely in business on your own account or really working like an employee. If a contract is judged inside IR35, the dividend route is effectively closed and you’re taxed much like an employee regardless of your company — so the limited-company advantage mostly vanishes. Outside IR35, the efficient salary-plus-dividends approach is available and a limited company usually comes out ahead.
If you’re not clear on which side of the line you’re on, the IR35 explainer walks through it.
When the umbrella actually wins
It isn’t always about the headline number. An umbrella means no company accounts, no corporation tax return, no separate business banking, and no responsibility for getting the tax-efficiency right. For a first contract, a short engagement, or anyone who simply doesn’t want the admin, that can be worth more than the extra few thousand. Run your figures, then weigh the gap against the hassle.
This is general information, not financial or tax advice. The right answer depends on your circumstances and IR35 status — confirm with an accountant. See HMRC’s off-payroll working guidance.