IR35 for Recruitment Agencies: Fee Payer, SDS and Margin

“Is it inside or outside?” is a question every contract desk has learned to ask since 2021. But in my experience, a lot of agencies treat the answer as the client’s problem. The client makes the determination, the client sends the paperwork, and the agency just carries on paying the invoice.

The trouble is that for most Ltd contractors placed with a medium or large client, the agency is the one who ends up running the tax. You’re the fee payer. You’re the deemed employer. And if the paperwork doesn’t make it down the chain properly, or the rate doesn’t change when the status does, it’s your margin and your liability on the line.

I’ve spent seven years in recruitment software, and IR35 is one of those areas where a small gap in the process turns into a big number later. I covered the basics in PAYE vs umbrella vs limited company contractors. This post goes deeper on IR35 itself: who’s responsible for what, what a status determination statement has to contain, what it does to your margin, and what to check on every placement.

A quick caveat before we start: this is a plain-English summary of HMRC’s guidance as it stands in October 2026, not tax advice. I’ve linked to the GOV.UK source for every rule, and if you’re unsure about a specific placement, speak to an accountant or a specialist.

The short version

The off-payroll working rules (IR35) apply when a contractor works through their own limited company but would have been an employee if they’d been hired directly (GOV.UK, understanding off-payroll working).
The client decides, if it’s in the public sector or a medium or large private sector business. It has to issue a status determination statement (SDS) with reasons.
If the role is inside IR35, the deemed employer runs the tax. That’s usually the agency paying the contractor’s company: you deduct income tax and employee NI, and you pay employer NI on top.
If the client is small and private sector, the contractor’s own company decides and deals with the tax. You pay the invoice as normal.
Agency size doesn’t matter. Only the client’s size does. A two-person agency has the same responsibilities as a big one (GOV.UK, off-payroll working rules for agencies).

Who is the fee payer, and who is the deemed employer?

These two terms get used interchangeably, but they aren’t quite the same thing.

The fee payer is whoever sits directly above the contractor’s limited company in the chain, which means whoever pays their invoice. If the client contracts with you and you pay the contractor’s company, that’s you. If you raise that invoice yourself, I’ve covered the self-billing rules in self-billing invoices for contractors.

The deemed employer is the party that actually has to operate PAYE. HMRC defines it as the lowest “qualifying person” in the chain who has been given the SDS (HMRC Employment Status Manual, ESM10017). To qualify, you have to:

have been passed the SDS by the party above you,
be UK resident or have a place of business in the UK, and
not be controlled by the worker, or have the worker or their associates holding a material interest in you.

For a typical UK agency paying a contractor’s company directly, that means you’re both the fee payer and the deemed employer, as soon as the SDS lands with you. Until then, the client remains the deemed employer (GOV.UK, deemed employer responsibilities).

It gets more interesting with longer chains. If there’s an overseas agency between you and the contractor, it can’t be the deemed employer, so the responsibility moves up to the lowest UK-based qualifying party, which might well be you. HMRC’s own example in ESM10017 is exactly that.

The status determination statement: what it has to contain

The SDS is the document that moves responsibility down the chain, so it’s worth knowing what makes one valid. According to HMRC, it must:

state the decision (employed or self-employed for tax purposes),
give the reasons for that decision, based on the employment status indicators, and
have been made with reasonable care.

If any of those is missing, the SDS isn’t valid, and the liability stays with the client (GOV.UK, status determination statements). An “inside IR35” label on a job advert isn’t an SDS. A CEST output (HMRC’s Check Employment Status for Tax tool) is an example of a valid one.

There are a few things in the guidance that I think agencies should take more seriously than they do:

You have to pass it on. If there’s another agency below you and you receive an SDS but don’t pass it down, you become the deemed employer, and you stay that way until you pass it on.
No SDS means pay gross. If you don’t receive one, HMRC’s guidance is to pay without deductions, but you can ask the party above you why it hasn’t arrived. Often it’s because the client is small. If you contract with the client directly, you can ask them to confirm their size.
Status is per contract, not per person. The same contractor can be inside IR35 on one placement and outside on another, so a status recorded against the candidate rather than the placement is a red flag.

Disagreeing with a determination

If you’re the deemed employer, you can challenge the client’s determination, and so can the contractor. The client has to consider the reasons, respond within 45 calendar days of receiving them, and keep the tax treatment unchanged while it does. If it changes its mind, it has to withdraw the old SDS and issue a new one with the date it applies from. If it doesn’t respond in time, the client becomes responsible for the tax until it does (GOV.UK, client-led disagreement process).

Two details matter for agencies. First, a disagreement has to give reasons in terms of the status indicators; “my status is wrong” isn’t enough. Second, an agency in the chain that isn’t the deemed employer has no right to use this process at all (HMRC Employment Status Manual, ESM10015).

For the back office, the bit that bites is the effective date. A new SDS can change the tax treatment part-way through a placement, so you need to know which status applied in which week, not just what the status is today.

When the contractor pushes back

An inside determination often reaches the contractor through you, so the pushback usually lands on your desk first. It helps to know what they can and can’t actually change.

If the client is medium or large, the contractor doesn’t get a veto. The client makes the decision, and the formal route is the disagreement process above. Beyond that, a contractor can:

Change the facts, not the label. Status follows the contract terms and how the work is actually done: whether they could really send a substitute, who controls what gets done and how, and what each side is obliged to offer and do (mutuality of obligation). HMRC is clear that written terms don’t count if day-to-day practice says otherwise (GOV.UK, making status determinations). A contractor can negotiate different terms, or give the client evidence it doesn’t have, such as details of their wider business (HMRC Employment Status Manual, ESM11006), but only if it’s true. HMRC treats arrangements contrived to get a particular result as deliberate non-compliance (ESM11010).
Walk away or renegotiate. They can turn the role down, push for a rate that reflects the deductions, or work through an umbrella company instead, where the off-payroll rules are unlikely to apply (GOV.UK, understanding off-payroll working).
Make the call themselves, if the client is small. Then the contractor’s own company decides whether the rules apply and deals with the tax (same GOV.UK page). The next section covers why “small” is trickier than it sounds.

A lot of contractors will also run HMRC’s Check Employment Status for Tax (CEST) tool and come back with a different answer. CEST is a free online questionnaire that anyone can use: the client, the agency or the contractor. Whether you answer as the worker or the hirer doesn’t change the result (ESM11006), and HMRC says it will stand by the result as long as the information is accurate and the tool is used in line with its guidance (GOV.UK, check employment status for tax). It isn’t perfect, and it’s often criticised for how it handles mutuality of obligation. HMRC’s position is that mutuality is a gateway question about whether there’s a contract at all, not something that changes the result (ESM11036). And “unable to determine” is a valid outcome, which HMRC says you shouldn’t fiddle the answers to avoid (GOV.UK, making status determinations).

The important bit for agencies is that a contractor’s own CEST result doesn’t override the client’s SDS. The client still has to take reasonable care, and if it doesn’t, the liability stays with the client (HMRC Employment Status Manual, ESM10014). But a CEST printout shows the answers and the reasoning behind the result, which is exactly what a valid disagreement needs, so it’s useful evidence. If a contractor sends you one, check the answers match how the role really runs, then pass it to the client with the disagreement. HMRC says agencies can use CEST to check a client’s determination too, so if something looks off, run CEST yourself before the placement starts.

Is the client actually small?

The small-client exemption is the reason a lot of Ltd placements never get an SDS at all, so it’s worth getting right.

For companies, a client is medium or large if it meets at least two of three tests for two consecutive financial years: turnover, balance sheet total and more than 50 employees (HMRC Employment Status Manual, ESM10006). The turnover and balance sheet thresholds went up from 6 April 2025, to more than £15 million and more than £7.5 million, for financial years starting on or after that date (ESM10006A).

The catch is timing. Because of how the filing periods work, HMRC says the earliest tax year the new thresholds can change a client’s position is 2027/28. So a client that’s “small now under the new limits” may still be medium or large for IR35 purposes this tax year. And a client’s size applies for the whole tax year, so it’s worth checking again each April rather than once when the account is opened.

To be honest, I’d ask clients to confirm their size in writing, and record it against the client with the tax year it applies to. Assuming is how agencies end up paying gross on placements that should have been inside.

What inside IR35 does to your margin

This is where it shows up in the numbers. As the deemed employer, you deduct income tax and employee NI from the payment to the contractor’s company and pass it to HMRC. That part is money passing through. But employer NI, and the apprenticeship levy if you pay it, must be paid on top. HMRC is clear that it can’t be deducted from the payment to the contractor’s company (GOV.UK, deemed employer responsibilities).

A worked example (illustrative)

These figures are illustrative, with round numbers, to show the mechanics. They use the 2026/27 employer NI rate of 15% above the secondary threshold of £96 a week (GOV.UK, rates and thresholds for employers 2026 to 2027). I’ve left out VAT, the apprenticeship levy and any deductible expenses to keep it simple. It isn’t advice.

Say you’ve placed a Ltd contractor on a 40-hour week, charged to the client at £30 an hour (£1,200), and paying their company £25 an hour (£1,000):

Illustrative, 40-hour week	Outside IR35	Inside IR35, rates unchanged	Inside IR35, pay rate adjusted	Inside IR35, charge rate adjusted
Charge to client	£1,200.00	£1,200.00	£1,200.00	£1,335.60
Paid to contractor’s company (before deductions)	£1,000.00	£1,000.00	£882.09	£1,000.00
Employer NI (15% above £96)	n/a	£135.60	£117.91	£135.60
Total cost to you	£1,000.00	£1,135.60	£1,000.00	£1,135.60
Margin	£200.00 (16.7%)	£64.40 (5.4%)	£200.00 (16.7%)	£200.00 (15.0%)

(The pay rate adjusted column works out at about £22.05 an hour, and the charge rate adjusted column at about £33.39 an hour.)

The second column is the one I worry about. Same contractor, same rates, same client, and the margin drops by about two thirds the moment the status changes. Nothing on the invoice to the client looks any different, so it’s easy to miss until someone runs the margin report.

The last two columns are the two ways to fix it: renegotiate the pay rate down, or the charge rate up, or somewhere in between. Both are commercial conversations, and both are much easier to have before the placement starts than three months in. And note that even the charge rate fix doesn’t get back to 16.7%, because the same £200 is now a smaller share of a bigger invoice.

Where liability lands when it goes wrong

This is the part that makes IR35 more than a margin problem.

If you’re the deemed employer and don’t operate PAYE, the unpaid tax and NI is yours. Since 6 April 2024, HMRC can reduce that bill by tax the contractor and their company already paid on the same income, but only income tax and employee NI. Employer NI and the apprenticeship levy aren’t reduced (HMRC Employment Status Manual, ESM10037). In HMRC’s own case study, the set-off cut the bill by 23% (ESM10038A). Helpful, but nowhere near a get-out.
If you’re the first agency in the chain, liability can come back to you if HMRC can’t collect from parties below you, for example if they’ve been dissolved for reasons other than genuine business failure. GOV.UK’s advice is to think carefully about who you contract with (GOV.UK, off-payroll working rules for agencies).
If someone gives you fraudulent information, such as a false declaration that the worker has no interest in their company, liability moves to whoever first provided it. If you received it in good faith and passed it on, you’re protected (HMRC Employment Status Manual, ESM10023). That protection is only as good as your records of what you were given and when.
If the client’s SDS isn’t valid, or it misses the 45-day deadline on a disagreement, the liability sits with the client rather than you. Again, you’ll only know that if you’ve kept the SDS and the dates.

Umbrella contractors are a separate story. IR35 is unlikely to apply to them, but since April 2026 agencies share liability for umbrella PAYE, which I covered in the PAYE vs umbrella vs Ltd post.

What to check on every Ltd placement

If I were setting up a Ltd placement tomorrow, this is what I’d want recorded against it:

Client size, confirmed in writing, and the tax year it applies to.
The SDS: the decision, whether it gives reasons, the date issued and the date it took effect.
Who the fee payer and deemed employer are, and whether there’s anyone else in the chain (including overseas agencies).
Whether you’ve passed the SDS on, if there’s an agency below you, and when.
Rates that reflect the status, with the margin checked inside IR35, not just outside.
Any disagreement, with the date raised, the 45-day deadline and the outcome.
Changes over time: a new SDS, a new financial year that changes the client’s size, or an extension on different terms. Keep the date each one takes effect, so you know which rules applied in which week.

If that’s living in an inbox and a spreadsheet, it’s going to slip eventually. I’ve written before about how small pay and bill errors compound, and a missed status change is a classic example: one wrong flag, and every timesheet after it is paid and billed on the wrong basis.

Where Paid & Billed fits in

I’m building Paid & Billed for small UK contract desks. The idea is that each placement holds its engagement type and IR35 status, with the dates they apply from, so the right pay, invoice and margin follow from every timesheet. If a status changes part-way through, the weeks before and after are handled differently, rather than relying on someone remembering.

It’s still in development, so I’m not going to pretend it does all of that today. But IR35 is exactly the kind of detail that gets lost between the client, the agency and the payroll, and I’d much rather build it with agencies who deal with it every week.

If that sounds like your desk, join the waitlist and help shape what gets built.