IR35 in Construction Explained: A Practical Guide for Contractors Hiring Subcontractors

Hiring subcontractors is an essential part of running most construction businesses, but getting a worker's employment status wrong can expose contractors to significant tax liabilities and unnecessary risk.

Although many subcontractors operate under the Construction Industry Scheme (CIS), CIS registration does not automatically mean a worker is genuinely self-employed for tax purposes. IR35 is a separate set of tax rules that looks beyond the written contract and considers how the working relationship operates in practice.

If HMRC concludes that a subcontractor should have been treated as an employee, a contractor could become liable for unpaid PAYE, National Insurance contributions, interest and penalties. Understanding how IR35 applies in the construction industry is therefore an important part of managing both compliance and financial risk.

This guide explains how IR35 in construction works, the factors HMRC considers when assessing employment status, and the practical steps contractors can take when engaging subcontractors.

1. What Is IR35?

IR35 is a set of UK tax rules designed to prevent individuals from avoiding employment taxes by providing their services through an intermediary, such as a personal service company (PSC), when their working arrangement is similar to employment.

Rather than relying solely on the written contract, HMRC considers the reality of the working relationship. This is often referred to as "substance over form". Even if a contract describes someone as self-employed, HMRC may decide they should be treated as an employee if the day-to-day working arrangements indicate an employment relationship.

For construction contractors, this means it is not enough to issue a subcontract agreement and deduct CIS where applicable. Contractors should also consider whether the individual is genuinely operating as an independent business or whether the engagement has characteristics of employment.

While many construction subcontractors work as sole traders and fall outside the scope of IR35, the rules can become relevant where services are provided through a limited company. Understanding the difference can help contractors reduce tax risk and make informed decisions before engaging subcontractors.

2. IR35 vs CIS: What's the Difference?

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2. IR35 vs CIS: What's the Difference?

One of the biggest misconceptions in the construction industry is that if a worker is registered under the Construction Industry Scheme (CIS), they are automatically considered self-employed. This is not the case.

Although both IR35 and CIS relate to the construction industry and taxation, they serve entirely different purposes.

The Construction Industry Scheme (CIS) is a tax deduction scheme that requires contractors to deduct tax from payments made to many subcontractors and pay those deductions to HMRC on the subcontractor's behalf.

IR35, on the other hand, is concerned with employment status for tax purposes. It considers whether an individual providing services through their own limited company is genuinely operating as an independent business or is effectively working as an employee.

This distinction is important because a subcontractor can be paid under CIS while HMRC still questions whether the working arrangement should be treated as employment for tax purposes.

Before engaging a subcontractor who operates through a limited company, contractors should consider both the CIS rules and whether an IR35 assessment is required.

IR35 and CIS compared

Construction Industry Scheme (CIS)	IR35
Tax deduction scheme	Employment status rules for tax
Applies to payments made to subcontractors	Applies where services are provided through an intermediary, such as a limited company
Determines how CIS deductions are made	Determines whether PAYE and National Insurance should apply
Administered through monthly CIS Returns	Assessed by reviewing the actual working relationship
Does not determine employment status	Looks beyond the written contract to how the work is carried out in practice

3. How HMRC Assesses Employment Status

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3. How HMRC Assesses Employment Status

When considering whether IR35 applies, HMRC looks at the reality of the working relationship rather than simply relying on the written contract. This means that even a well-drafted subcontract agreement may carry little weight if day-to-day working practices suggest an employment relationship.

There is no single factor that determines employment status. Instead, HMRC considers the overall picture, with particular attention given to three key areas.

3.1 Control

One of the strongest indicators of employment is the level of control exercised over how the work is carried out.

In the construction industry, it is normal for contractors to specify what work needs to be completed, the required quality standards and project deadlines. However, this is different from controlling how an experienced subcontractor performs their work.

For example, a self-employed electrician may be instructed to complete the first-fix installation by a specified date while deciding independently how the work is organised and completed. In contrast, if the contractor controls the subcontractor's daily tasks, working hours, methods and supervision in the same way as an employee, this could indicate an employment relationship.

It is also important to recognise that health and safety requirements, site inductions and compliance with site rules are normal on construction projects and do not, on their own, indicate employment.

3.2 Right of Substitution

HMRC also considers whether the subcontractor has a genuine right to send someone else to complete the work.

A genuine business is often able to provide a suitably qualified substitute if the original subcontractor is unavailable, provided the replacement meets the contractor's reasonable competency and health and safety requirements.

If, however, the contractor expects the work to be completed by one specific individual and would not accept an alternative, this may suggest a relationship that is closer to employment.

The key consideration is whether the right of substitution exists in practice, rather than simply appearing in the written contract.

3.3 Mutuality of Obligation

Another important factor is whether both parties are obliged to continue offering and accepting work.

Many construction subcontractors are engaged for a specific project or package of work. Once that work is completed, the relationship may naturally come to an end without any expectation of further work.

An employment relationship is more likely where:

• the contractor is expected to provide continuous work,

• the individual is expected to accept that work,

• there is no genuine opportunity to decline future engagements.

Project-based engagements with clearly defined start and finish dates are generally more consistent with genuine self-employment than open-ended arrangements resembling permanent employment.

Remember: HMRC Looks at the Whole Picture

Although control, substitution and mutuality of obligation are among the most important considerations, HMRC does not base its decision on a single factor.

Other aspects of the working relationship may also be relevant, including:

• Whether the subcontractor works for multiple clients.

• Who provides tools, equipment and materials.

• Whether the subcontractor bears financial risk.

• Whether they correct defective work at their own expense.

• How they invoice for their services.

• Whether they market themselves as an independent business.

Ultimately, HMRC assesses the overall relationship rather than applying a simple checklist. Contractors should therefore ensure that both their contracts and their day-to-day working arrangements accurately reflect genuine self-employment.

4. Practical Steps Before Engaging a Subcontractor

Understanding how HMRC assesses employment status is only part of the process. Before engaging a subcontractor, contractors should take practical steps to ensure the working arrangement genuinely reflects an independent business relationship.

Although every engagement should be considered on its own facts, the following checks can help reduce risk and demonstrate good compliance.

4.1 Consider How the Individual Will Work

Before agreeing terms, think about how the subcontractor will carry out the work in practice.

Ask yourself:

• Will they decide how the work is completed?

• Can they organise their own working methods?

• Are they engaged for a specific project or package of work?

• Will they be free to work for other clients?

The answers should reflect a genuine business-to-business relationship rather than one that resembles employment.

4.2 Ensure the Written Contract Reflects Reality

A well-written subcontract agreement is important, but it should accurately reflect the way the work is actually carried out.

HMRC places greater weight on the reality of the working relationship than the wording of a contract. If the contract states that a subcontractor has complete independence but, in practice, they work under the same conditions as employees, the written agreement is unlikely to determine the outcome.

Contracts and day-to-day working practices should therefore remain consistent throughout the engagement.

4.3 Keep Evidence of Genuine Self-Employment

Good record keeping can help demonstrate that appropriate consideration was given before engaging a subcontractor.

Useful evidence may include:

• A signed subcontract agreement.

• Evidence that the subcontractor operates through their own business.

• Public liability insurance where appropriate.

• Copies of quotations or invoices.

• Correspondence confirming the agreed scope of work.

• Evidence that the subcontractor works for other clients where applicable.

Maintaining organised records can make it easier to respond if HMRC ever reviews the engagement.

4.4 Review Long-Term Working Arrangements

Employment status is not something that should only be considered at the start of a project.

A subcontractor who was genuinely self-employed at the beginning of an engagement may gradually become integrated into the business if the working relationship changes over time.

For example, warning signs may include:

• Working exclusively for one contractor over an extended period.

• Carrying out the same role as employed staff.

• Being closely supervised on a daily basis.

• Having little commercial independence.

• Being expected to accept ongoing work without interruption.

Regularly reviewing long-term subcontractor arrangements can help identify potential risks before they become a problem.

4.5 Seek Professional Advice When You're Unsure

Employment status can be one of the more complex areas of UK tax legislation, particularly where subcontractors operate through limited companies or where working arrangements change during a project.

Seeking professional advice before entering into a new arrangement is often far simpler and less costly than resolving disputes or HMRC enquiries later.

Taking time to assess employment status properly can help contractors reduce tax risk, protect cash flow and demonstrate that reasonable care has been taken when engaging subcontractors.

Conclusion

Understanding IR35 in construction is about more than complying with tax legislation. It is about protecting your business from unnecessary financial risk and ensuring that subcontractor arrangements genuinely reflect independent working relationships.

While many construction businesses regularly engage subcontractors, every working arrangement should be considered on its own facts. Taking time to review employment status, ensuring contracts reflect reality and maintaining appropriate records can significantly reduce the risk of future HMRC disputes.

As construction businesses grow, managing compliance alongside CIS, VAT, payroll and day-to-day bookkeeping becomes increasingly important. Having robust financial systems in place not only helps reduce risk but also provides greater confidence when taking on new projects and expanding your workforce.

If your business needs support with construction bookkeeping, CIS administration, VAT, payroll or wider construction accounting, Vau Consult provides practical finance support tailored specifically to contractors, subcontractors and construction SMEs.

Frequently Asked Questions

Does having a CIS number prove that a subcontractor is self-employed?

No. CIS registration and verification determine how qualifying construction payments should be processed. They do not conclusively determine whether an individual is employed or self-employed.

Does IR35 apply to sole traders?

IR35 generally concerns individuals providing services through an intermediary, commonly their own limited company.

A sole trader can still be considered an employee for tax purposes, but this is normally dealt with under the ordinary employment-status rules rather than IR35.

Does working through a limited company automatically mean outside IR35?

No. The purpose of IR35 is to examine situations where an individual supplies services through a limited company or other intermediary but works in a way that resembles employment.

Can HMRC disregard a written subcontract agreement?

HMRC can examine the actual working relationship rather than relying only on the description used in the agreement.

The contract remains important, but it should accurately reflect the real working practices.

Does using personal tools prove self-employment?

No single factor proves self-employment. Providing significant tools or equipment may support an outside-IR35 or self-employed position, but control, personal service, financial risk and the wider business relationship must also be considered.

Can a subcontractor work for one contractor and remain self-employed?

Working for one contractor is a relevant consideration but is not automatically decisive.

The complete relationship must be assessed, including control, substitution, financial risk, equipment, payment arrangements and whether the subcontractor operates an independent business.

Should every subcontractor receive the same status decision?

No. Employment status and IR35 should be assessed on an engagement-by-engagement basis.

Different subcontractors performing similar roles may have different working arrangements and therefore different status outcomes.

This article provides general information and should not be treated as legal or tax advice for a specific engagement. Employment status and IR35 decisions depend on the individual facts and working arrangements.