IR35 for Agencies: Responsibilities and Compliance

Recruitment agencies sit at the centre of the IR35 supply chain, and the off-payroll working rules have given them significant new responsibilities. As the fee-payer in most contractor engagements, agencies bear the obligation to deduct PAYE tax and National Insurance when a contractor is determined to be inside IR35. Getting this wrong exposes the agency to substantial financial liability — including the tax that should have been deducted, plus interest and penalties.

In this guide, I will explain exactly what agencies need to know about IR35, their legal obligations, and how to manage compliance without alienating the contractors they depend on.

The Agency's Role in the IR35 Supply Chain

Under the off-payroll working rules, the responsibilities are distributed across three parties:

The end client (medium or large private sector, or public sector) is responsible for determining whether a contractor falls inside or outside IR35. They must issue a Status Determination Statement (SDS) to the contractor and the next party in the chain — typically the agency.

The agency (the fee-payer) is responsible for applying the client's determination. If the SDS says the contractor is inside IR35, the agency must deduct PAYE income tax, employee National Insurance, and pay employer National Insurance before paying the contractor's personal service company.

The contractor receives the SDS and has the right to challenge it. If they disagree with the determination, the client must have a dispute resolution process in place.

The critical point for agencies is that liability follows the fee-payer. If the client fails to make a determination or makes an incorrect one, and the agency does not take reasonable care, the tax liability can transfer to the agency. This makes compliance not just an obligation but a matter of financial self-preservation.

According to HMRC's fee-payer guidance, the fee-payer is the party that pays the worker's intermediary (the PSC) and is responsible for operating PAYE where required.

Due Diligence: What Agencies Must Do

Agencies cannot simply apply whatever the client tells them without question. They have a duty of care to ensure the determination process is reasonable. Here is what good due diligence looks like:

Confirm the client's size. The off-payroll rules only apply to medium and large private sector clients (and all public sector bodies). If the client is small (meeting two of: turnover under £10.2 million, balance sheet under £5.1 million, fewer than 50 employees), the responsibility falls on the contractor's PSC, not the agency. However, the agency should verify this rather than taking the client's word for it.

Obtain the SDS. Before placing a contractor, ensure the client has provided a Status Determination Statement. This should be in writing and should include the client's conclusion (inside or outside IR35) and the reasons for that conclusion.

Check the SDS is reasonable. While agencies are not expected to be IR35 experts, they should sense-check the SDS. If a client determines that every single contractor is outside IR35 regardless of their working practices, that is a red flag. Similarly, blanket inside IR35 determinations without individual assessment are not compliant.

Maintain records. Keep copies of all SDSs, correspondence with clients about IR35 determinations, and records of any contractor disputes and their resolution.

Apply the determination correctly. If the SDS says inside IR35, set up the payroll deductions. If it says outside, pay the contractor's PSC gross. If the client has not provided an SDS, treat the engagement as inside IR35 to protect the agency.

What Happens When Clients Get It Wrong

One of the biggest risks for agencies is liability transfer. If the end client fails to take reasonable care in their IR35 determination, the tax liability can transfer down the chain to the fee-payer — the agency.

This means that if HMRC investigates and finds that a contractor should have been inside IR35, and the client's determination process was inadequate, the agency may be liable for:

• The PAYE income tax that should have been deducted
• The employee National Insurance that should have been deducted
• The employer National Insurance
• Interest on the above amounts
• Potential penalties

The potential financial exposure is enormous. For a single contractor earning £100,000 per year who was incorrectly classified as outside IR35, the agency's liability could exceed £30,000 per year. Multiply this across multiple contractors and multiple years, and the figures become existential.

To protect against this, agencies should:

• Document their due diligence process
• Challenge clients who provide unreasonable determinations
• Consider IR35 insurance products
• Seek legal advice on their processes

Managing Contractor Relationships

IR35 compliance creates friction in the agency-contractor relationship. Contractors who believe they are genuinely outside IR35 may resent being placed inside, and some will refuse to work through agencies that automatically apply inside IR35 determinations.

Agencies can manage this by:

Being transparent. Explain the process to contractors clearly. Many contractors understand that the agency is following the client's determination, not making the decision themselves.

Facilitating the dispute process. If a contractor disagrees with the client's determination, help them access the dispute resolution process. Acting as a neutral intermediary can preserve the relationship.

Offering both inside and outside IR35 roles. Clearly marketing roles by their IR35 status helps contractors make informed decisions about which engagements to pursue.

Adjusting rates. Where possible, negotiate higher rates for inside IR35 roles to partially offset the contractor's increased tax burden. This makes inside IR35 roles more palatable for contractors.

For a contractor's perspective on how IR35 affects their finances, see my guide on inside vs outside IR35 financial impact.

Compliance Frameworks for Agencies

Establishing a robust IR35 compliance framework protects the agency and demonstrates reasonable care. A good framework includes:

Standard operating procedures for obtaining and reviewing SDSs from clients.

Training for agency staff on IR35 basics, so they can identify obvious issues with client determinations.

Escalation processes for cases where the client's determination seems unreasonable or where the contractor disputes.

Record-keeping systems that store SDSs, correspondence, and payroll records in an organised, auditable manner.

Regular reviews of the compliance process to ensure it remains current with any legislative changes.

Legal review of the agency's standard contracts to ensure they reflect IR35 obligations correctly.

According to the Recruitment and Employment Confederation (REC), agencies should treat IR35 compliance as a core business process rather than an afterthought.

Common Mistakes Agencies Make

Applying blanket determinations. Some agencies apply inside IR35 to all contractors to avoid risk. While this eliminates the agency's liability, it is not compliant with the off-payroll rules, which require individual assessment. It also drives away contractors and reduces the agency's talent pool.

Not obtaining SDSs before placement. Starting a contractor without an SDS in place creates a compliance gap and potential liability.

Ignoring contractor disputes. When a contractor disputes an SDS, the agency must pass the dispute to the client. Ignoring disputes or pressuring contractors to accept is not compliant.

Failing to update assessments. If a contractor's working practices change significantly during an engagement, a fresh determination may be needed.

Not checking client size. Assuming all clients are medium or large can result in unnecessary inside IR35 determinations for contractors working for small companies.

IR35 and the Construction Industry

Agencies placing contractors in the construction industry face additional complexity because the Construction Industry Scheme (CIS) interacts with IR35. A contractor who is inside IR35 but also subject to CIS deductions presents a complex compliance scenario.

For more on this interaction, read my article on IR35 and CIS overlap.

Practical Advice for Agencies

IR35 compliance is not going away. The legislation is firmly established, and HMRC is increasingly focused on enforcement. Agencies that build robust compliance processes now will be better positioned to attract clients and contractors, avoid liability, and operate with confidence.

Start by reviewing your current processes against the framework outlined above. Identify gaps, invest in training, and — if you have not already — engage a specialist adviser to review your compliance approach.

For the broader contracting picture, including tax calculations and self-assessment, Accounted helps contractors manage their finances effectively. Agencies can recommend Accounted to their contractors as a tool for managing both inside and outside IR35 engagements. Learn more on our features page.

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