Writing for Taxation magazine, Employment Taxes Director Stephen Baker and Tax Transactions Senior Manager Michelle Bryan analyse the IR35 (off-payroll working) rules, their cross-border aspects, and what UK businesses should consider when engaging overseas personal service companies (PSCs).
Key points
- The increasingly globalised nature of work has exposed gaps and ambiguities regarding how IR35 rules apply to overseas individuals and entities.
- Significant compliance considerations for UK businesses engaging overseas PSCs, particularly where the contractual supply chain includes non-resident entities.
- The draft legislation for Finance Bill 2025-26 introduces several measures designed to strengthen compliance across labour supply chains, including the potential imposition of joint and several liability for unpaid PAYE and NICs.
- In the event of non-compliance with PAYE or NIC obligations, liability could fall back upon the UK client or associated recruitment agency.
- HMRC could pursue unpaid liabilities not only against domestic umbrella companies but potentially against the UK entities that contract with overseas intermediaries.
Steering a clear course
The landscape of IR35 compliance in the UK has undergone significant evolution, particularly in the aftermath of the Covid-19 pandemic, accelerating global workforce integration and remote working practices. This shift has brought renewed focus to the tax and legal implications of engaging overseas contractors and personal service companies (PSCs), especially given the complex interplay between domestic UK rules and international tax frameworks.
This article aims to provide an up-to-date analysis of the cross-border aspects of IR35, highlighting the challenges for UK businesses engaging overseas PSCs and exploring some of the possible implications of the July 2025 draft umbrella company legislation.
Background and scope of IR35
Introduced in 2000, IR35 (or more recently the Off Payroll Workers legislation) was designed to counter disguised employment, ensuring individuals who effectively operate as employees rather than as genuine self-employed contractors are taxed accordingly.
Historically, IR35 has primarily targeted UK-based contractors operating through their own intermediaries, notably PSCs. However, the increasingly globalised nature of work has exposed gaps and ambiguities regarding how these rules apply to overseas individuals and entities.
The complexities intensify where overseas PSCs supply services to UK clients, or where non-resident company directors and international employees are involved. HMRC has grappled with enforcing IR35 across borders due to jurisdictional constraints, varying national tax regimes and the difficulty of applying employment status tests internationally. The legal interpretations hinge on nuanced distinctions between residence, place of work and the location of the contracting entity.
Impact of Covid-19 on IR35 and remote working
The Covid-19 pandemic acted as a catalyst, normalising remote working arrangements and blurring the traditional boundaries of employment location. We have noted in the profession that many UK businesses increasingly rely on overseas contractors, often unaware of the full tax consequences. This paradigm shift has heightened the risk of inadvertent non-compliance with IR35 rules and related obligations such as the requirement to operate PAYE on deemed payments.
Pre-pandemic, overseas PSCs engaged by UK clients operated in a relatively grey area, with HMRC enforcement constrained by practical and legal challenges. Since 2021, HMRC has intensified its focus on IR35 compliance, including the overseas element, leveraging data analytics and increased international cooperation. For UK businesses, this requires enhanced due diligence, revised contract structures and often the introduction of robust compliance frameworks tailored around international engagement.
The legislative position
The IR35 rules are primarily legislated under Part 2 of ITEPA 2003, with the operative provisions split between Chapter 8 (s 48 to s 61) and Chapter 10 (s 61N to s 61T). While both chapters seek to counter ‘disguised employment’ through the use of intermediaries – typically a PSC – the responsibility for assessing and operating PAYE and NIC differs fundamentally.
ITEPA 2003, Chapter 8, often referred to as the ‘old rules’, applies where an individual provides services to an end user through an intermediary and the client is a ‘small company’ (as defined in s 60A and by reference to the Companies Act 2006, s 382), or is located wholly overseas. In such cases, it remains the intermediary’s responsibility (typically the PSC) to determine whether the arrangements fall within IR35 and, if so, to account for deemed employment income under s 54. The calculation methodology of the deemed payment and associated deductions is set out in ss 54-61.
By contrast, Chapter 10 – introduced by the Finance Act 2017, with effect from April 2017 in the public sector and extended to medium and large private sector entities from April 2021 – shifts the operational compliance responsibilities to the client (ie the end-user) where the client is UK-based and not ‘small’. Under s 61N, the client must assess the deemed employment status and provide a status determination statement (SDS) (s 61NA). Where the rules apply, the fee-payer (often the agency or client making chain payment to the PSC) must operate and account for PAYE and NICs (s 61T).
Consequently, where the client does not meet HMRC’s territorial conditions (eg where it is wholly overseas), Chapter 10 does not apply, and responsibility for IR35 compliance remains with the intermediary under Chapter 8. For cross-border engagements, this distinction between Chapters 8 and 10 is critical. This can create significant compliance considerations for UK businesses engaging overseas PSCs, particularly where the contractual supply chain includes non-resident entities, which may not always be apparent at the outset.
The July 2025 draft legislation and its implications
On 21 July 2025, as part of draft legislation for Finance Bill 2025-26, the UK government published a policy paper titled Umbrella companies – tackling non-compliance in the umbrella company market. This represents a further development in the broader framework of employment tax compliance.
Although the legislation is primarily aimed at umbrella companies operating within the UK, its ramifications may extend, in certain circumstances, to overseas contractors who provide services to UK clients via their own PSCs. The draft legislation introduces several measures designed to strengthen compliance across labour supply chains, including the potential imposition of joint and several liability for unpaid PAYE and NICs. The intention is to ensure that parties in the chain, from umbrella companies to recruitment agencies and end clients, are held accountable for the accurate operation of UK payroll obligations.
The implications for overseas PSCs arise primarily through the concept of joint and several liability. UK businesses engaging contractors through PSCs – particularly those operating outside the UK – must now consider that, in the event of non-compliance with PAYE or NIC obligations, liability could fall back upon the UK client or associated recruitment agency. This is especially relevant where a UK client exercises significant control over the contractor’s work, or where the PSC is effectively managed or directed from the UK.
In essence, the legislation extends a layer of accountability along the supply chain, ensuring that HMRC could pursue unpaid liabilities not only against domestic umbrella companies but potentially against the UK entities that contract with overseas intermediaries.
While the July 2025 draft legislation does not directly amend IR35, it represents a significant reinforcement of compliance expectations within the UK labour supply chain. For overseas PSCs providing services to UK clients, the legislation signals that UK-engaged parties may be held accountable for PAYE and NIC compliance, and that any attempt to circumvent UK employment tax obligations through offshore intermediaries could attract enforcement activity.
Challenges for UK businesses with overseas PSCs
One of the principal challenges for UK businesses lies in correctly determining employment status when the contractor operates offshore. To ensure best practice, a review should always be undertaken to understand where the individual will be physically performing their duties, as well as understanding their own tax and social security position.
For the reasons already outlined above, it’s critical to establish whether an overseas contractor falls within the scope of UK income tax and NICs. Factors to consider are:
- where the person is resident;
- whether they spend any days in the UK (if so, how many); and
- whether they perform substantive work in the UK (for NIC purposes, we also consider whether the worker is gainfully employed in the UK).
If a UK business engages with an overseas contractor who does no work in the UK, it may be reasonable to assume that they are outside the scope of UK income tax (and social security) and therefore no status assessment is required, although this does need to be looked at in detail.
If a contractor is within the scope of UK income tax, their employment status will need to be assessed, and the traditional tests applied – such as mutuality of obligation, control and personal service. However, for overseas-based contractors, these tests should be considered in a cross-jurisdictional context. This often requires deep legal and tax expertise, as factors such as governing law, place of performance and contractual terms can materially affect the status analysis.
Furthermore, where overseas PSCs are subject to local taxation regimes, there is a risk of double taxation or non-alignment between UK and foreign tax authorities. UK businesses must consider double taxation treaties, transfer pricing rules and permanent establishment (PE) risks, which may expose both parties to additional compliance reporting and unintended tax liabilities.
The use of employers of record (EoR) enables businesses to ‘outsource’ their employment and related administration (such as payroll) to a third party in a cost-effective way; however, consideration would need to be given to corporate tax risks and employee integration in an outsourced model, and local specialist advice in the relevant overseas jurisdiction should always be sought to understand the domestic legislation.
The administrative burden on UK businesses and engagers is not inconsiderable. They must implement and embed processes to collect accurate data on overseas contractors, monitor material changes in their working patterns and status, plus ensure the correct payroll treatment is applied. Failure to carry out these administrative steps can result in significant penalties, including retrospective tax and NIC assessments and interest charges.
Residency rules and employment status
Non-resident company directors and international employees present another layer of complexity. IR35’s applicability depends on whether the individual is performing duties personally and if the working relationship mirrors employment. For non-resident directors, residency rules under the statutory residence test (SRT) affect tax treatment and social security liabilities.
UK companies must assess the employment status of non-resident directors with reference to both UK domestic law and applicable international conventions. The nuances of cross-border director appointments, the location of board meetings, and the operational control exercised by the individual can influence whether IR35’s deeming provisions apply.
The increasing prevalence of international remote working arrangements complicates the matter, requiring continuous review of the evolving tax landscape, including ongoing discussions around digital services taxation and global minimum tax rules under Organisation for Economic Co-Operation and Development (OECD) frameworks.
Ensuring compliance: practical steps
For UK companies, achieving robust compliance requires a proactive and informed approach.
First, conducting comprehensive employment status assessments using HMRC guidance and utilising specialist legal advice is essential. These assessments must consider both domestic and international factors.
Second, revising contracts to reflect actual working arrangements, ensuring clarity on substitution rights, control and mutual obligations, can potentially mitigate IR35 risks. Clear and unambiguous documentation, reflecting the substantive working fact pattern, can support the position if challenged by HMRC.
Third, integrating status determination statements and payroll adjustments within onboarding and ongoing monitoring processes ensures adherence to the off-payroll rules, including for overseas engagements. Using technology solutions to manage contractor data and automate compliance workflows can reduce operational strain.
Lastly, companies should maintain open communication channels with contractors and PSCs to clarify tax responsibilities and the impact of IR35, avoiding any misunderstandings and potential disputes arising.
The broader tax and regulatory environment
Beyond IR35, UK businesses must navigate a broader regulatory environment that includes the requirement to comply with other reporting obligations, such as real time information (RTI) submissions to HMRC, and consider implications under international tax treaties and anti-avoidance rules.
Evolving legal frameworks such as the OECD’s base erosion and profit shifting (BEPS) measures, which seek to prevent profit shifting and tax base erosion through cross-border arrangements, should also be considered in cross-border working arrangements.
These international efforts emphasise transparency and cooperation, thereby increasing the likelihood of stringent enforcement and information exchange relating to overseas PSCs.
The UK has taken a proactive approach in implementing BEPS reforms with the pillar two framework already embedded into UK domestic legislation, and pillar one, which is in progress. These frameworks seek to address the tax challenges arising from the digitalisation of the economy and to ensure that large multinational groups pay a minimum level of tax on profits arising in each jurisdiction they operate in.
While most PSCs won’t be affected directly by pillar two –given its focus on multinational groups with consolidated revenues exceeding €750m – a UK company engaging with a PSC in a ‘non-qualifying territory’ should still be cautious. In such cases, the SME exemption from UK transfer pricing rules may not apply, meaning transactions between the UK entity and the overseas PSC could fall within the scope of transfer pricing regulations.
Case study
A medium-sized UK tech company (JimBot Ltd) hires a software developer operating via a PSC based in a low tax jurisdiction. The developer works full-time, attends daily meetings and follows UK team instructions.
Under IR35:
- The developer may be considered a ‘disguised employee’.
- JimBot Ltd must assess the employment status of the individual.
- If IR35 applies, JimBot Ltd must operate and withhold PAYE and NICs on the deemed employment payment relating to duties performed for the UK.
Under international rules:
- The relevant tax treaty between the UK and the developer’s jurisdiction must be considered. It may affect where income is taxed, especially depending on where the duties are physically performed.
- Social security coordination rules (eg bilateral agreements or EU protocols) may determine which country’s system applies and whether UK NICs are due.
- Where the PSC is operating in a ‘non-qualifying territory’ (which may well be the case with a low tax jurisdiction), the SME exemption for UK transfer pricing would not apply and any transactions between the two entities would be subject to this regime.
This example highlights how complex cross-border hiring can be and why careful planning, treaty analysis and ongoing compliance reviews are essential.
Conclusion
The cross-border application of IR35 remains a challenging but increasingly critical compliance area for UK businesses engaging overseas contractors and PSCs. The Covid-19 pandemic has accelerated changes in work patterns, necessitating a fresh focus on employment status assessments, payroll compliance and risk management in international contexts. The draft legislation for Finance Bill 2025-26 represents a significant step in extending labour supply chain provisions, demanding heightened diligence from UK engagers.
Navigating these developments requires a nuanced understanding of the interplay between UK domestic law, international tax treaties and practical business realities. Businesses that invest in expert guidance, robust compliance frameworks and ongoing monitoring will be best placed to mitigate risk, optimise contractor engagement and maintain fiscal integrity in an increasingly globalised workforce environment.
How BKL can help
Our specialists in employment tax and business tax can guide you through the changing regulations, including IR35, and ensure that you’re fully compliant. This includes reviewing your processes to help you minimise your risk and your tax liability.
For a chat about how we can help you, get in touch with Stephen Baker or Michelle Bryan, or send us an enquiry.
