IR35, officially known as the Off-Payroll Working Rules, is HMRC legislation designed to identify individuals working as disguised employees through PSCs. In 2025, IR35 compliance in the defence sector is critical. Non-compliance can result in significant tax liabilities and fines.
Since 2021, medium and large defence organisations have been responsible for determining a contractor’s IR35 status. Contractors must take extra care to ensure their working practices and documentation support the client’s IR35 determination. This guide covers the key changes affecting IR35 for defence contractors, updates to legislation, and how using a trusted defence umbrella company can help reduce your risk.
IR35 Determinations: What Do “Inside” and “Outside” Really Mean?
When a client assesses your IR35 status, they’ll issue a Status Determination Statement (SDS) confirming whether you’re inside or outside IR35. Here’s what each outcome means for you as a defence contractor:
Inside IR35
- Income is treated like regular employment
- Tax and National Insurance are deducted at source
- Fewer tax benefits
- Less admin, but less control over your finances
- Often the case for long-term or highly supervised roles within MOD or government agencies
Outside IR35
- Manage your own finances
- More admin work
- Higher HMRC Scrutiny
- Operate as an independent business
Who Does IR35 Affect in the Defence Sector?
IR35 impacts a wide range of professionals working in the defence industry, particularly those operating through a Personal Service Company (PSC) or limited company. If you’re a contractor engaged in a long-term assignment, embedded within a team, or working under close direction and control of your client, you’re more likely to fall inside IR35.
Common examples include:
- Contractors working on-site at MOD facilities
- Those with fixed working hours, limited autonomy, or who report to a line manager
- Engineers, cyber security consultants, project managers, and IT specialists on long-term engagements
In these scenarios, even if you’re technically self-employed, HMRC may view your role as one of disguised employment. Understanding your working practices and engaging with a compliant umbrella company can significantly reduce your exposure to risk.
IR35 Updates – What You Need to Know
These IR35 updates directly impact IR35 compliance in the defence sector, where contractor roles often blur the lines between employed and self-employed status.
1. New Contractor Rights Around Client Size
From April 6, 2025, contractors can formally request clarification of a client’s size (small, medium, or large) to determine if IR35 applies. Clients must respond within 45 days. This is especially relevant for defence contractors working with evolving or merging firms.
2. No Change to IR35 Thresholds Until 2027
Although Companies House is adjusting company-size thresholds, IR35 responsibilities remain the same until 2027. That means defence companies classed as medium or large in 2024 will still be responsible for IR35 determinations in 2025 and 2026.
3. Increased HMRC Enforcement and Liability Risk
HMRC is increasing enforcement activity across high-value government contracts. Draft legislation proposes joint and several liability for umbrella companies and agencies from April 2026, further raising the stakes for compliant practices.
Tips For Defence Contractors
Request a Status Determination Statement (SDS)
Ensure your client provides a written SDS, clearly stating whether your engagement is inside or outside IR35. Don’t rely on verbal assurances.
Align Contract Terms with Real Work Practices
Even if your contract says you’re outside IR35, HMRC will examine actual working conditions. Defence contractors often face tight oversight, fixed hours, and location-specific work—all red flags.
Keep Detailed Records
Save evidence of:
- Right to substitution
- Use of your own equipment
- Independent scheduling
- Non-employee treatment
This is especially crucial if you’re operating via a limited company.
Benefits Of Using an Umbrella Company for Defence Contractors
If your role falls inside IR35, or you want to avoid IR35 risks altogether, working via a compliant umbrella company such as Trafalgar Umbrella is a smart solution for the following reasons:
- IR35 compliant PAYE employment structure
- Fast payment within 24 hours via “SalaryNow”
- No need to manage your own taxes or limited company
- Access to holiday pay, sick pay, and pension contributions
By using Trafalgar Umbrella, you become a direct employee, meaning IR35 rules no longer apply—your tax is deducted at source, and you stay 100% compliant.
Get in touch today to see if Trafalgar Umbrella is the right fit for your next defence contract.