Knowing what an IR35 is and how it can affect you is key to running a smooth operating small business and even something to keep in mind for business growth. As a UK tax rule, it’s important that small business owners are aware of the implications if the rules are not followed. That’s why we’ve laid out all you need to know here. Read on to find out more and how Accountancy Solutions can help.
| The TL;DR: If you’re a small business hiring contractors, IR35 is mostly their problem, not yours. If you’re the contractor, you must check this yourself. |
What is IR35?
IR35 is a UK tax rule. It makes sure self-employed contractors who actually act as an employee of the business pay roughly the same tax as a normal employee would.
Why does IR35 exist?
Some people work through their own limited company but actually act like an employee of the business. This is known officially as the off-payroll working rules and is designed to tackle ‘disguised employment’.
What is disguised employment?
Disguised employment describes a working arrangement where a worker is classified as a self-employed independent contractor, but their day-to-day relationship with the business actually mirrors that of a regular employee.
Why does disguised employment happen and why is HMRC cracking down on it?
Some companies and contractors often prefer freelance arrangements for tax efficiencies. When a worker is genuinely self-employed, both parties save money. This is how:
Company
The business avoids paying Employer National Insurance Contributions (NICs), pension contributions, and providing statutory benefits (like holiday or sick pay).
Employee
Operating through a limited company allows them to take a small salary and draw the rest as dividends, which carry much lower tax rates than regular employment income.
However, if the worker behaves exactly like an employee but either party uses a corporate structure solely to pay less tax, HMRC views this as ‘disguising’ the true nature of the employment and is therefore a breach of tax or employment regulations. This can lead to penalties.
How do you know if a job is within the bounds of IR35?
Within the bounds of IR35, i.e., taxed like an employee, the business will tell the employee how and when to work, can’t send someone else in the employee’s place, and the employee is treated like part of their team.
Outside the bounds of IR35, the business chooses how to do the work and take on business risk.
Generally, HMRC ignores the label on the contract and looks at the actual reality of the working relationship using three primary pillars:
| Factor | Genuine Independent Contractor (Decides how, when, and where the work is done) | Disguised Employee (Managed daily via has set hours and strict supervision) |
| Substitution | Can send a qualified substitute to do the job instead. | Must perform the work personally. Cannot swap out. |
| Mutuality (MOO) | Hired for a specific project. No expectation of future work. | Continuous rolling work. Client must provide hours. |
| Integration | Separate from the company. Uses their own equipment. | Integrated into the team. Has a company email/badge. |
What happens if a disguised worker is caught?
After the review, if a worker looks, acts, and is managed like an employee, HMRC will reclassify them as a disguised employee, forcing the relevant party to pay back taxes, interest, and potential penalties.
What does IR35 mean if you’re a small business?
Small business hiring contractors
If your business qualifies as “small,” you are exempt from managing IR35 assessments.
- No status determinations: You do not have to decide if a contractor is inside or outside IR35. You do not need to issue a Status Determination Statement (SDS).
- No tax risk: You are not legally or financially liable for deducting tax or National Insurance from their invoices. The financial risk of a wrong classification stays entirely with the contractor’s own limited company.
- One legal obligation: If a contractor or recruitment agency asks you to prove your business size, you must respond in writing within 45 days confirming that you meet the small business criteria.
What classifies a small business?
You must meet two of the below criteria for two consecutive fiscal years in order to qualify for exemption.
- Turnover of £15 million or less
- Balance sheet total of £7.5 million or less
- 50 employees or fewer
This will need to be proved to a contractor, agency and/or HMRC.
| Good to know: There are two exceptions to this criteria: public sector organisations and public companies always have to follow the full rules, whatever their size. |
Contractor operating as a small personal service company
If you run a small limited company (Personal Service Company or PSC) and take on work for a client who qualifies as a small business, the responsibility is on you.
- Because the business you work with is exempt, the rules revert to the original framework. You must evaluate the contract and daily working reality to determine if the role is inside or outside IR35.
- You carry the financial risk – if HMRC audits your business and decides you are a ‘disguised employee’, you or your own small business can be billed for taxes, interest, and potential penalties.
- Provided you can justify an ‘outside IR35’ status, you can structure your company’s income and dividends. However, this is an additional responsibility to bear in mind.
What does IR35 look like in practice as a small business?
If you’re a small business hiring contractors, you don’t have to issue status determinations or deduct tax, but it’s good practice to tell contractors and agencies that you’re small. Agencies, contractors and HMRC all have the right to request confirmation of whether a business qualifies as small.
| Remember: If you grow past the small business thresholds, responsibility of IR35 moves to you. |
If you’re a contractor running your own limited company and working for small clients, you need to assess each contract yourself and account for any tax due if it falls inside IR35.
Still need help with IR35 as a small business?
Still unsure about IR35 for small businesses? Don’t worry, our team of expert accountants are here to help. Contact our team.
Next, check out our guide on buying property as a limited company.