The IR35 (Off Payroll) rules came into play in April 2021 (for private sector clients). An exemption exists if a business meets the definition of a ‘small company’.
In this guide, we look at what the small company exemption means in practice.
We’ve updated this guide with the new April 2025 definitions of a small company.
In brief, what are IR35 and the Off-Payroll Working Rules?
IR35 and Off Payroll are tax rules that apply to businesses that engage contractors through intermediaries, such as personal service companies (PSCs).
The original IR35 rules (2000) are designed to ensure that contractors who are effectively employees are taxed as such, even if they are engaged through an intermediary.
The Off-Payroll rules, implemented in 2017 (public sector) and 2021 (private sector), require clients rather than workers to determine a contractor’s IR35 status.
If a client operating the Off Payroll rules deems a contractor to be ‘inside IR35,’ the client must provide the contractor company with a status determination statement detailing its decision.
The client is then responsible for calculating and deducting any employment taxes the contractor’s company owes during the assignment.
What is the small companies’ exemption to the Off Payroll rules?
The small companies exemption is a provision that allows small businesses to avoid having to deal with the off-payroll rules.
To qualify for the small company exemption, a business must meet the following criteria:
New criteria came into play from April 2025 (previous criteria in italics).
It must be a private company.
It must have an annual turnover of no more than £15 million (£10.2 million).
It must have a balance sheet of no more than £7.5 million (£5.1 million).
It must have an average of no more than 50 employees (unchanged).
The official guidance is in ESM10006. It doesn’t appear to have been updated with the April 2025 criteria, which are discussed separately here.
If a business qualifies for the small companies exemption, it is not required to assess the IR35 status of contractors that it engages.
Instead, the contractor’s limited company is responsible for assessing IR35 status, as it always was before the introduction of the the off-Payroll rules.
The small companies exemption is a valuable benefit for small businesses that engage contractors. It can save businesses time and money and help them avoid the risk of HMRC penalties.
Small companies exemption – key points
When hiring workers, businesses should assess whether they are eligible for the small business exemption. However, even if a business qualifies as small, it may need to comply with IR35 rules over time.
It’s important for businesses to fully understand their group structure to ensure all relevant entities and individuals are included when determining if they meet the small business test conditions.
The small companies criteria apply to the aggregate position of a group of companies using the definition of the Companies Act 2006
If a business is exempt due to its small status, it should inform any limited company contractors it engages so that they can apply the ‘original’ IR35 rules accordingly.
Intermediaries (limited company contractors) can request confirmation of a business’s small status.
If a business is no longer considered small, it must inform its intermediaries that they (the client) are now responsible for applying IR35.
What should small company end-clients need to do
It is important to note that the small companies exemption is not a complete solution. Even if a business qualifies for the exemption, it is still important to ensure that contractors are properly engaged and that their tax affairs are in order.
Here are some tips for businesses that qualify for the small companies exemption:
You must understand the criteria for the exemption and keep records to demonstrate that you meet them.
Get professional advice on the IR35 rules and on how to properly engage contractors. Use a tax specialist such as Qdos to help draft your contracts.
Monitor your business’s turnover, balance sheet total, and number of employees to ensure that you remain eligible for the exemption.
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