Off Payroll (IR35) rules – what is the small companies exemption?

The 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’. Here we look at what the small company exemption means in practice.

In brief, what is IR35 and the Off Payroll working rules?

IR35 and Off Payroll are a set of 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, which were implemented in 2017 (public sector) and 2021 (private sector) placed the onus of working out a contractor’s IR35 status onto clients themselves, rather than the worker.

If a contractor is deemed to be ‘inside IR35’ by a client operating the Off Payroll rules, the client must provide the contractor company with a status determination statement which details its decision.

The client is then responsible for calculating and deducting any employment taxes owed by the contractor’s company 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:

  • It must be a private company.
  • It must have an annual turnover of no more than £10.2 million.
  • It must have a balance sheet total of no more than £5.1 million.
  • It must have an average of no more than 50 employees.

You can read the official guidance in ESM10006.

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 responsibility for assessing IR35 status rests with the contractor, as it always did prior to the introduction of 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 it can help to 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 currently 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 applies 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 they can apply the ‘original’ IR35 rules accordingly.
  • Intermediaries (limited company contractors) have the right to request confirmation of a business’s small status.
  • In the event that 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:

  • Make sure that you understand the criteria for the exemption and that you keep records to demonstrate that you meet the criteria.
  • 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 the number of employees to make sure that you remain eligible for the exemption.

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Last updated: 12th August 2023