How are small companies, sole traders, contracted out services, and overseas entities affected by IR35?
IR35, otherwise known as the intermediaries legislation, doesn’t apply to every engagement. With various exemptions and criteria to consider, this article unpacks each method of working and whether IR35 applies. Not only will we look at small companies, sole traders, contracted out services, and overseas entities, but also focus upon how all of this effects end clients as the party typically responsible for determining IR35 status.
Are small companies exempt from IR35?
In short, yes. However, whether you meet the small business criteria might not be so clear. The off-payroll rules apply solely to public or private sector businesses classed as medium or large. This is known as the small companies exemption. So, what are the criteria?
What is classed as a small company?
In order to be classed as a small company, two of the following three criteria must be met:
- Turnover of no more than £10.2million
- Balance sheet total no more than £5.1million
- Number of employees less than 50
If your company does not meet and exceeds any two of these criteria for two consecutive financial years, then the small companies exemption will no longer apply. In these cases, you will be responsible for applying the off-payroll working rules as of the tax year after the filing date of the second consecutive year.
What about group companies?
The exemption applies to group companies as a whole. So if your business is classed as small but is part of a wider group, that could push your company into the medium or large business size meaning you may still have to consider IR35.
Who is classed as a sole trader?
A sole trader or sole proprietorship is a self-employed individual providing services without a limited company registration. Sole traders keep all business profits after paying tax and are personally responsible for business losses.
Are sole traders exempt from IR35?
IR35 only applies to personal service companies (PSCs), as such sole traders fall outside the scope of IR35. Despite this, there are a similar set of rules in place known as ‘Employment status’ that apply to sole traders. As such, clients may still hold liability if HMRC determined that the worker was employed.
Contracted out services?
What are contracted out services?
Contracted out services, also known as outsourced services or the provision of managed services, are a complete packaged service provided by a third-party and delivered to a client. This can come in many forms but in all the service provider retains full responsibility for the management and completion of the services for which the client pays a fixed fee based upon milestones, deliverables, or the completion of the service.
Does IR35 apply to service providers?
For an end client in an engagement with a genuine managed service provider (MSP), the responsibility for determining IR35 status sits with the MSP. Liability for any unpaid tax or national insurance will sit with the fee-payer in the engagement which more often than not is also the MSP.
Put simply, any end clients making use of genuinely contracted out services should not have to be concerned about the application of IR35.
However, where an end client wrongly assumes that they are receiving ‘genuinely’ contracted out services they may fail to fulfil their IR35 obligations as a result. If this is the case and the engagement in question is found to be operating inside of IR35, the end client may be found to be failing to meet their IR35 obligations. At this point they are likely to be saddled with the responsibility for paying backdated PAYE and NIC as well as any associated liabilities.
What about overseas clients or intermediaries?
Understanding who is liable and responsible for IR35 when it involves an overseas member in the contractual chain is no simple task. The liability and responsibility for IR35 changes dependent upon whether certain members of the contractual chain are classed as offshore or whether each party member meets their relevant obligations. Because of this, it is vital that end clients go into engagements with a full awareness of the potential risk, doing any research necessary to ensure IR35 is accounted for.
How does IR35 affect overseas end clients?
Where an end client is based wholly overseas, that end client is neither liable for IR35 or responsible for determining it. However, what classifies an entity as ‘wholly overseas’?
If either of the following apply, then a business will not be classed as wholly overseas:
- Incorporated in the UK
- The central management and control of business is in the UK
Permanent UK establishment
- Fixed place of business in the UK
- Agent who has, and habitually exercises, authority to do business on behalf of the client
How does IR35 affect end clients that are not wholly overseas?
Any clients who do not meet the above criteria for being wholly overseas will be responsible for determining the IR35 status of any UK resident contractors. In other words, the off-payroll rules will apply. If an end client in this situation does not meet their IR35 obligations, it will consequently be liable for tax and NICs where the rules apply. In these circumstances, HRMC will pursue any debt through the company’s UK-based permanent establishment.
Unsure where to start when it comes to your IR35 obligations? Take a look at IR35 Audits. Our IR35 audits offer an in-depth review of your business operations focusing upon providing advice and support around engaging off-payroll workers. Feel free to get in contact for further information.