Understanding IR35 Legislation Impact on Small Companies

The IR35 Private Sector legislation, introduced in April 2021, placed significant responsibilities on medium to large private sector organisations to ascertain the employment status for tax purposes of all Personal Services Company (“PSC”) contractors they engage. Small businesses, however, were exempt from this requirement. 

What qualifies a business for IR35 small company exemption?

A business qualifies as small if it meets at least two of the following criteria:

• Annual turnover not exceeding £10.2m.

• Balance sheet total not more than £5.1m.

• An average of no more than 50 employees during the financial year.

If a business qualifies for the small companies exemption, it does not need to determine the IR35 status of its contractors. This responsibility falls on the contractors themselves, as was the case before the Off Payroll rules were introduced. 

Challenges of small company IR35 classification

Despite these exemptions, smaller consultancies have faced challenges following the introduction of the Private Sector changes. Such organisations, with typically 2-3 directors and a few employees, are being classified as an ‘in-scope PSC’ for IR35 purposes. We have observed smaller companies, which are clearly established businesses with their own premises and serving multiple clients simultaneously, being categorised as Inside IR35. This is particularly common when dealing with Public Sector clients, leading to a significant dilemma.

These smaller businesses, in need of stable revenue during turbulent times, are compelled to accept longer-term contracts but suffer a reduced market rate due to the tax deductions applied.

How are small companies mitigating IR35 impact?

We have assisted 'savvier' small businesses in assessing their engagement with off-payroll workers, ensuring all parties are aligned on tax status. Though legally not required to assess their off-payroll workers, these proactive businesses are future-proofing their operations and promoting best practices for several reasons. This foresight will give them an advantage by maintaining a firm grasp on the tax status of their contractors.

It is crucial to plan ahead, considering the possibility that:

1. The IR35 legislation's assessment requirements may be extended to small businesses.

2. Growth of a small business might lead to a necessity for such assessments. The small company's exemption ceases if it meets two of the three criteria outlined above for two consecutive financial years.

3. Challenges in acquisitions due to uncertain tax statuses of off-payroll workers. A small business may become medium - large overnight after an acquisition. 

In conclusion, while it may seem that small businesses are less affected by IR35, this is not always the case. Forward-thinking and understanding the significance of taking proactive steps is essential for all businesses navigating the complexities of IR35 legislation.

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