IR35 MythBuster #3 - The small company exemption

Fact or Myth? If the small companies' exemption applies, an agency could still be liable for unpaid tax under the new IR35 rules.

Myth. The legislation only shifts liability to the agency when the client qualifies as medium or large. If the small companies' exemption applies, the contractor’s limited company is responsible for IR35 status determinations and any additional tax payments.

What changed?

In April 2021 the off-payroll rules were extended to the private sector, which means that any agency or client that pays a contractor's limited company have to consider the new rules and its potential liability. Clients are exempt from the rules if they are a small company or if they are not UK-based. In both these situations, the contractor remains liable for IR35.

What is the small company exemption?

There has been some confusion around how the small companies’ exemption affects agencies despite the fact that HMRC has issued guidance on the subject: https://www.gov.uk/guidance/off-payroll-working-for-agencies

Originally, under ITEPA 2003 Chapter 8, a contractor’s limited company was responsible for making IR35 determinations and paying any additional taxes and NI contributions where required. From April 2021 onwards, these responsibilities moved up the supply chain such that:

• the client needs to make a status determination; and
• the ‘fee payer’, usually the agency, will be liable for any tax payments.

However, the legislation contains an exemption for situations in which the contractor’s client is a small company namely when it meets two out of three of these conditions:

• an annual turnover of less than £10.2 million
• a balance sheet total of less than £5.1 million
• fewer than 50 employees

There is a general acceptance that “small” clients don’t have to consider IR35. Small clients should be aware that the onus is on them to provide evidence of their size to the contractor or the agency within 45 days if requested to do so., If a client can demonstrate that it is genuinely small, some people have (wrongly) suggested that this leaves the agency on the hook for any IR35 related payments.

The source of the confusion here may be HMRC’s guidance, which states that: “The conditions about size only apply to clients. If you are a small-sized fee-payer you will still be responsible for applying off-payroll working rules.” This simply means that the size of the agency isn’t relevant to determining who is responsible for IR35, it is only the client’s size that should be considered.

The legislation introduced the concept of “Status Determination Statements” (SDS) in its amendments to ITEPA 2003 Part 2 Chapter 10. Chapter 10 also contains the definition “fee payer”, stating that the client is responsible for providing the SDS to the supply chain but that the fee payer is liable for tax payments. However, it is important to note that this chapter only applies where the end client “qualifies as medium or large for a tax year”. End clients that are based abroad and do not have a UK connection are also exempt.

The small companies’ exemption is contained in Chapter 8 of the legislation. This chapter contains the "old" style private sector IR35 rules, which will be applicable to a situation in which the contractor works for a small company in the private sector. It does not make any provisions about the responsibilities of the fee payer. In other words: the contractor’s limited company remains liable for tax payments under the small companies’ exemption.