When the ‘off-payroll’ IR35 rules were extended to the private sector in April 2021, ‘small companies’ were excluded from the legislation. Here we explain how this exemption works, and answer some frequently asked questions.
Scroll down for changes to company threshold sizes from April 2025 onwards.
What is the small company exemption?
When the Government confirmed plans to extend the off-payroll rules to private sector firms in October 2018, the Budget documentation contained a notable exclusion for small company clients.
Small organisations will be exempt, minimising administrative burdens for the vast majority of engagers, and HMRC will provide support and guidance to medium and large organisations ahead of implementation.
Although there was initially some confusion over the definition of the term ‘small’, subsequent legislation confirmed that it is based on the same criteria contained in the Companies Act 2006.
The definition of a ‘small’ company changed from April 2025
The definition of company sizes changed from April 2025 onwards, as detailed in an update to the Companies Act 2006.
This is good news for contractors, as more clients will qualify as ‘small’ companies, if – within a 12-month period – they meet two or more of the following criteria (pre-April 2025 in brackets):
- Turnover – not more than £15 million (£10.2 million)
- Balance sheet total – not more than £7.5 million (£5.1 million)
- Number of employees – no more than 50 (no change)
Read the HMRC guidance here. The Off-Payroll legislation itself is contained in Chapter 10 of ITEPA 2003.
What should I do if my client is a ‘small’ company
Any contractors engaged by small companies should operate the IR35 rules as they would have done before the Off Payroll private sector extension in April 2021.
The responsibility for determining the employment status of workers remains with the contractor’s company, and does not pass to clients who meet the definition of a ‘small company’.
It is worth noting that any party in the contract supply chain can ask you (the contractor) to confirm that your client is exempt. Clearly, the client itself must confirm this if asked.
Please note that if your client has become a ‘small company’ as a result of the April 2025 criteria change (above), you will have to wait until the off-payroll rules no longer apply.
What happens if my client is part of a larger group of companies?
If a hiring company is part of a group and the parent company heading that group is considered a small business, the hiring company can also be classified as a small business.
The Off Payroll rules state that the small business test must be applied to the entire group entity. This means looking at the total combined turnover and balance sheet of all connected businesses and persons, rather than just the individual hiring company.
Figures from all members of the group are included irrespective of whether group members are resident in the UK or not, so the worldwide group is considered.
Clearly, this qualification stops larger firms from setting up smaller subsidiaries purely to avoid the IR35 rules.
See ESM10007 for the technical details relating to groups.
What happens if my ‘small’ client no longer meets the definition of ‘small’ in the future?
A company’s exemption from the IR35 rules ceases if it meets two of the three financial criteria (annual turnover, balance sheet total, and number of employees) for two years in a row.
If this happens, the previously ‘small’ company becomes responsible for determining the employment status of any workers starting from the tax year following the filing date of the financial statements for the second consecutive year when the criteria were met.
What happens if my ‘medium’ business client is now a ‘small’ business?
If your client now fits the April 2025 ‘small business’ criteria, you should be aware that this doesn’t mean they are immediately freed from the burden of operating the Off Payroll (IR35) rules.
This is because there is a transitional provision in place. Here is an extract from the relevant HMRC employment status manual:
The effect of the provision is to treat a company or group as having met the relevant size conditions in a previous year if the new thresholds were used to determine its size. This, in turn, determines the tax year in which any size changes take effect.
So, the earliest the change will affect contractors is April 2027. Find out more here.
