With the application of the off-payroll rules to the private sector since 6th April 2021, is working as a sole trader a smart way to ensure your contract work falls outside IR35?
What is a sole trader?
The most popular type of business structure in the UK is the sole tradership – comprising 56% of all UK businesses in 2021. This equates to around 3.2 million people.
It is simple to get started as a sole trader – you (the individual) and your business are treated as a single entity from a tax point of view. You pay income tax annually via the self-assessment process, and Class 2 and 4 NICs.
However, unlike trading via a limited company, your liability is not unlimited if things go wrong as a self-employed person.
Despite the ease with which you can set up as a sole trader, there are some fundamental reasons why professional contractors rarely trade this way.
Contractors rarely work as sole traders
Most contractors work via an intermediary; either via a limited company or an umbrella.
There are two main reasons why this is the case:
The Income Tax (Earnings and Pensions) Act 2003 does not allow self-employment when a recruitment agency is involved in the relationship between supplier and client.
Also, if you are hired as a sole trader, and subsequently found to be an ’employee’ for tax purposes, then you could make a claim for employment rights from your recruiter.
The recruiter could also become liable for additional tax and NICs.
From the contractor’s point of view, there are also several compelling reasons why a limited company is a more appropriate business structure to trade under, compared to self-employment:
- Your liability is limited should things go wrong.
- The ‘limited’ status portrays a professional image.
- There are some tax benefits for trading via a limited company (although much reduced in recent years).
Sole traders and IR35 – no intermediary
If contractors rarely work as sole traders for the reasons explored above, then is IR35 even a consideration?
The answer to this lies in the fundamental basis of IR35 – otherwise known as The Intermediaries Legislation.
The rules were created in 2000 to clamp down on the use of intermediaries (limited companies) by workers, who would otherwise be deemed to be ’employees’ were it not for the existence of the limited company in the recruitment chain.
So, IR35 will not apply to an engagement if the worker is not working via an intermediary (a limited company).
However, employment status is not merely a consideration for limited company workers.
Sole traders and disguised employment
Just as IR35 tackles so-called disguised employment by limited company contractors, agency legislation exists to tackle disguised employment by sole traders.
In recent years, some employers have preferred to hire ‘self-employed’ workers rather than employees, to save money, and protect themselves from assuming employer-type obligations.
As a result, the Government drafted agency legislation to tackle this practice (see ESM2029). If you are deemed to be working under the supervision, direction or control (SDC) of a client, then you are deemed to be an employee for tax purposes. You can find out more about the agency legislation – as clarified in 2016 – here.
Sole trading and IR35 – in conclusion
Clearly, becoming a sole trader does not circumvent the IR35 rules, as the legislation only applies to intermediaries.
As we have discussed; if recruiters did routinely hire sole traders, separate employment status rules would still apply anyway.
Put simply, if you are not truly working in business on your own account, then you are likely to be treated as an employee for tax purposes, regardless of the business structure you trade under.
The key is to be able to trade outside IR35 legitimately as a limited company worker as demonstrated by the terms of your contracts, and the way you carry out this work (your working practices).
Read our core IR35 guides to get started!
If you are self employed, try our self employed tax calculator.
