Small Company Exemption From the Off-Payroll Working Rules Explained

Small Company Exemption from the Off-Payroll Rules

If you operate through a limited company and take on contracts with smaller clients, understanding the small company exemption is essential. It affects who assesses your IR35 status, who bears the tax liability, and how you should structure your engagement.

What the Off-Payroll Rules Actually Say

The off-payroll working rules, introduced for the private sector in April 2021, shifted responsibility for IR35 status assessments from contractors to the end client. Under those rules, medium and large clients must issue a Status Determination Statement (SDS) and, if they determine the role falls inside IR35, deduct tax and National Insurance at source through the fee-payer in the supply chain.

However, this shift in responsibility does not apply to every client. Small companies are exempt from the off-payroll rules entirely.

Which Clients Qualify as Small?

The definition of a small company is drawn from the Companies Act 2006. A company qualifies as small if it meets at least two of the following three conditions in a given financial year:

• Annual turnover of no more than the relevant threshold
• A balance sheet total of no more than the relevant threshold
• No more than 50 employees

From April 2025, the thresholds were revised upward. The turnover limit increased to £15 million and the balance sheet limit to £7.5 million. These increases follow changes to the Companies Act thresholds and are intended to reduce administrative burden on growing businesses.

The revised thresholds are expected to affect approximately 14,000 companies that were previously classified as medium-sized. For tax purposes, the earliest financial year in which those companies could benefit from the changed thresholds is 2026/27, depending on their accounting reference dates and when they first meet the new criteria.

It is also worth noting that unincorporated businesses, sole traders, and partnerships with no corporate structure are generally treated similarly to small companies for these purposes, meaning the same exemption logic applies.

What Happens When You Work for a Small Client

When a client qualifies as small and is therefore exempt from the off-payroll rules, the original IR35 rules apply. That means:

• Your own intermediary, typically your personal service company (PSC), is responsible for assessing employment status
• If the engagement falls inside IR35, your PSC must calculate and pay the deemed employment payment, accounting for PAYE and National Insurance
• The client is not required to issue an SDS and bears no direct liability for the determination

This is a meaningful distinction. With a small client, you retain full control over the assessment process, but you also carry the risk if HMRC later disagrees with your conclusion.

Practical Considerations for Contractors

Working for a client that claims to be small does not automatically remove HMRC scrutiny from your engagement. There are several steps worth taking:

• Verify your client's size independently. Check their most recent filed accounts at Companies House to confirm they meet at least two of the three qualifying conditions. Do not rely solely on the client's word.
• Document your status assessment carefully. Even under the original IR35 rules, a well-reasoned assessment referencing the key status tests, particularly substitution rights and the degree of control the client exercises over your work, provides important protection.
• Review your contract. The written terms should reflect the genuine working relationship. Pay particular attention to substitution clauses and whether the client retains a right of control over how, when, and where you work.
• Consider an independent contract review. A specialist IR35 adviser or tax consultant can provide a written opinion, which is useful evidence if HMRC opens an enquiry.
• Look at IR35 insurance. Several providers offer cover for tax liabilities, professional fees, and penalties arising from an HMRC investigation.

For official guidance on how HMRC approaches employment status under the original rules, refer to HMRC's off-payroll working guidance.

How Status is Assessed Under the Original Rules

When you are responsible for your own assessment, the key factors HMRC and the courts consider include:

• Substitution: Does your contract give you a genuine, unfettered right to send a substitute to carry out the work? A real substitution right, exercisable without the client's veto, weighs strongly in favour of self-employment.
• Control: Does the client direct how you carry out the work, or do you retain autonomy over method? The greater the client's control over working practices, the more likely HMRC is to view the arrangement as employment-like.
• Mutuality of obligation: While substitution and control are the primary tests following the Supreme Court's reasoning in PGMOL, the overall picture of the relationship matters. Consider whether there is any expectation of ongoing work beyond the specific contract.

No single factor is conclusive. HMRC's Check Employment Status for Tax (CEST) tool can assist with the assessment, but HMRC acknowledges that CEST results are not determinative. A broader review of all the facts is always advisable.

Summary

The small company exemption from the off-payroll rules is a significant feature of the current IR35 landscape. With threshold changes taking effect from April 2025 under the revised Companies Act definitions, more clients may now qualify, and contractors engaged with them will continue to be assessed under the original IR35 framework, with responsibility sitting firmly with the PSC.

This platform does not determine, verify, or warrant IR35 status; the SDS is the client's legal responsibility. Contractors should take their own advice and consider IR35 insurance.