Does IR35 apply to sole traders?

The dual impacts of the IR35 amendment in April 2021 and the ongoing pandemic has been a major challenge for many contractors and employees. IR35 was implemented in 2000 to prevent workers  from disguising their employment status to reduce the amount of their tax payments. A year has passed and the new IR35 rule still confuses many business owners. Many contractors fear the impact lies mostly to them. Will IR35 affect sole traders? What important information do they need to be aware of in  order to comply with the income tax laws? 


Sole traders are exempted from IR35 but…

The good news is that IR35 doesn’t apply to sole traders. However, on top of the multiple responsibilities they need to manage in their business is also making sure that they have the correct employment status when providing a service to a client. In the IR35 amendment, medium and large private businesses are now responsible for determining the IR35 status of the contractor they hired. These companies will be held liable for the financial penalties when their contractors are caught inside IR35. That’s why it’s important to fully understand the boundaries of a sole trader’s contractual relationship with its client, especially if they’re going to provide service to a big corporation. 

For many who feel differently about the IR35, these are the key information you need to keep in mind to make sure that you’re on the right side of IR35 are:

  1. Understanding the rules that fall under your legal business structure (sole trader, private limited company and partnership)
  2. Knowing the differences between a sole trader and  a contractor
  3. Work with an employment status specialist to make sure you understand the three indicators to determine your IRC status (control, substitution and mutuality of obligation)

The UK government identifies sole traders as self-employed who run their own business. They don’t have the rights and responsibilities of an employee and worker, they pay their own National Insurance and tax, and operate under the terms “self-employed”, “consultant” or “independent contractor”. Their contract should be “contract for services” and “consultancy agreement”. Contractors, on the other hand, can be self-employed and have the employment status of a worker or employee if they are hired by a company. The rights of a worker includes hiring a substitute to complete the work. 

So, who may be affected by the new IR35 rules? 

  • Workers who are providing their service through an intermediary
  • Clients who are receiving services from workers through intermediary
  • Recruitment agencies, also known as employment businesses or intermediaries, who are providing workers’ services through intermediary

An intermediary is a person or business that provides workers’ services to a client. The off-payroll rules apply to them. 


Setting up as a sole trader and tax obligations

Individuals determined to set-up their business as a sole trader must have earned more than £1,000 from self-employment between 6 April 2021 and 5 April 2022. They must present proof that they are self-employed such as your statement of accounts or the Self-Assessment tax return. To qualify for benefits, they need to pay their Class 2 and Class 4 National Insurance contributions. 

However, if you are a self-employed contractor running an intermediary business, you are obligated to make the relevant taxes and NI contributions for your workers through PAYE. If you haven’t registered with HMRC yet, you must do so to avoid the penalty. The next HMRC registration will be on 5 October 2022.


Check Employment Status for Tax (CEST)

Even though sole traders are exempted from IR35, they still need to know about the Check Employment Status for Tax (CEST). This can help them clear their employment status if the HMRC investigates while under contract with a client. Yet, many deem this tool to be problematic even if the HMRC are objective with their process. 

The HMRC uses this tool to determine if a worker is under the employed or self-employed classification for tax purposes. The sole trader and client must work together and go through the following checklist should the HMRC investigates their business. 

  • Review details of the contract
  • What are the responsibilities of the worker under the contract?
  • Who decides the scope of work? 
  • Who decides when, where and how the work is done? 
  • How will the worker be paid? 
  • Does the worker receive corporate benefits and reimbursements for expenses? 

Sole traders must also know if they’re providing service to small, medium or large businesses. Small businesses are exempted from the IR35. The Companies Act of 2006 defines a medium or large as:

  • the company has more than 50 employees
  • the company has an annual turnover of more than £10.2 million
  • the company’s balance sheet total is more than £5.1million


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