What is the small companies exemption for off-payroll rules?

What is the small companies exemption under the off-payroll working rules?

The small companies exemption is a statutory provision that excludes small private sector organisations from the off-payroll working rules (Chapter 10 of ITEPA 2003).

If a hiring business qualifies as small, it is exempt from the requirement to assess a contractor's IR35 status or issue a Status Determination Statement (SDS). Instead, the rules revert to the original IR35 framework established in 2000. Under this older framework, the contractor's intermediary, usually a Personal Service Company (PSC), is responsible for determining whether the engagement resembles employment and for settling any relevant tax and National Insurance contributions.

This exemption applies only when engaging workers through an intermediary such as a PSC. If a business contracts directly with a sole trader, standard employment status rules apply rather than IR35, meaning equal care must be taken to ensure that an employment relationship is not inadvertently created.

How does a business qualify for the small companies exemption?

To qualify for the small companies exemption, a business must meet the definition of a small company set out in the Companies Act 2006. This definition applies to limited companies, limited liability partnerships (LLPs), overseas companies, and unregistered companies.

A business is automatically classified as small during its first financial year of trading. To maintain or achieve small status in subsequent years, an organisation must meet at least two of the following three criteria:

• Annual turnover must not exceed the statutory limit.
• Balance sheet total must not exceed the statutory limit.
• The average number of employees during the financial year must be no more than 50.

A change in size status only takes effect if a business meets or fails these criteria for two consecutive financial years.

What are the small company size thresholds for IR35?

The financial thresholds used to define a small company are increasing, which expands the number of businesses that qualify for the exemption.

For financial years and accounting periods beginning before 1 April 2025, the thresholds are:

• Annual turnover: Up to £15 million.
• Balance sheet total: Up to £7.5 million.
• Average number of employees: Up to 50.

While the employee limit remains fixed at 50, the higher financial caps mean that many growing or mid-sized businesses will return to the exempt category once these accounting periods are completed and filed.

How do you test your business size for a specific tax year?

To establish whether the small company exemption applies to a specific tax year, you must examine the financial years that ended before that tax year began. Crucially, the rules consider the latest financial year in which the statutory filing date fell before the start of the tax year, as well as the financial year immediately preceding it.

Because a company must meet or fail the criteria for two consecutive years to alter its status, and because of the standard nine-month filing window for corporate accounts, the transition to the new, higher thresholds will take time to manifest.

What happens when a business grows and loses its small status?

When a business expands and ceases to meet the small company criteria for two consecutive financial years, it becomes subject to the off-payroll working rules. The obligation to perform IR35 assessments and issue Status Determination Statements begins on the first day of the tax year following the statutory filing date of that second financial year.

The preparation window depends entirely on your corporate year-end. For a company with a financial year ending 31 December whose accounts must be filed by 30 September, the off-payroll rules will apply from the following 6 April. This provides a six-month window to implement compliance measures. However, a company with a financial year ending 30 June and a filing deadline of 31 March will have only six days before the rules take effect on 6 April.

How do corporate takeovers and group structures affect IR35?

Corporate transactions can instantly alter your IR35 compliance obligations. If a small, exempt company is acquired by a medium or large corporate group, it loses its independent exemption.

Under the legislation, an acquired small company retains its small status only for the specific accounting period in which the takeover occurs. It must adopt the off-payroll rules at the start of the tax year following the filing date for that transitional accounting period.

Furthermore, if a business belongs to a corporate group structure or a joint venture, the small company test cannot be applied to an individual subsidiary in isolation. The rules require aggregating turnover, balance sheet totals, and employee numbers across all connected global entities. This prevents organisations from artificially splitting their operations into smaller units to avoid off-payroll liabilities.

What are the IR35 small business rules for unincorporated entities?

Unincorporated businesses, such as partnerships and sole traders, do not have a balance sheet total or employee count requirement under these specific rules. Instead, their size status is determined solely by turnover.

For an unincorporated partnership, the business must assess its turnover from the last financial year that ended at least nine months before the start of the relevant tax year. If the turnover is below the threshold (£10.2 million, or £15 million for periods starting on or after 1 April 2025), the business is exempt.

For individual sole traders, the assessment follows a similar pattern, but the calculation relies on the calendar year ending immediately before the start of the tax year.