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If you’re self-employed, perhaps as a contractor or freelancer, there’s a good chance you’ll have heard of IR35. UK tax legislation can be complex at the best of times and IR35 is something that can cause a lot of confusion and concern amongst the self-employed.
To keep things clear from the start, IR35 doesn’t apply to sole traders. In this post we’ll explore what IR35 is, why sole traders are exempt and what other obligations they have.
What Is IR35?
IR35 is a piece of tax legislation designed by HMRC to prevent tax avoidance through disguised employment. This occurs when individuals that work through intermediaries are essentially working as employees but paying tax as if they were self-employed. This allows them to leverage tax efficiencies to reduce their liability which results in significant revenue losses for HMRC.
Also known as the off-payroll working rules, IR35 assesses contracts to determine whether an individual is genuinely self-employed by looking at factors such as the level of control they have over how, where and when they complete their duties, the right to send a substitute to replace them should they be unable to work and mutuality of obligation which determines whether there’s an expectation of further work upon completion of a contract.
If a contract is deemed to be outside IR35, HMRC considers you to be genuinely self-employed and you have responsibility for your tax affairs and how you pay yourself. If you’re inside IR35, HMRC considers you to be an employee for tax purposes and your income tax and NICs will be deducted at source through PAYE.
Why Does IR35 Not Apply to Sole Traders?
As a sole trader you work as an individual and there’s no intermediary involved. An intermediary is an entity through which a contractor provides their services to a client such as Personal Service Companies or Umbrella Companies. Intermediaries are irrelevant in the context of a sole trader which means sole traders are outside the scope of IR35 legislation.
IR35 is only applicable where there are 3 parties involved, for example the worker, the intermediary (usually their limited company) and the client. There are only 2 parties involved for sole traders which negates the need for an IR35 assessment.
A sole trader engages directly with their clients with no middleman and they’re clearly self-employed which means there can be no disguised employment. They are also taxed differently from a contractor who works through their own limited company as they pay income tax and NICs on taxable company profit, whereas limited company contractors will usually receive a salary and dividends with the company taxed separately.
Employment Status Checks and Sole Traders
Although sole traders don’t have to worry about IR35, they can still be impacted by employment status checks which are assessments done by HMRC to ascertain whether an individual should be classified as self-employed or as an employee for tax purposes.
HMRC can conduct these checks on an ad hoc basis if they have reason to believe there may be an incorrect classification of an individual’s employment status or as part of routine audits and compliance checks.
HMRC will consider factors such as the level of control you have over how you work, whether there’s a mutual obligation between you and your client, if you can provide a substitute to work in your place and whether you use your own equipment and take on the financial risk.
Essentially they assess your working relationship with your client and if they determine that it’s like an employment relationship then the client could face penalties and having to pay backdated tax and the sole trader would have to pay their taxes through PAYE.
To safeguard your self-employed status as a sole trader, focus on keeping control over how, when and where your work is done rather than being instructed by your client. Use your own supplies and equipment and if possible work for multiple clients, as well as securing new ones and avoid exclusive long term arrangements with a single client.
Sole Trader Accounting With Gorilla
Operating as a sole trader is the simplest way to be self-employed and not having to contend with IR35 helps significantly in that respect. Setup is quick and easy, you have full control over your business and tax is relatively simple, but on the flipside you have personal responsibility for business debt and the tax planning opportunities are limited.
For that reason, many sole traders will incorporate their business in time, and when they do, they are subject to IR35 assessments so it’s important to understand the IR35 rules and to ensure compliance and avoid any fines or penalties.
Whatever your business structure, we’re on hand to help with your accountancy needs. Our sole trader and limited company accounting packages are all fully inclusive with your own dedicated accountant, full inclusive FreeAgent access and a guaranteed same working day response to your queries.
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