HMRC’s IR35 Small Business Exemption Explained
Under the off payroll working IR35 legislation, which was introduced in April 2021 to the private sector, there is an exemption for ‘small company’ clients. If a business qualifies for the small company exemption, it is not required to assess the IR35 status of contractors that it engages. Instead, the contractor’s limited company is responsible for assessing IR35 status, as it always was before the introduction of the off payroll rules. This exemption has been updated in April 2025, but as usual with HMRC this leaves a lot of questions and little clarity. In this blog we’ll be looking at the original exemption, the updated exemption, and answering the common questions asked around the subject.
Why is there a small company exemption?
The Conservative Government in place in October 2018 released documentation that contained the rationale for the small company exemption – this being that small businesses (as the client) will be exempt from the administrative burden of assessing IR35 status, whilst HMRC would provide support and guidance to ‘medium and large’ companies.
Who decides what the definition of a ‘small company’ is?
The Government. Within The Companies Act 2006 there is criteria that HMRC use to define what is, and what is not a small company. This act was updated in April 2025. The ‘IR35’ legislation that HMRC then use to apply the small company exclusion can be found here.
Pre-April 2025 definition
If within a 12-month period a business meets two or more of the following criteria they meet the definition of and qualify as a small business:
- Turnover: Not more than £10.2 million
- Balance sheet total: Not more than £5.1 million
- Number of employees: No more than 50.
Post-April 2025 definition
If within a 12-month period a business meets two or more of the following criteria they meet the definition of and qualify as a small business:
- Turnover: Not more than £15.0 million (£4.8 million increase)
- Balance sheet total: Not more than £7.5 million (£2.4 million increase)
- Number of employees: No more than 50 (no change).
Who benefits from the amendments?
Contractors and small companies, as those qualifying will remain so, with more businesses being brought into scope and eligible to utilise the exemption. The change is expected to bring around 14,000 businesses into the definition of a small business that were not previously exempt and becomes a valuable benefit for small businesses that engage contractors as it can save them time and money and help them avoid the risk of HMRC penalties.
When does the amended definition commence?
The likelihood is that those businesses who expect to take advantage of the amendments and fall into the definition of a small company will unfortunately not see a reprieve from their off payroll obligations until April 2027 at the earliest. But why? Well, whilst two of the three thresholds increased from April 2025, they only apply to the businesses financial years beginning on or after that date, so the earliest filing date or an accounting period beginning on or after the 6th April 2025 is in January 2025 – which in turn therefore means the 2027/28 tax year. Nothings simple with HMRC is it?
Small company exemption key points
- When hiring a limited company contractor, the business should assess whether they’re eligible for the small business exemption
- Businesses must fully understand their group structure to ensure all relevant entities and individuals are included when determining if they meet the small business exemption requirements
- The small company criteria applies to the aggregate position of a group of companies using the definition of the Companies Act 2006
- If a business is exempt, it should inform any limited company contractor(s) it engages and that the ‘original’ IR35 rules apply
- A limited company contractor can request confirmation of a business’s small status.
- When a business no longer qualifies for the small company exemption it must inform the limited company contractor(s) that they are no longer responsible for assessing their IR35 status and that the client (likely the business) now has that responsibility.
FAQ’s
What should I do if my client qualifies as a ‘small’ company?
A contractor engaged by a qualifying small company must operate and assess IR35 as they would have done prior to the off payroll rules coming into force. The responsibility for determining the IR35 status remains with the contractor’s limited company.
How do I request confirmation of a business’s small status?
Under the off payroll working rules, contractors (and recruitment agencies) can request confirmation of a business’s size from them. The request should be clear in that it is in relation to the off payroll working rules and to which tax year the request relates. The business must confirm its size within whichever is the later of:
- 45 days from the date of its receipt of the request to confirm its size
- 45 days prior to the start of the tax year specified in the request.
What happens if my client is part of a larger group of businesses?
If an end client is part of a wider group of businesses, and the parent business of that group is considered a small company, the end client can also be classified as a small company – as the off payroll rules state that the small company exemption test must be applied to the entire group. This means looking at the total combined turnover and balance sheet of all connected businesses and persons, rather than just the individual end client. Figures from all businesses in the group are included on a worldwide basis and are irrespective of whether a business is resident in the UK or not. This is done to stop groups from setting up smaller subsidiaries and/or locate businesses outside of the UK purely to avoid the IR35 rules.
What if a ‘small’ business no longer meets the definition of ‘small’ in the future?
A business’s exemption from the off payroll working IR35 rules ceases if it meets two of the three financial criteria for two years in a row. If this happens, the previously ‘small’ business becomes responsible for determining the IR35 status of any contractors – and starting from the tax year following the filing date of the financial statements for the second consecutive year when the criteria were met. To add a layer of protection, businesses responsible for assessing IR35 and liable for any IR35 tax liabilities should consider taking out an IR35 insurance.
What happens if a ‘medium’ business client is now a ‘small’ business?
If a business at some point meets the ‘small company’ criteria, having not done so previously, it does not mean they are immediately unencumbered from the liability of operating the off payroll working rules. This is because there is a transitional provision in place, and its effect is to treat a business or group as having met the relevant threshold conditions in a previous year if the new thresholds were used to determine its size. The result is that in turn, this determines the tax year in which any size changes take effect.
