Does IR35 Apply To Sole Traders?

For sole traders, or those working with contractors, it’s important to understand your tax obligations. If you have been contracting for a business – or hiring contractors – it’s likely you will have come across of IR35 legislation – but does IR35 apply to sole traders?

In this blog, we provide some detail around what IR35 is with a particular focus on sole traders.

Read on to find out whether IR35 applies to sole traders.

Let’s get straight to it – no, IR35 does not apply to sole traders.

A sole trader and their business – for tax purposes – are one and the same. They own an unincorporated business in its entirety.

As such, sole traders do not operate through an intermediary.

However, those who work through a limited Personal Service Company (PSC) are potentially liable to pay IR35.

To understand how this works in principle, read on.

What is IR35?

IR35 refers to tax legislation intended to stop tax avoidance by “disguised” employees.

A disguised employee is an individual who for all intents and purposes is a full-time employee of a company. However, they actually work via an intermediary (such as their own limited company – as PSC).

By disguising their employment, an individual can make tax savings as well as circumvent National Insurance contributions through opting to take dividends from their own business rather than a salary.

Employers can benefit, too. Typical employee rights aren’t necessary, including NI payments and pension contributions.

To combat this situation, HMRC use IR35 legislation – which can have significant financial consequences for those found out.

Inside versus outside: The impact of IR35

Having investigated the potential tax avoidance of an individual, HMRC will refer to the case as being either inside or outside IR35.

If found to be inside IR35, an individual can expect a potentially significant financial penalty in terms of unpaid income tax and NI payments.

Take-home pay can be hit by as much as 25% and this is compounded by the fact HMRC are entitled to investigate an individual’s tax affairs over the six preceding tax years.

Those outside of IR35 won’t face any additional fees.

For more information on your potential IR35 liability you can use HMRC’s Check Employment Status for Tax tool or speak with a Chartered Tax Advisor.

How did IR35 change in April 2021?

Changes to IR35 were scheduled for 2020, but due to the pandemic were postponed to April last year.

Essentially, the changes put the onus on the employer to investigate and confirm whether a contractor should, in fact, be regarded as an employee.

Consequently, it is the employer who will burden the financial impact of improper employment.