IR35 and Sole Traders
Navigating the intricate landscape of UK tax legislation is no easy feat, especially for contractors. Amidst the myriad of regulations, one term stands out prominently: IR35. But does IR35 apply to sole traders?
In this comprehensive guide, we delve deep into the heart of IR35. Whether you’re an aspiring contractor or a seasoned veteran seeking clarity, this guide aims to demystify IR35, empowering you with the knowledge to make informed decisions and remain compliant.
Does IR35 Apply to Sole Traders?
A sole trader is someone who owns 100% of an unincorporated business. As a sole trader, you and your business are legally one entity; you are not distinct in the way a limited company is from its owners.
IR35 does not apply to sole traders as they operate as self-employed individuals. The IR35 legislation only applies to contractors working through intermediaries (such as a limited company). Although IR35 does not apply to Sole Traders, the issue of employment status for tax purposes remains. The rules for determining employment status are similar to those for determining IR35 status.
Which employment status tax legislation applies to you as a sole trader is determined by whether you’re a direct hire or working via an agency.
i) Working as a Direct Hire
For sole traders engaged directly, the hiring organisation must consider traditional employment status tests. These tests are similar to IR35, covering substitution, mutuality of obligations, supervision, direction and control.
The end client decides your employment status, whether you are genuinely self-employed or operating as an employee. Like IR35, if a sole trader works for a client in a way that could be deemed disguised employment, the end client is at risk of being considered the employer. They would be liable for any unpaid income tax and National Insurance contributions should the correct amount not be paid to HMRC, not the sole trader.
ii) Working Via an Agency
For sole traders engaged via an agency, the agency placing the contractor must consider the Onshore Intermediaries legislation. The agency is responsible for determining the contractor’s employment status.
The assessment criteria used are a simplified version of IR35, limited to whether the contractor works under supervision, direction or control. Any supervision, direction or control over the sole trader’s services could indicate disguised employment.
If this applies, the agency is responsible for deducting the relevant taxes and is liable for anything unpaid should the assessment be wrong. It is for this reason most agencies are not prepared to engage with sole traders if they are not subject to PAYE; they are not willing to accept the additional liability.
Why Contractors Don't Work As Sole Traders
Contractors rarely work as sole traders as they usually don’t have a choice; most agencies and clients will refuse to engage them. They will stipulate that they require a company (limited or umbrella) to act as an intermediary in the chain of services.
They do this for two main reasons:
i) Additional Tax Liability
Similar to IR35, if a client hires a sole trader as a contractor and is subsequently subject to an HMRC investigation over their employment status, they are liable for any additional income tax, National Insurance contributions, penalties, or fines. Most are unwilling to take on this risk.
i) Employment Rights
As no intermediary (limited company etc) separates the contractor from the client, a contractor is one step closer to the employer. Therefore, there is a greater risk that an individual trading as a sole trader could look to claim employment rights from the client, a common occurrence in sectors such as construction.
In addition to the above, operating as a sole trader has downsides for the contractors themselves. For a sole trader, there is no distinction between business and individual. You hold personal responsibility for the businesses’ debts and may have to sell off personal assets to meet those debts should something go wrong.
See our guide on Limited Company vs Sole Trader for further details.