As a sole trader, it’s important that you have a firm idea of the tax and legislation that applies to you, whether that’s Income Tax, VAT or even IR35 – which is probably the reason you’ve arrived on this webpage. The question ‘does IR35 apply to sole traders?’ crops up regularly. After all, this set of tax rules often makes the newspaper headlines as a legislation that impacts freelancers. So do sole traders need to consider IR35? In a word, no. But like with most tax-related questions, there’s a little more to it than this and there might even be a point in your freelance career that IR35 comes into play. To make sure you’re up to speed before we dive into further detail about IR35 and sole traders, we’ll first define these key terms.
What is a sole trader?
A sole trader is someone who owns 100% of an unincorporated business. As a sole trader, you and your business are legally one entity – in simple terms this means it’s not separate from you in the way that an incorporated company is from its owner(s). Working as a sole trader is the simplest and by far the most popular way to start a business , with 3.5m people operating this way in the UK.
What is IR35?
The intermediaries legislation, otherwise known as IR35 was introduced in 2000 with the aim of stopping freelancers and contractors from working as disguised employees. Disguised employment happens when an individual working through an intermediary in which they own more than 5% (usually their own limited company) provides their services to clients in a manner that reflects employment – the problem here is that the worker should in fact be paying tax as an employee, not as a self-employed worker. As a result, if a contract is deemed inside IR35 you become an ‘employee for tax purposes’ and your income for that engagement will be subject to PAYE tax and National Insurance Contributions (NICs), just like an employee. However, contractors working inside IR35 do not receive employment rights in return for paying this tax, which understandably is a bone of contention. If your engagement falls outside IR35 it’s because you deliver your services as a genuine business. You won’t be taxed as an employee for income received from this contract, meaning you can benefit from the tax advantages available to all small business owners. Still confused about IR35? Don’t worry, we explain everything you need to know in this jargon-free guide to IR35.
So why doesn’t IR35 apply to sole traders?
IR35 only affects individuals who work through their own intermediary usually a ‘Personal Service Company’ (PSC). A PSC is a limited company set up by an individual who will use it as a vehicle through which to provide their services to clients. PSCs usually have just one owner and one shareholder, although some contractors assign shares of the company to their spouse. Because sole traders aren’t incorporated businesses, IR35 isn’t a consideration. That said, if and when you decide to start freelancing through your own limited company, it’s important that you’re clued up on IR35 because it will come into play.
Does something similar to IR35 exist for sole traders?
Yes. After the government became concerned that businesses were engaging sole traders whose engagement reflects employment as a way to save on hiring costs and duck employer obligations, the Agency Legislation was introduced in 2014. For sole traders who work through agencies, these rules are similar to IR35 but the assessment criteria has been simplified. If a sole trader works under the Supervision, Direction or Control (SDC) of the client, they will become an employee for tax purposes, with the agency responsible for deducting the appropriate tax and NICs. If you’re a sole trader who works directly with clients, agency legislation rules won’t impact you. However, a decision must be made about your employment status – in other words, are you truly self-employed or should you be classed as an employee or even a ‘worker’ and therefore be granted employment rights and be subject to PAYE tax and NIC deductions at source? More information on this can be found on the government website, in the Employment Status Manual.
Is there anything else to bear in mind?
Given the complicated nature of IR35 and employment status, you might benefit from a quick recap of the above:
- IR35 does not apply to sole traders
- IR35 affects freelancers and contractors working through an intermediary in which they own more than 5%, this is usually their own limited company (PSC)
- Agency legislation and employment status rules are both considerations for sole traders