IR35 and sole traders: setting the record straight on HMRC’s disliked rules

A common misconception among freelancers operating as sole traders is that IR35 compliance is a consideration -- to set the record straight, it’s not.

Does IR35 catch sole traders? Answered here, once and for all...

IR35 doesn’t factor into the equation for sole traders. The legislation only comes into play when an individual provides their services via an intermediary, such as a personal service company, typically a limited company, writes Seb Maley, CEO of Qdos.

So what’s the reason for this difference? Well, prior to the inception of IR35 in 2000, HMRC couldn’t challenge employment status where there was a corporate entity – i.e. a personal service company – between the worker and the agency or client.

In the absence of this entity, there’s a direct relationship between the taxpayer and its customer, and so HMRC has always been able to police relationships where the worker is a sole trader.

What does the IR35 legislation test for?

The introduction of IR35 was effectively a reactionary extension to existing employment status rules governing sole traders. Furthermore, the determining factors used for IR35 – from Personal Service to Control and Mutuality of Obligation – have their foundation in these original status rules, which are utilised in both tax and employment law.

Due to IR35 being contained within a specific piece of legislation, and as it has a recognisable moniker, it’s taken the majority of the limelight since its arrival.

HMRC risks still remain in sole trader engagements

But, in the background, traditional employment status rules have always been there, and continue to pose a risk to engagers of sole traders.

HMRC does investigate what’s known as ‘false self-employment’, which refers to a sole trader working under self-employed status when, in fact, the relationship between them and their engager reflects employment.

In the event of ‘false self-employment’, the engager is liable to HMRC for missing employment taxes, not the sole trader.

What about IR35 if sole traders use a recruitment agency?

This applies unless a sole trader operates via a recruitment agency – in which case, the ‘Agency Legislation’, also known as ‘Section 44’ becomes a consideration. Under these rules, the agency is liable.

As you might have clocked, this is similar to how the system works under the April 6th 2017/201 off-payroll rules. Following the introduction of these rules, unless a contractor is engaged by a small business, they are no longer liable for non-compliance relating to contracts which weren’t complete prior to the rules’ introduction. The risk lies with the ‘fee-paying’ party, which is either the end-client or the recruitment agency.

Key case law (tbc): PGMOL

While not widely publicised, there have been many tax status cases involving sole traders over the years. A recent example, which is still ongoing, is the case involving Football League referees working for the refereeing body, PGMOL. The ultimate results of this particular case are likely to have an impact on status across all fronts – including IR35.

Given there’s now a level of alignment in the rules involving either sole traders or personal service companies, we may start to see a higher level of compliance activity by HMRC in both areas.

Looking ahead, HMRC may also aim to strengthen the mechanics of the rules involving traditional status. At present, there are no requirements for a formal determination to be made where sole traders are concerned (whereas a Status Determination Statement must be issued in engagements falling under the off-payroll rules).

Final thought

Those who engage sole traders should be acutely aware of the risk and should undertake the same level of ‘due diligence’ as those who engage personal service companies. After all, engagements involving sole traders are prevalent across many industries -- from construction to finance and creative industries.