Does IR35 apply to sole traders? IR35 is a tax legislation designed to prevent ‘disguised employment,’ where contractors work as employees but pay less tax through a limited company. There is often confusion about its relevance to sole traders. This guide explains IR35, its impact on sole traders, and the key employment status considerations for tax purposes.
Sole trader insurance
Sole trader liability insurance helps shield you from unexpected claims, keeping your business secure. Whether you’re a freelancer, consultant, or small business owner, having the right coverage is crucial. Stay protected and gain peace of mind today.
What is IR35 and who does it apply to?
IR35, also known as the off-payroll working rules, applies to individuals who provide services through an intermediary, typically a personal service company (PSC). It ensures that contractors who would otherwise be employees for tax purposes pay the appropriate taxes.
The rules apply to workers operating through their own limited companies, partnerships, or other intermediaries, but do not apply directly to sole traders. However, sole traders must still be mindful of their employment status.
Does IR35 apply to sole traders?
No, IR35 does not apply to sole traders. The legislation is specifically designed for incorporated businesses, meaning those working as individuals without a limited company fall outside its scope.
That said, sole traders still need to consider their employment status, as misclassification could lead to tax liabilities for their clients.
Why sole traders still need to consider employment status
Even though IR35 does not affect sole traders, HMRC uses similar criteria to determine whether a sole trader is genuinely self-employed. If a sole trader is found to be operating in an employment-like relationship, their client may be responsible for deducting tax and National Insurance contributions.
HMRC considers the following factors to assess employment status:
- Control – Does the client dictate how, when, and where the work is done?
- Substitution – Can the sole trader send someone else to complete the work?
- Mutuality of obligation (MOO) – Is the client required to offer work, and is the sole trader obligated to accept it?
The Onshore Intermediaries Legislation and sole traders
Sole traders working through recruitment agencies must also be aware of the Onshore Intermediaries Legislation, introduced in 2014. This legislation ensures that:
- Agencies engaging sole traders must deduct PAYE tax if there is evidence of control over the worker.
- If the sole trader is deemed to be under supervision, direction, or control (SDC), they may be considered an employee for tax purposes.
Risks of misclassification as a sole trader
If HMRC determines that a sole trader is effectively an employee, the consequences include:
- The client may need to pay backdated tax and National Insurance.
- The client could face penalties and interest charges.
- The sole trader may have difficulty securing work if clients fear misclassification risks.
How to ensure you are operating as a genuine sole trader
To maintain self-employed status and avoid misclassification:
- Work for multiple clients rather than relying on a single income source.
- Provide your own equipment and take financial risk for project outcomes.
- Ensure contracts reflect self-employment, including substitution clauses.
- Maintain independence by setting your own hours and working methods.
Tax obligations for sole traders
Unlike limited company contractors, sole traders must handle their own tax responsibilities, which include:
- Self-assessment tax return – Submitted annually to HMRC.
- Income tax – Paid at standard UK tax rates.
- National Insurance contributions (NICs) – Class 2 and Class 4 NICs apply.
Comparing sole traders vs. limited company contractors
| Feature | Sole Trader | Limited Company Contractor |
|---|---|---|
| IR35 Applicability | No | Yes (if deemed inside IR35) |
| Business Structure | Individual | Separate legal entity |
| Tax Efficiency | Lower | Higher tax efficiency with dividends |
| Admin & Costs | Lower | More admin, accounting, and compliance costs |
| Liability | Unlimited personal liability | Limited liability |
Summary
IR35 does not apply to sole traders, but employment status still matters. If HMRC determines that a sole trader is working under conditions similar to employment, their client may be required to deduct PAYE tax. Sole traders should take steps to demonstrate their self-employed status and comply with tax obligations to avoid misclassification risks.
