Are sole traders affected by IR35?

Does IR35 apply to sole traders? Understanding the tax legislation behind employment status

The simple answer is that IR35 does not affect sole traders. The IR35 legislation applies only to incorporated businesses and therefore a sole trader cannot be caught by IR35.

Although IR35 doesn’t apply to sole traders, employment status does, and the rules for determining employment status are very similar to the rules for determining IR35 status.

 

Which employment status tax legislation applies to sole traders?

Onshore Intermediaries legislation

Prior to 2014, sole traders operating through an agency could be deemed genuinely self-employed if they could prove that they had a right to provide a substitution. However, HMRC believed that many sole traders were operating as disguised employees by falsely claiming that they could provide a substitute.

As of 6th April 2014, the Onshore Intermediaries Legislation (also known as the Agency Legislation) has been in place to ensure that the correct tax and national insurance is deducted from sole traders engaged through agencies relative to their employment status.

This legislation focuses upon the presence of supervision, direction, and control (SDC) in an engagement in order to gauge employment status. In essence, any SDC exercised by an end client over the services provided by a sole trader could constitute an indicator of disguised employment.

 

Traditional employment status

Traditional employment status focuses upon the relationship between a directly engaged sole trader and their client.

The tests that determine traditional employment status are the same as those that determine the IR35 status of contractors.

For example:

• Substitution: The right of the sole trader to provide an alternative individual in order to fulfil the services on their behalf
• Control: The right of the client to control how, when, and where the services of the sole trader are delivered
• Mutuality of obligations: Is there a mutual lack of obligation between both parties?

For more information on employment status tests, see our guidance here.

 

How does employment status impact sole traders?

Sole traders don’t carry any liability for their own employment status.

The client organisation is responsible for paying additional taxes, interest, and possibly penalties should a sole trader be considered an employee for tax purposes.

Client organisations have always held the responsibility for ensuring they are engaging sole traders under the correct employment status. However, sole traders may now find themselves becoming increasingly included within client status determination processes since IR35 reform in April 2021, with employment status now a more critical concern for compliance departments.

Whilst sole traders do not carry any liability, they could suffer a deduction from future earnings, as the likelihood is that they would be placed onto the payroll of the end client.

 

What are my tax obligations as a sole trader?

Whereas limited company contractors are a separate legal entity from their company, this is not the case with sole traders. Sole traders and their business are taxed as one entity. This is done through an annual self assessment tax return which can be completed online via a Government gateway account.

For more information on how to complete a self-assessment tax return see here.

 

How much is the tax rate for sole traders?

The personal allowance for the 2021/2022 tax year is £12,570.

A personal allowance is the maximum amount that can be earned before any income tax is paid.

For any amount of income above this threshold, the following levels of tax deduction apply:

• Basic Income: 20% on income up to £50,270
• Higher Income: 40% on income between £50,271 and £150,000
• Additional Income: 45% on income over £150,000.

Qdos offer a range of bespoke tax consultancy curated by a team of experienced tax professionals and ex-HMRC Inspectors. With a proven record of successfully resolving disputes, our team is ready to help you understand your employment status.

Take a look at our Tax Enquiry Insurance or get in contact with a member of our team today.