HM Revenue & Customs (HMRC) anticipates an annual loss of £20 million in tax revenue due to non-compliance with IR35 rules, following recent government changes to business size classifications, according to a Freedom of Information (FOI) response.
As reported by the Computer Weekly, the changes, implemented on April 6, 2025, adjusted the criteria under the Companies Act 2006, increasing the turnover and balance sheet thresholds used to define micro, small, and medium-sized enterprises (SMEs).
Under the new rules, a company qualifies as “small” if its aggregate turnover is £15 million or less (previously £10.2 million or less) and its balance sheet total is under £7.5 million (previously £9 million or less).
These adjustments mean an estimated 10,000 businesses previously classified as medium-sized will now be considered small. This has significant implications for the IR35 off-payroll working rules, which came into force for the private sector in April 2021.
Those rules made medium and large companies responsible for determining whether their contractors should be taxed similarly to employees (inside IR35) or as self-employed individuals (outside IR35). Small businesses are exempt from this obligation, leaving the responsibility for determining IR35 status with the contractor themselves.
According to government figures, approximately 20,000 contractors engaged by these newly reclassified businesses will be affected by the shift.
The £20 million shortfall prediction emerged from an FOI request submitted by Dave Chaplin, CEO of IR35 Shield.
HMRC’s response stated: “It is estimated that around 1.5%, or between 2,000-to-2,500 of all individuals within the off-payroll working rules and working for medium- or large-sized businesses will change employment arrangements and revert to non-compliance with the IR35 rules as a result of the definition change.”
HMRC further estimated these individuals would pay roughly £10,000 less tax per year each, leading to the £20 million annual revenue loss. The tax authority clarified that compliant contractors, who were already paying the correct taxes, would be unaffected and do not contribute to the additional revenue collected under the off-payroll reforms.
However, Mr. Chaplin argues that the shift in responsibility should not inherently lead to a tax loss.
“Just because the tax liability shifts to the contractor that does not give the contractor a license to ignore the original legislation, which will still be in force,” he stated.
“All that changes is that the tax liability switches back from the client to the contractor, hence no change in taxes paid.”
Furthermore, both Chaplin and Seb Maley, CEO of Qdos, highlighted a significant delay before these changes impact IR35 obligations.
An update to HMRC’s Employment Status Manual confirmed that the earliest a company can leverage its new “small” status for IR35 purposes is April 6, 2027. This is due to rules requiring a company to meet the size criteria for consecutive years.
“It’s going to feel like one step forward two steps back for freelancers and contractors engaged by these medium-sized firms,” said Mr. Maley, noting the disappointment among contractors who hoped for an immediate change.
“We’re still two years away from these freelancers being transferred back the responsibility for determining IR35 status.”
In the meantime, the administrative burden of IR35 compliance remains with the client companies until they officially qualify as small under the two-year rule.
Maley advised contractors concerned about incorrect status determinations by their clients to seek second opinions and challenge assessments if necessary.
Understanding HMRC’s IR35
IR35, formally known as the Intermediaries Legislation, is one of the most significant and often misunderstood tax regulations affecting contractors and freelancers in the UK. Introduced by HM Revenue and Customs (HMRC) to tackle what they consider “disguised employment,” IR35 has undergone significant changes over the years, with major reforms in both the public and private sectors.
What is IR35?
IR35 refers to tax legislation designed to combat tax avoidance by workers who provide services to clients through an intermediary (typically their own limited company) but who would be considered employees if the intermediary wasn’t used. These workers are sometimes known as “disguised employees” or “deemed employees.”
The Purpose of IR35
The legislation aims to ensure that individuals working through intermediaries who are effectively employees pay broadly the same Income Tax and National Insurance contributions as regular employees. HMRC introduced IR35 because they believed many workers were using personal service companies (PSCs) primarily to avoid paying employee taxes, despite working in what HMRC would consider an employment relationship.
How IR35 Works
IR35 status is determined by examining the actual working relationship between the contractor and the client, looking beyond the written contract to the reality of the working arrangement. Key factors include:
• Control: The degree of supervision, direction, and control the client has over how the contractor completes their work
- Substitution: Whether the contractor can send someone else to do the work in their place
- Mutuality of obligation: Whether the client must offer work and the contractor must accept it
- Financial risk: Whether the contractor takes on financial risk like employees typically don’t
- Equipment: Whether the contractor uses their own equipment or the client’s
- Part and parcel: The extent to which the contractor is integrated into the client’s organization
Off-Payroll Working Rules
In 2017 and 2021, HMRC introduced significant reforms to IR35, known as the “Off-Payroll Working Rules.” These changes shifted the responsibility for determining IR35 status from the contractor to the client in both public sector (2017) and medium/large private sector organizations (2021).
Implications of IR35
For Contractors
- Inside IR35: Pay PAYE Income Tax and National Insurance as an employee would
- Outside IR35: Can pay themselves more tax-efficiently through dividends
For Businesses
- Legal responsibility to correctly determine status (for medium/large businesses)
- Potential tax liability if determinations are incorrect
- Administrative burden of making determinations
Best Practices for Compliance
- Conduct thorough status determinations for each engagement
- Maintain detailed records of determinations and reasoning
- Ensure contracts accurately reflect the actual working relationship
- Consider using HMRC’s Check Employment Status for Tax (CEST) tool
- Obtain professional advice for complex cases
Recent Developments
The IR35 landscape continues to evolve, with court cases regularly setting new precedents and HMRC refining their approach to enforcement. Businesses and contractors alike must stay informed about these changes to remain compliant.
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