Summary
- IR35 is UK tax legislation that taxes a contractor’s fees as employment income where they supply services through a personal service company but the underlying relationship is really one of employment.
- Responsibility for assessing IR35 status depends on company size, with small companies leaving the decision to the intermediary and larger companies issuing a Status Determination Statement.
- Where a contractor disputes a Status Determination Statement, the engaging company must consider the disagreement and respond within 45 calendar days, or it becomes the deemed employer for PAYE purposes.
- This guide explains IR35 compliance for software service companies engaging contractors through personal service companies in the United Kingdom.
- LegalVision’s employment lawyers advise software service companies on assessing IR35 status, drafting contractor agreements and responding to Status Determination Statement disagreements.
Tips for Businesses
Do not rely on contract wording alone, since HMRC weighs actual working practices more heavily where the two diverge. Avoid blanket status determinations, since each engagement needs its own assessment on its own facts. Document every assessment and keep it under review as a contractor’s role or working practices change. Speak to an employment lawyer at LegalVision about assessing whether your contractor engagements fall inside IR35.
On this page
- Engaging Contractors in Software Service Companies
- What the IR35 Rules Mean for Software Service Companies
- Who Is Responsible for IR35 Compliance?
- Assessing When IR35 Applies to Software Service Companies
- Contracts and Working Arrangements in Software Service Companies
- Practical Steps for Software Service Companies to Reduce Risk
- Taking Advice on IR35 and Employment Status for Software Service Companies
- Key Takeaways
- Frequently Asked Questions
IR35 is UK tax legislation that stops an individual from reducing tax by supplying services through an intermediary, such as a personal service company, where the true relationship is employment. A software service company that engages a contractor through a personal service company must consider whether IR35 applies to that engagement. The company’s size decides who carries that responsibility. The Companies Act 2006 small company test decides this. This article explains how IR35 applies to software service companies that engage contractors through personal service companies, who carries responsibility for the assessment, the factors that determine status, and what a company must do if a contractor disputes its Status Determination Statement.
Engaging Contractors in Software Service Companies
Consultancy allows software service companies to access specialist skills that are not available in-house. It also supports short-term or project-based work. Many businesses in the sector operate flexible delivery models. Staffing needs often change as projects start, change scope or end. Using contractors can be a cost-effective alternative to permanent recruitment, without taking on onerous long-term commitments.
Software service companies commonly engage contractors for software development, systems implementation, and other technical projects. These roles often require specialist expertise for a limited period. In the IT and software sector, contractors frequently provide services through their own limited companies, commonly known as personal service companies (PSCs). While this structure can be tax-efficient for individuals, it creates additional tax and employment status risk for the engaging business.
What the IR35 Rules Mean for Software Service Companies
IR35 is UK tax legislation. Put simply, its purpose is to prevent individuals from avoiding income tax and National Insurance by supplying their services through intermediaries when the underlying relationship is (in reality) one of employment. This is often described as disguised employment.
In simple terms, IR35 asks whether the individual would be treated as an employee for tax purposes if the intermediary did not exist. Where IR35 applies, the fees paid for the individual’s services are taxed in a similar way to employment income.
By contrast, where a software service company engages a genuinely self-employed individual directly (and no intermediary is involved), the IR35 rules do not apply. In those cases, the individual usually pays income tax and National Insurance through self-assessment.
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Who Is Responsible for IR35 Compliance?
Responsibility for IR35 depends on the size of the software service company and whether an intermediary is used.
A private-sector software service company is treated as a small company if it meets at least two of the following conditions:
- annual turnover of no more than £15 million
- a balance sheet total of no more than £7.5 million
- an average of no more than 50 employees
Where a software service company is a small company that is exempt, the IR35 rules do not apply. In those cases, responsibility for assessing IR35 status and paying tax remains with the intermediary, usually the PSC.
Assessing When IR35 Applies to Software Service Companies
For IR35 purposes, the key question is whether the individual would be an employee for tax purposes if engaged directly.
Status is assessed by looking at the whole working relationship. Relevant factors include the level of control over how, when, and where work is done, whether there is a genuine right of substitution, the presence of mutual obligations, the level of financial risk and how integrated the individual is into the organisation.
No single factor determines status, and each engagement must be assessed on its own facts.
Contracts and Working Arrangements in Software Service Companies
Written contracts are important and should reflect the intended relationship between the parties. However, contracts are not decisive for IR35 purposes.
If the written terms do not match what happens in practice, greater weight will be placed on day-to-day working arrangements. Contracts should be reviewed regularly, especially where projects, roles or working practices change in the SaaS industry.
Where an engagement genuinely falls outside IR35, responsibility for paying tax sits with the contractor and the intermediary, not the software service company that engages them.
Practical Steps for Software Service Companies to Reduce Risk
Important steps to reduce risk include the following:
- identify contractor engagements that involve intermediaries and carefully consider whether the IR35 rules apply;
- where required, carry out and document robust employment status assessments;
- issue clear Status Determination Statements (SDSs) and share them with the relevant parties;
- review contractor arrangements regularly, particularly where working practices or contractual arrangements change;
- avoid blanket status determinations and assess each engagement on its individual circumstances;
- where IR35 applies, the fee-payer must deduct the appropriate Income Tax and employee National Insurance Contributions (NICs); and
- account for employer NICs and, where applicable, the Apprenticeship Levy before making payment to the intermediary.
Taking Advice on IR35 and Employment Status for Software Service Companies
IR35 and employment status are wide and complex areas of law. Each engagement depends on its specific facts and working practices.
Employment status assessments carry financial risk. Incorrect decisions can lead to unpaid tax, National Insurance Contributions, interest and penalties. Taking legal advice can help software service companies to carefully assess risk and apply the IR35 rules consistently. This is particularly important where their contractor arrangements are unclear or high-value.
“The businesses that get caught out are rarely the ones who ignore IR35 outright. They are the ones who assume a well-drafted contract settles the question on its own. What actually happens day to day matters just as much as what the paperwork says, so treat every engagement as its own assessment rather than reaching for a template answer.”
Learn how to manage employment disputes and protect your business from legal action.
Key Takeaways
Using contractors can afford software service companies significant flexibility and access to specialist skills when needed for client projects. However, engaging contractors through PSCs can also give rise to tax risk if arrangements are not structured correctly.
Software service companies should understand when the IR35 rules apply and their obligations, document decisions carefully, and ensure contracts reflect working arrangements correctly. Legal advice should always be taken where uncertainty exists, to help avoid risk.
LegalVision provides ongoing legal support for businesses through our fixed-fee legal membership. Our experienced employment lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 0808 196 8584 or visit our membership page.
Frequently Asked Questions
What is IR35?
IR35 is UK tax legislation which is designed in order to restrict individuals from avoiding income tax and National Insurance by providing services through intermediaries where the underlying relationship is employment-like.
Does IR35 apply to sole traders?
IR35 applies where services are provided through an intermediary such as a personal service company. Where a sole trader is engaged directly, IR35 does not apply. However, if the working relationship would be considered employment, the business may have tax and employment law obligations under general employment status rules.
What factors determine employment status under IR35?
No single factor decides status. Relevant factors include how much control the company has over how, when and where the contractor works, whether the contractor holds a genuine right of substitution, whether mutual obligations exist, the contractor’s financial risk, and how integrated the contractor is into the business.
What should a contractor agreement include to manage IR35 risk?
A written contract should reflect the intended working relationship, though it is not decisive on its own for IR35 purposes. Key clauses to include cover control, substitution rights, equipment, exclusivity and termination, since these terms should match how the engagement operates in practice.
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