Employment Status and IR35: What Small Businesses Need to Know

Running a small business often means juggling a hundred things at once; clients, cash flow, operations, people... and then the legal bits that make your head spin.

Employment status and IR35 might sound like accountant-speak, but understanding them is vital if you want to stay compliant, avoid tax headaches, and build a happy, fair workplace.

So, let’s break it down in plain English.

💡 Why Employment Status Matters

Before you even think about IR35, you need to understand how to correctly classify the people who work for you.

There are three main types of employment status in UK law:

1. Employee - works under a contract of employment.

   • You control their work, hours, and how they do it.

   • They get employee rights like holiday pay, sick pay, redundancy, and maternity leave.

   • Example: Sarah works 9–5 in your office, you approve her holidays, and she uses your laptop. She’s your employee.

     
     

2. Worker - a middle ground between employee and self-employed.

   • They have some rights (like holiday pay and national minimum wage), but not all employee benefits.

   • They usually have more flexibility.

   • Example: James does casual shifts in your café when needed. He’s not guaranteed hours but is paid for the work he does - he’s a worker.

     
     

3. Self-Employed / Contractor – runs their own business.

   • They decide when, how, and where they work.

   • They handle their own tax, insurance, and risk.

   • Example: Emma is a web designer who works for several clients, invoices you monthly, and uses her own equipment. She’s self-employed.

     
     

⚠️ The Risks of Getting Employment Status Wrong

Getting this wrong can cost you - financially and legally.

If someone you’ve treated as self-employed later claims they were actually an employee or worker, you could face:

• Backdated tax and National Insurance - HMRC can demand that you pay unpaid tax and NI contributions, plus penalties and interest.

• Unpaid holiday pay - workers are entitled to 5.6 weeks’ paid holiday per year, and claims can go back up to two years.

• Statutory payments - such as sick pay, maternity/paternity pay, and redundancy pay.

• Auto-enrolment pension contributions - if they should’ve been enrolled in your pension scheme, you’ll need to make back payments for both employer and employee contributions.

• Unfair dismissal or discrimination claims - if you end the relationship and they’re later found to have employee status, they could claim unfair dismissal or discrimination, which can lead to tribunal costs and reputational damage.

• Reputational risk - being challenged by HMRC or taken to tribunal can impact your brand and client confidence.
  

Even if you win, the time, stress, and distraction of defending a claim can take your focus off running and growing your business.

Enter IR35 - The Further Complication

Now, let’s add IR35 into the mix.

IR35 (or “off-payroll working rules”) is designed to stop people working like employees but being paid as contractors to avoid tax.

It mainly applies when someone provides their services through a limited company (often called a Personal Service Company or PSC).

The question is:

If this person didn’t have their company, would they actually be your employee?

If the answer is yes, they’re inside IR35, meaning you need to treat them like an employee for tax purposes.

If the answer is no, they’re outside IR35, meaning they’re genuinely self-employed.

⚖️ How to Work Out IR35 Status

The main factors HMRC look at are:

1. Control – Do you decide how, when, and where the work is done?

2. Substitution – Can the person send someone else to do the work instead of them?

3. Mutuality of Obligation (MOO) – Are you obliged to offer work, and are they obliged to accept it?

Who’s Responsible?

This depends on who the client is:

• Public sector or medium/large private companies: the client (you) must assess and determine the IR35 status using HMRC’s Check Employment Status for Tax (CEST) tool.

• Small businesses (as defined by the Companies Act - meeting two of the following: turnover under £10.2m, balance sheet under £5.1m, fewer than 50 employees): The contractor’s company is responsible for determining IR35 status.

  
  

Even so, it’s wise for small businesses to understand the basics - if HMRC disagrees later, it can still cause a messy dispute.

✅ What You Can Do

1. Use clear contracts. Spell out terms like control, substitution, and project deliverables.

2. Avoid “disguised employment.” If someone’s working like an employee, treat them as one.

3. Use the CEST tool (search “HMRC CEST tool” online) to check grey areas.

4. Review arrangements regularly. A contractor’s role might evolve over time.

5. Get HR or legal advice before making changes - it’s far cheaper than an HMRC investigation later.

   
   

In Short

Employment status defines how someone works for you.IR35 ensures people working like employees are taxed fairly. Get them wrong, and you risk fines, back payments, and legal disputes. Get them right, and you’ll protect your business and your people.

Want help checking your contracts or employment status?

At The HR Crowd, we help small businesses stay compliant while keeping things practical and people-focused.If you’re unsure about your setup, or just want peace of mind - let’s chat.

👉 Book a free clarity call