The IR35 small company exemption is about to change in scope, but the effect will not be felt until 6 April 2027. The Companies Act size thresholds rose on 6 April 2025, yet HMRC’s Employment Status Manual confirms the earliest a reclassified company can be treated as “small” for off-payroll purposes is April 2027. Contractors and clients who assume the change is immediate risk applying the wrong rules.
This matters because the small company exemption determines who carries the IR35 status decision, and the liability that goes with it — the client or the contractor’s own company.
What Is the IR35 Small Company Exemption?
Under the off-payroll working rules, medium and large clients in the private sector must determine the IR35 status of the contractors they engage and account for any resulting tax. Where the client qualifies as “small”, that responsibility instead sits with the contractor’s personal service company (PSC).
Small status is defined by the Companies Act size thresholds. To qualify, a company must not exceed two of three limits across turnover, balance sheet total and employee numbers. When those limits rose on 6 April 2025, a band of medium companies moved towards small status.
Why the Impact Is Delayed Until April 2027
HMRC’s Employment Status Manual, updated on 8 April 2025, confirms that a company reclassified as small under the higher thresholds cannot be treated as small for off-payroll purposes until 6 April 2027. Size classification depends on two consecutive financial years, so the change works through with a lag.
The practical figures are significant. HMRC estimates that around 10,000 medium businesses will fall out of off-payroll scope, and a Freedom of Information response puts the resulting cost to the Exchequer at roughly £20 million a year in IR35 non-compliance.
Do Not Switch the Rules Early
Applying small-company treatment before a business genuinely qualifies is a common error. Until the two-year test is met and April 2027 arrives, medium clients retain the duty to determine status and operate PAYE where required. Getting the timing wrong shifts liability to the wrong party.
What Does the Small Company Exemption Actually Do to Risk?
When a client qualifies as small, the off-payroll obligation does not simply lighten — it disappears. The client no longer has to consider the status of its relationship with the contractor at all. The status decision, the associated administration, and the tax risk of getting it wrong all move to the contractor’s PSC.
That is a clean transfer, not a reduction. It is precisely why the timing test matters. A client that assumes small status too early has walked away from a duty it still holds, while a contractor that assumes it too early takes on risk that is not yet theirs.
The One Duty a Small Client Retains
Once a client is properly established as small, it carries a single, modest obligation. Where another party in the supply chain asks whether the client is small — or questions why it has not issued a status determination statement (SDS) — the client must respond within 45 days confirming that it meets the small company definition.
That is the extent of it. There is no ongoing status assessment and no SDS to produce, only the requirement to answer a legitimate enquiry within the statutory window. Ignoring the request does not remove the exemption, but it invites unnecessary scrutiny and undermines confidence in the supply chain. A short, documented reply settles the point.
The Enforcement Backdrop
Off-payroll reform has already produced substantial revenue, and HMRC has the data to show it. Figures published in early 2025 indicate the reforms generated around £4.2 billion in additional tax over four years, affecting roughly 120,000 contractors, with an average additional bill of about £10,000 each.
Those numbers explain HMRC’s continued focus. IR35 is not a settled area where enforcement has softened — it is a proven source of revenue with active compliance activity behind it. Once responsibility sits with the PSC, that scrutiny follows the contractor.
How Should Clients and Contractors Prepare?
The transition period between now and April 2027 rewards careful process over assumption. Businesses near the threshold should treat classification as a live compliance question, and contractors should understand where liability will land once the exemption applies.
- Confirm your size status against two consecutive financial years, not a single strong year.
- Keep operating off-payroll duties until you genuinely qualify as small.
- Retain status determination statements and the reasoning behind them for the period the duty applies.
- Once established as small, be ready to confirm that status within 45 days if a supply-chain party enquires or queries a missing SDS.
- Contractors should plan for the point at which status responsibility returns to the PSC, and evidence status on the facts of each engagement.
- Review supply chains where contractors engage through umbrellas, as tax liability now flows up the chain under the joint and several liability (JSL) rules in force from 6 April 2026.
Contractors should not assume a client’s reclassification returns responsibility to them ahead of schedule. When it does, the risk is entirely theirs, so the evidence needs to be in order.
Conclusion
The IR35 small company exemption is widening, but slowly and on HMRC’s timetable — with April 2027 as the earliest date reclassified companies can rely on it. FCSA’s position is straightforward: the exemption changes who carries the decision and the risk, not whether compliance matters. When a client becomes small, that risk moves wholesale to the contractor, and the client’s one remaining duty is to confirm its status within 45 days when asked. Evidence, reasonable care and accurate timing remain the tests that stand up to scrutiny.
Agencies and clients managing off-payroll risk should engage accredited providers. Review the standards behind FCSA Accreditation and check the FCSA Members register when building a compliant supply chain.
