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HMRC predicts IR35-related £20m annual tax loss due to business size classification changes
HMRC predicts that changes made by the government to the classification criteria used to decide if businesses should be considered small or medium-sized entities will cost the Treasury £20m each year in IR35 non-compliance
A rejig of the government regulations used to classify company sizes will cost the Treasury around £20m in lost tax each year due to IR35 non-compliance, according to a freedom of information (FOI) response from HM Revenue & Customs (HMRC).
The UK government introduced changes on 6 April 2025 that increased the balance sheet and turnover thresholds used to determine whether companies should be classified as micro, small or medium-sized businesses, as per the terms of the Companies Act 2006.
Under the reworked criteria, a company will be classified as a small business if they have an aggregate turnover of £15m or less and a balance sheet total of under £7.5m.
Previously, to qualify as a small business, a company would need a turnover of less than £10.2m and a balance sheet of £9m or less.
Government figures suggest the changes will result in 10,000 medium-sized businesses falling out of scope of the private sector IR35 off-payroll reforms, as a result of them being reclassified as small businesses.
The reforms, which came into force in April 2021, made medium-to-large companies responsible for determining if the contractors they engage should be taxed in the same way as off-payroll employees (outside IR35) or in the same way as salaried workers (inside IR35).
Before the private sector reforms came into force, contractors were responsible for determining whether or not the work they did and how it was carried out meant their engagements should be classified as inside or outside IR35.
According to the government’s own figures, the change in business size classifications looks set to impact 20,000 contractors who are engaged by medium-to-large businesses.
However, Computer Weekly has seen HMRC’s response to an FOI request, submitted by Dave Chaplin, CEO of IR35 compliance company IR35 Shield, which suggests the changes will have a detrimental impact on the Treasury’s IR35-related tax take.
The document states that HMRC produced an estimate that suggests the changes to company size turnover and balance sheet thresholds will cost the Exchequer £20m each year due to contractors affected by the changes failing to comply with the IR35 rules.
“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,” said HMRC in its FOI response.
“It’s estimated they will pay in the region of £10,000 less in tax per year as a result, making a total loss of revenue of around £20m in tax liabilities per year. There is no cost associated with normal, compliant behaviour, since contractors already paying correct taxes would have been unaffected by off-payroll reform and do not contribute to the additional revenue it continues to collect.”
Speaking to Computer Weekly, Chaplin said that while HMRC expects that 20,000 contractors will be affected by the changes, this should not result in any difference in the amount of taxes paid to the Treasury.
“It’s important to note that 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,” warned Chaplin. “All that changes is that the tax liability switches back from the client to the contractor, hence no change in taxes paid.”
Switching responsibility
Chaplin said contractors should also take note of the fact that the changes made to the Companies Act 2006 will have little impact on their working arrangements for at least two years. This is because the earliest a medium company can qualify as small where their IR35 obligations are concerned is 6 April 2027, as confirmed by an update to the HMRC Employment Status Manual on 8 April 2025.
“[And] let’s be clear: the number of contractors that this may benefit is minimal and the fundamental challenges with IR35 remain, continuing to impede the flexibility of Britain’s independent workforce,” he said.
“The off-payroll rules continue to force contractors into suboptimal quasi-employment models and place an unnecessary burden on UK enterprises. If Labour wants meaningful change that produces growth, they need to address IR35 itself, not just adjust reporting thresholds.”
Even so, Seb Maley, CEO of contractor insurance company Qdos, said there will be contractors out there who will be disappointed by the time lag between the changes being introduced and taking effect from an IR35 perspective.
“It’s going to feel like one step forward two steps back for freelancers and contractors engaged by these medium-sized firms that are set to be relieved of the off-payroll rules,” he said.
“There was hope this change would kick in overnight, but a government [Employment Status Manual] update has revealed the devil in the detail,” said Maley. “It shows that we’re still two years away from these freelancers being transferred back the responsibility for determining IR35 status – effectively, assessing if they pay tax as a self-employed worker or employee.”
In the interim, all contractors can do, he said, is sit tight and allow their clients to continue feeling the administrative burden of IR35.
“That being said, if a freelancer’s concerned their client has misapplied their IR35 status, they’re well within their right to seek a second opinion, which can be used to challenge this determination,” said Maley.
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