Chapter 10 and the small company exemption

The off-payroll working rules in Chapter 10 of the Income Tax (Earnings and Pensions) Act 2003 apply where the end client is a medium or large company. Where the client is small, Chapter 10 does not apply, and the contractor's PSC remains responsible for assessing its own status under the original intermediaries legislation, Chapter 8.

The distinction is fundamental because it shifts responsibility. Under Chapter 10, the end client determines whether the engagement is inside or outside IR35 by issuing a Status Determination Statement, and the fee-payer (typically a recruitment agency) operates PAYE and National Insurance on the income. Under Chapter 8, the PSC contractor does both: determines status and calculates any tax due. Which regime applies depends entirely on the size of the end client.

The definition of "small" was imported from Companies Act 2006 s.382. From financial years beginning on or after 6 April 2025, that test was tightened by the definition of a "small company" in the act, which requires the company to meet two or more of three conditions. This change in the statutory test represents a significant shift in the threshold, raising the bar for which clients trigger Chapter 10's stricter regime.

The three conditions: the 2026 thresholds

A company is small, and thus falls outside Chapter 10, if it meets two or more of these three conditions for a given financial year:

  • Turnover not more than £15,000,000 (raised from £10.2m)
  • Balance sheet total not more than £7,500,000 (raised from £5.1m)
  • Not more than 50 employees (unchanged)

These thresholds apply to financial years beginning on or after 6 April 2025. If a company breaches any two of the three conditions, it is not small and Chapter 10 applies. The key point is "two or more": meeting all three conditions is sufficient, but meeting just two is enough. Conversely, meeting only one condition (for instance, having turnover below £15m but a balance sheet above £7.5m and more than 50 employees) does not qualify as small.

The turnover and balance-sheet thresholds rose by roughly 50% (the employee count was left at 50), which was designed to bring more companies inside the small company exemption and reduce the number that must comply with Chapter 10's Status Determination Statement and employer PAYE obligations. In practice, many growing mid-market companies caught by Chapter 10 under the old test may now fall outside it, provided they clear the two-year rule and the timing lag below.

The practical benefit of these raised thresholds should not be overstated. Many contractors will not see the impact until 2027/28 or later because of the two consecutive years rule and the relevant financial year lag. For 2026/27, most previously medium and large clients remain in Chapter 10 scope.

The two consecutive years rule

A company's status does not change on the basis of a single financial year's results. The key statutory rule is that a company must meet (or cease to meet) the conditions in two consecutive financial years before its status is revised. This is set out in Companies Act 2006 s.382(2).

In practice, this means the following: if a company has been in Chapter 10 scope because it breached the thresholds, and in the most recent financial year it now meets two or more of the three conditions, it will still be in Chapter 10 scope for the next tax year because it has only met the conditions in one year. Only once it has met the conditions for two consecutive years will it drop out of Chapter 10 scope.

Conversely, if a company was previously small (met the conditions), breaches them in one year, it remains outside Chapter 10 for that year, and only after breaching them in a second consecutive year will it move into Chapter 10 scope.

The relevant financial year lag: why the exemption is not immediate

The critical timing issue is that off-payroll obligations are not determined by a company's current financial position, but by its status as of the "relevant financial year". The relevant financial year for a given tax year is the client's last financial year that ended before the start of that tax year, with enough time to file accounts at Companies House.

This creates a lag. If a client's financial year ends on 31 December 2025, its accounts must be filed by 30 September 2026. However, the relevant financial year for the tax year 2026/27 (which begins 6 April 2026) is the year ending 31 December 2025. So for 2026/27, the client's off-payroll status is determined by its 31 December 2025 accounts.

But the client must also meet the conditions in two consecutive years. If the 31 December 2025 year is the first year the client meets the small-company thresholds, the status change does not take effect until the client has also met them in the 31 December 2026 year. That year ends 31 December 2026, meaning the earliest the exemption applies is for the tax year 2027/28 (starting 6 April 2027).

For many clients with different year-ends, or those that have only recently breached the thresholds, the lag is even longer. A client with a year-end of 30 June may not drop out of Chapter 10 scope until 6 April 2028.

The 6 April 2027 earliest timing: practical implications

Most contractors should assume that their medium and large clients are still in Chapter 10 scope for the 2026/27 tax year, even if those clients recently breached the raised thresholds. The two consecutive years rule and the relevant financial year lag mean that a drop out of scope cannot occur before 6 April 2027, and for many clients it is later. This is a critical point that is often misunderstood or overlooked.

Two lags compound to produce that date. First, a client must meet the conditions in two consecutive financial years before its size category changes (s.382(2)), so a single good year does nothing. Second, the contractor's obligation for a tax year is fixed by the relevant financial year, the last year that ended before the start of that tax year, so even a confirmed change in size only feeds through a year or more later. The worked example below traces both through a real year-end.

This is an important message: raising the thresholds is a long-term protection, not an immediate relief. A contractor told by a client that it intends to fall out of scope on the back of recent growth should not rely on it until the client has met the conditions in two consecutive financial years and those years feed through to the relevant financial year for the tax year in question.

Worked example: a 30 June year-end client

Acme Ltd engages a contractor through their PSC and has historically been a medium company, so the engagement has sat inside Chapter 10. Acme has a 30 June year-end. Its turnover has fallen and, in the year to 30 June 2025, it first meets two of the three small-company conditions (turnover £14m, balance sheet £7m, 60 employees: the first two conditions are met, which is enough). The contractor asks whether this takes the engagement out of Chapter 10 for 2026/27.

It does not. Two mechanics keep Acme in scope:

  • The relevant financial year. Acme's off-payroll position for the 2026/27 tax year (which starts 6 April 2026) is fixed by its last financial year that ended before that date with time to file. That is the year to 30 June 2025. Acme's later results cannot change its 2026/27 obligation.
  • Two consecutive years. Under Companies Act 2006 s.382(2), a company that has been medium does not become small until it has met the conditions in two consecutive financial years. The year to 30 June 2025 is only the first qualifying year, so on that year-end Acme is still treated as medium.

So for 2026/27 Acme remains in Chapter 10, and the contractor's engagement is determined and operated by Acme and its fee-payer exactly as before. The earliest Acme can genuinely exit is as follows. It needs a second consecutive qualifying year, the year to 30 June 2026. The first tax year whose relevant financial year is the year to 30 June 2026 is 2027/28 (which begins 6 April 2027, and looks back to the last year ended before that date, namely 30 June 2026). So even on the most favourable reading, a previously medium 30 June client cannot drop out of Chapter 10 before 6 April 2027, and that is only if both the year to 30 June 2025 and the year to 30 June 2026 qualify.

The same lag applies to other year-ends. A client meeting the conditions for the first time in the year to 31 December 2025, and again in the year to 31 December 2026, has its first fully qualifying pair complete at 31 December 2026; the earliest tax year that draws on that year as its relevant financial year is again 2027/28. The headline holds across the calendar: the earliest a previously medium client falls out of Chapter 10 on the raised thresholds is 6 April 2027, and for many fact patterns it is 6 April 2028.

To avoid surprises, contractors should ask their clients to confirm whether they are in scope for Chapter 10 for the current tax year. The client's accountant or finance team can usually give a clear answer based on the most recent filed accounts and the two-year rule. The key conversation is: "Do you meet two or more of the three thresholds, and have you done so for two consecutive financial years?" Only if the answer is "yes" to both should the contractor assume the exemption applies.

Chapter 8 vs Chapter 10: what changes if the exemption applies

When the small company exemption applies, the contractor's PSC becomes responsible for its own status determination under Chapter 8. This represents a fundamental shift in the regulatory framework. Instead of waiting for the end client to issue a Status Determination Statement and having PAYE operated by a fee-payer, the contractor makes the status call independently and reports the position through Self Assessment. This creates three key structural differences from Chapter 10:

The 5% expenses allowance

Under Chapter 8, where the PSC is inside IR35, the deemed employment payment calculation allows a flat 5% deduction from the relevant engagement income as an administrative expenses allowance, recognising the reasonable overhead cost of running the PSC. Under Chapter 10 the fee-payer operates PAYE on the deemed payment with no equivalent allowance, so none of the income gets that relief. This retained 5% is the single clearest tax advantage of a small (Chapter 8) client over a medium one.

The benefit is modest but real. On £50,000 of inside-IR35 engagement income the 5% allowance shelters £2,500 from the deemed salary; the cash value depends on the contractor's marginal position, but as a rough conservative guide a basic-rate taxpayer saves on the order of a few hundred pounds and a higher-rate taxpayer somewhat more, before considering the employer NIC and corporation tax interactions that run through the deemed-payment computation. It is a recurring per-engagement benefit, not a one-off, so a contractor weighing a small client against a medium one should model it, but should not expect it to transform the economics on its own.

Status determination and PAYE

Under Chapter 10, the end client issues a Status Determination Statement and decides whether the engagement is inside or outside IR35. The fee-payer then operates PAYE and National Insurance on the deemed payment if the SDS is inside.

Under Chapter 8, the PSC self-assesses. If the engagement is inside, the PSC computes the deemed payment at year-end. If outside, the PSC's income is assessed as professional income and the contractor extracts profit via salary and dividends in the usual way.

The PSC has more control over the determination process under Chapter 8 but also more responsibility. The contractor cannot rely on the client to have taken reasonable care; the PSC's own assessment is what matters.

No employment status determination by the client

Because Chapter 10 does not apply to small companies, the client is not required to issue a Status Determination Statement. This can be simpler administratively, but it also means the contractor cannot use the client-led disagreement process available under Chapter 10.

Non-corporate clients: LLPs and partnerships

The Companies Act 2006 s.382 definition applies only to limited companies. For other entity types (limited liability partnerships, general partnerships, unincorporated bodies) the test sits in ITEPA 2003 s.60C and is turnover-based, so the £15m / £7.5m / 50 conditions do not transfer across. A contractor with a non-corporate end client should not assume the company test applies and should ask the client to confirm its status under s.60C, taking specific advice where the entity type is unusual.

Practical steps: confirming your client's status

The answer is rarely obvious from the look of the business; it depends on filed accounts and the two-year rule, so it is worth establishing in writing as part of planning your IR35 position. The steps:

  1. Ask the client in writing whether they are a small, medium or large company for Chapter 10 purposes.
  2. Ask them to provide the most recent filed accounts or a written confirmation from their accountant or company secretary showing turnover, balance sheet total and headcount.
  3. Check the dates: the relevant financial year for 2026/27 is the last year that ended before 6 April 2026. For most clients, that is the year ending 31 December 2025 or 31 March 2026.
  4. Ask specifically whether the client meets (or has met) the thresholds in two consecutive financial years. If not, the two-year rule means the client is still in the old category for at least one more tax year.
  5. Keep the written confirmation on file. If HMRC later issues a challenge, this will be evidence that you took reasonable steps to establish the client's status.

Do not rely on a client's casual expectation that it will meet the thresholds; get it in writing and reference the two-consecutive-years rule so the client understands why an expectation is not enough. For more on how status is determined under Chapter 10, see off-payroll working rules for the private sector.

The consequences when Chapter 10 does not apply

When the small company exemption applies, the engagement reverts to Chapter 8, and the practical change is in who does the work and how the calculation runs, not in whether employer National Insurance is borne at all. Two points are commonly misunderstood.

Who operates the deemed payment, and where the tax falls

Under Chapter 10 for a medium or large client, an inside-IR35 engagement is dealt with before the money reaches the PSC: the fee-payer (usually the recruitment agency) treats the payment as a deemed direct payment and operates PAYE and employee National Insurance on it, then pays employer National Insurance at 15% and the Apprenticeship Levy on top. The PSC receives income that has already been taxed.

Under Chapter 8 for a small client, nobody upstream operates PAYE. If the engagement is inside IR35, the PSC self-assesses and computes a deemed employment payment at its own year-end, then accounts for the PAYE and NIC itself through the company payroll and reports the position. The contractor extracts any genuinely outside-IR35 profit via salary and dividends in the usual way, but the inside-IR35 income runs through the deemed-payment calculation first.

Employer National Insurance is still borne under Chapter 8

A persistent myth is that moving to Chapter 8 removes the 15% employer National Insurance cost on inside-IR35 income. It does not. The Chapter 8 deemed employment payment is built by taking the engagement income, applying the deductions described below, and then grossing down for employer NIC before the balance is treated as deemed salary. In other words, the company still funds employer Class 1 NIC at 15% out of the inside-IR35 income, just as the fee-payer would under Chapter 10. The charge is operated by the PSC rather than a fee-payer, but it is the same charge on the same income.

The genuine difference between the two regimes is therefore not the employer NIC, which both bear, but two things: under Chapter 8 the PSC (not the client) determines status and operates the whole calculation, and under Chapter 8 the deemed-payment calculation keeps the 5% administrative expenses allowance that Chapter 10 abolished. That 5% allowance, explained earlier, is the one quantifiable tax advantage of a small (Chapter 8) client over a medium one: a flat 5% of the relevant engagement income comes out before the deemed salary is struck, which a Chapter 10 engagement does not get. There is no separate employer-NIC saving to add to it.

Receiving an SDS when you think the exemption applies

If a client issues a Status Determination Statement at all, it is asserting that Chapter 10 applies to it, so a contractor who believes the client is small has a genuine conflict to resolve rather than an SDS to accept at face value. The first step is to clarify the client's size, because if the exemption applies no SDS should have been issued. Where the contractor wants to press the point, the client-led disagreement process under ITEPA 2003 s.61T is available, but note its limit here: because the exemption turns on the client's size rather than the engagement's facts, any disagreement is about classification (small versus medium), not the working practices or contract terms that a normal status dispute would turn on.

International and edge cases

Chapter 10 also does not apply where there is no UK fee-payer, for example an overseas client with no UK entity in the supply chain. In that case the PSC stays under Chapter 8 regardless of the client's size. This is relatively rare but matters for contractors working directly for overseas clients or foreign-owned UK subsidiaries with no UK party operating PAYE. The test is simply whether any entity between the PSC and the end client is responsible for operating PAYE; if none is, Chapter 8 applies.

Status tests under Chapter 8 still apply

A common misunderstanding is that falling outside Chapter 10 as a small-client engagement makes the contractor automatically outside IR35. It does not. The exemption removes the client's determination duty and its PAYE obligation, but the same status tests still bite: the PSC must assess personal service, control and mutuality of obligation for itself under Chapter 8. If that assessment is inside, the PSC computes a deemed employment payment; if outside, the income is professional income extracted through the usual salary and dividend route. Either way a status assessment is necessary. Chapter 8 simplifies the administration (no SDS, no client-operated PAYE) but shifts the responsibility for getting status right onto the contractor.

Summary and next steps

The small company exemption means that contractors with small clients remain outside Chapter 10 and are responsible for their own status under Chapter 8. The new thresholds (£15m turnover, £7.5m balance sheet, 50 employees for financial years beginning on or after 6 April 2025) have raised the bar for Chapter 10 scope, but the two consecutive years rule and the relevant financial year lag mean that the exemption is not immediate. Most contractors should assume their medium clients are still in scope for 2026/27.

The practical advantage of the exemption, where it applies, is narrower than is often claimed. The PSC takes back control of the status decision and operates the calculation itself, and the deemed-payment computation keeps the 5% administrative expenses allowance that Chapter 10 abolished. It does not, however, remove the 15% employer National Insurance on inside-IR35 income: the Chapter 8 calculation grosses that down in the same way a fee-payer would, so the company still bears it. The real attraction of a small client is the retained 5% allowance plus self-determination, not an employer-NIC saving that does not exist.

To confirm whether the small company exemption applies, ask the client to provide written confirmation of their status, including the turnover and balance sheet figures from the most recent filed accounts, and clarification on whether they have met the thresholds in two consecutive years. Once confirmed in writing, the contractor can be confident that Chapter 8 applies. Keep that confirmation on file; if HMRC later challenges the status, this written evidence demonstrates that you took reasonable steps to establish the client's position.

For contractors facing an inside-IR35 determination under Chapter 8, or unsure about their status, the next step is a thorough contract review and assessment of the working practices against the three status tests. A well-drafted contract is helpful, but HMRC and tribunals look at how the engagement actually operates, not just the written terms. We can help with that assessment and support you with planning the tax treatment under either Chapter 8 or Chapter 10. Related reading: what IR35 is, consequences when caught inside, and protecting outside status. Contact us to discuss your situation and to get a clear view of your obligations for the current tax year.