Introduction to IR35
IR35 has been a thorn in the side of many limited company directors, particularly those operating as contractors.
With increasing HMRC scrutiny, many businesses have found themselves facing unexpected tax liabilities, leading some to financial distress.
But what happens if your company struggles due to IR35?
Could IR35 lead to insolvency?
In this guide, we’ll explore everything directors need to know.
What is IR35?
IR35, also known as the off-payroll working rules, is legislation designed to tackle tax avoidance by ensuring that contractors who work like employees pay similar tax and National Insurance contributions (NICs).
The key factors in determining IR35 status include:
- Control – Does the client dictate how, when, and where you work?
- Substitution – Can you send a substitute to complete the work?
- Mutuality of Obligation (MOO) – Is there an obligation to provide ongoing work?
If you fail the IR35 test, you are considered inside IR35, meaning your earnings will be taxed as employment income.
IR35 and Limited Companies: The Financial Impact
If your contract is deemed inside IR35, this can have serious financial implications for your limited company, including:
- A significant increase in tax liabilities (PAYE and NICs).
- Reduced take-home pay, making it harder to maintain cash flow.
- A loss of financial control as clients dictate tax deductions.
- Fewer opportunities, as many companies avoid engaging limited company contractors due to the compliance burden.
For many directors, these changes make it unsustainable to continue operating through a Personal Service Company (PSC).
Can IR35 Lead to Company Insolvency?
Yes, IR35 has already pushed many contractors into insolvency. Here’s how:
1. Tax Arrears and Unexpected Liabilities
HMRC investigations into IR35 status often result in retrospective tax demands, which can go back several years.
If your company is hit with a large demand, this can trigger cash flow problems and potential insolvency.
2. Lack of Work Due to IR35 Compliance Issues
As more companies shift towards hiring only PAYE employees or umbrella contractors, many PSCs find themselves unable to secure contracts.
Without regular income, companies quickly fall into financial distress.
3. Director’s Loan Account (DLA) Liabilities
Many directors take drawings via dividends rather than salary.
If an IR35 determination forces the company to reclassify earnings, this can create overdrawn director’s loan accounts, making the director personally liable for repayments.
4. Creditors Demanding Payment
A PSC struggling with IR35-related financial strain may find it hard to pay creditors, such as:
- HMRC (for VAT, Corporation Tax, PAYE)
- Suppliers or subcontractors
- Accountants or professional service providers
When debts go unpaid, creditors may issue a winding-up petition, forcing the company into liquidation.
What Are Your Options if Your Company is Struggling Due to IR35?
If IR35 has left your company financially unsustainable, you do have options:
1. Creditors’ Voluntary Liquidation (CVL)
If your company is insolvent, a Creditors’ Voluntary Liquidation (CVL) allows you to close it down in an orderly manner.
This is often the best option if:
- Your company cannot pay its debts due to IR35 changes.
- You no longer have viable contracts.
- You want to avoid legal action from creditors.
A licensed insolvency practitioner will handle the process, ensuring debts are settled fairly.
2. Members’ Voluntary Liquidation (MVL)
If your company is still solvent but no longer viable due to IR35, an MVL (Members’ Voluntary Liquidation) could allow you to extract retained profits tax-efficiently before closing.
This is a better option than simply dissolving the company, as it enables directors to benefit from Business Asset Disposal Relief (previously Entrepreneurs’ Relief), reducing the tax on funds withdrawn.
3. Company Voluntary Arrangement (CVA)
If your company has tax liabilities but is still viable, a Company Voluntary Arrangement (CVA) could allow you to negotiate with HMRC and other creditors to pay off debts over time.
4. Dissolution
For companies with no outstanding liabilities, dissolution (striking off) may be an option.
However, this is not suitable if you have debts, as creditors (including HMRC) can object to the dissolution and force liquidation.
Should You Close Your Limited Company Due to IR35?
If IR35 has made contracting financially unfeasible, you might consider closing your limited company and working under an umbrella company or returning to full employment.
However, if you have outstanding debts or tax liabilities, you must take professional advice to ensure you handle the closure legally and avoid personal liability.
IR35 & Insolvency: Key Takeaways
- Being inside IR35 can increase tax costs and impact cash flow.
- Many PSCs have gone insolvent due to IR35-related financial strain.
- Unexpected tax bills, contract losses, and HMRC enforcement increase the risk of insolvency.
- If your company is struggling, options include CVL, MVL, or a CVA.
- Seeking advice early can prevent personal liability and allow a smoother exit.
Need Advice on IR35 and Insolvency?
If you’re a limited company director struggling with IR35-related financial issues, Business Helpline can provide free, impartial advice on the best course of action. Call our expert advisors at 0800 088 2142 or book a consultation online today.
