Why Connected Entities Matter in Recruitment

Connected entities rules exist to prevent tax and regulatory avoidance through the fragmentation of what is economically a single business into multiple nominally separate organisations. For staffing agencies, the most consequential application is in the IR35 off-payroll working rules, where connected entities determine whether the small company exemption applies to an end client. If a private sector business is connected to other businesses that together breach the small company thresholds, the obligation to determine IR35 status and account for payroll taxes sits with the end client, not the contractor. Agencies that fail to understand this get the liability chain wrong and expose both their clients and themselves.

The concept also arises in relation to the Employment Allowance, where connected companies cannot each claim the full allowance independently. For umbrella companies and payroll businesses operating within larger group structures, connected entities analysis is a recurring compliance requirement, not a one-time check. HMRC's enforcement interest in umbrella company arrangements has increased materially since 2021, and connected entity structures are a specific area of scrutiny.

For agencies advising clients who are building contractor workforces across group companies — perhaps an operating subsidiary using contractors who are technically engaged through a holding company arrangement — accurate connected entity analysis is the difference between a compliant structure and a disguised employment arrangement with retrospective PAYE liability.

How Connected Entities Work

Under UK company law and HMRC definitions, entities are connected if one controls the other, or if both are controlled by the same person or group. Control typically means holding more than 50% of ordinary share capital, or being entitled to more than 50% of voting rights. For IR35 purposes, the connected entities test draws on the Companies Act 2006 definition of associated companies, which extends to parent companies, subsidiaries, and entities under common control.

The practical effect is that a small company that appears to sit below the IR35 small business thresholds — turnover under £10.2 million, balance sheet under £5.1 million, fewer than 50 employees — may actually be required to apply the off-payroll rules if its connected entities push the group above those thresholds on an aggregated basis. Two or more thresholds must be breached for the exemption to fall away, but agencies and their clients cannot assess this without understanding the full connected entity picture.

For a recruiter placing contractors at what appears to be a small independent retailer, the question becomes whether that retailer is a subsidiary of a larger group. If the parent group employs 2,000 people and has turnover of £150 million, the small company exemption does not apply to the subsidiary, regardless of the subsidiary's own financial profile. The IR35 determination responsibility sits with the end client, and the agency's fee structure, insurance requirements, and payroll arrangements all need to reflect that reality.

Connected Entities in Practice

A compliance manager at a mid-size IT staffing agency is onboarding a new client — a software development company that has self-classified as a small business and claims the IR35 small company exemption. The compliance manager runs a connected entities check using Companies House data and the client's confirmation of group structure. She identifies that the software company is a wholly owned subsidiary of a US-based technology group with UK turnover exceeding £80 million. The small company exemption does not apply. She updates the engagement terms to require the client to issue Status Determination Statements for all contractors, adjusts the agency's liability documentation accordingly, and flags the issue to the contractor workforce before any engagements begin. Three contractors who had been operating via their personal service companies are briefed on the change and offered umbrella company arrangements as an alternative.