How Does IR35 Apply When a Contractor Runs a Separate Limited Company?

The Two-Company Problem That Most IR35 Guides Ignore

Most IR35 advice assumes you have one contract at a time. One client. One limited company. One set of accounts.

But what if you are a contractor who also runs a separate trading business? Maybe you do IT contracting through your PSC (personal service company) while also running an ecommerce store, a consultancy, or a property management company through a second limited company. Or perhaps you are a contractor who started a separate business on the side that has grown into something real.

This is where the standard IR35 explained guides fall short. They treat your contracting company as your only company. The reality is more complex, and HMRC knows it.

As ICAEW qualified accountants, we see this situation regularly. A contractor in Bristol with a six-figure outside-IR35 contract and a separate limited company running a digital agency. A freelance project manager in Leeds who also owns a property company through a separate Ltd. The tax treatment of each company is distinct, but they interact in ways that catch people out.

Let me walk through how IR35 works when you have two companies, where the risks sit, and how to structure things properly.

IR35 Explained: The Basics First

IR35 is HMRC's off-payroll working legislation. It targets contractors who work through a limited company but would be classed as employees if they were engaged directly. The rules determine whether you pay tax and NI as an employee (inside IR35) or as a business owner (outside IR35).

For a medium or large client, the responsibility for determining your IR35 status sits with them. They issue a Status Determination Statement (SDS). If they deem you inside IR35, your limited company receives the income net of tax and NI, which the client deducts at source. Your company effectively becomes a payroll vehicle for that contract.

For small clients, the determination stays with you and your limited company. You assess whether the contract would make you a deemed employee.

That much is standard. The complication comes when you have a second limited company that is not your PSC.

What Happens When You Have Two Limited Companies?

Each limited company is a separate legal entity. HMRC treats them independently for IR35 purposes. Your contracting company (Company A) is assessed on the contracts it performs. Your separate trading company (Company B) is assessed on its own activities.

This sounds straightforward, but the interaction creates several traps.

Trap 1: Dividend Planning Across Two Companies

Many contractors take a small salary from their contracting company and draw the rest as dividends. That works fine when you have one company. With two, you need to think about the total dividend income you receive across both companies.

Dividends from Company A and Company B both count toward your personal dividend allowance of £500 (2025/26) and your overall income tax bands. If Company A pays you £40,000 in dividends and Company B pays you £20,000, your total dividend income is £60,000. The first £500 is tax-free. The remaining £59,500 is taxed at your marginal dividend rate: 8.75% within the basic rate band, 33.75% within the higher rate band, and 39.35% above £125,140.

This is simple arithmetic, but we see contractors accidentally push themselves into the higher rate band because they forget to consolidate dividend income from both companies. A contractor earning £50,270 in salary and dividends from Company A might think they are safely within the basic rate band. Add £20,000 in dividends from Company B, and they are now paying 33.75% on £20,000 of that total. That is an extra £5,000 in tax they did not budget for.

Trap 2: The Associated Companies Rule

This is the big one. For corporation tax purposes, two companies are associated if one controls the other, or if both are under common control. If you are the sole director and shareholder of both Company A and Company B, they are associated companies.

Why does this matter? Corporation tax marginal relief bands are divided between associated companies. The small profits rate of 19% applies to profits up to £50,000 for a single company. With two associated companies, that threshold is split. Each company gets £25,000 of the small profits band. The marginal relief band of £50,000 to £250,000 is also split, giving each company £25,000 to £125,000.

Here is a worked example. Company A makes £60,000 profit. Company B makes £20,000 profit. Total group profit is £80,000. With two associated companies, the small profits rate band is £25,000 per company. Company A pays 19% on the first £25,000 (£4,750) and marginal relief on the remaining £35,000. Company B pays 19% on its full £20,000 (£3,800). The overall corporation tax bill is higher than if the companies were not associated.

You can avoid associated company status if the companies are genuinely independent. For example, if you own 100% of Company A and your spouse owns 100% of Company B, and neither of you has any involvement in the other's company, they are not associated. But HMRC looks at the substance. If your spouse is a silent nominee and you make all the decisions, HMRC will treat them as associated anyway.

Trap 3: Director's Loan Account Across Companies

If you borrow money from Company A and repay it through Company B, or move funds between the two companies without proper documentation, you create a director's loan account problem. Each company must record loans to you as a director's loan account balance. If the balance exceeds £10,000 at any point, you have a beneficial loan benefit in kind that must be reported on a P11D.

Worse, if you do not repay the loan within 9 months and 1 day of the company's year-end, the company pays S455 tax at 33.75% on the outstanding amount. That tax is refundable when you repay the loan, but it ties up cash in the meantime.

We have seen contractors use Company B to pay personal expenses and then treat it as a dividend from Company A. That is not how it works. Each company is separate. If Company B pays your personal credit card bill, that is a director's loan from Company B, not a dividend from Company A.

Outside-IR35 Contract With a Separate Trading Company: The Practical Structure

If you have an outside-IR35 contract through Company A and a separate trading business through Company B, the cleanest structure keeps the two completely separate. Separate bank accounts, separate bookkeeping, separate VAT registrations if applicable, separate payroll.

Company A pays you a salary and dividends. Company B pays you a separate salary and dividends. You report both on your self assessment return (SA100). Each company files its own corporation tax return (CT600) and annual accounts.

If Company B is genuinely trading and not just a vehicle to hold your contracting income, HMRC has no basis to challenge the separation. A contractor who does IT work through Company A and runs a property portfolio through Company B has two distinct businesses. The IR35 status of Company A has no bearing on Company B's activities.

The risk arises if Company B has no real trading activity and exists only to receive dividends from Company A or to hold cash. HMRC could argue that Company B is a sham and that the two companies should be treated as one for tax purposes. That would collapse the associated company protections and could trigger a full IR35 review of all income.

What About Inside-IR35 Contracts?

If your contracting company (Company A) is deemed inside IR35, the client deducts PAYE and NI before paying your company. Company A receives the net amount. That net amount is still company income, but it has already suffered tax and NI. You cannot then pay yourself dividends from that income without considering the tax already paid.

Company B is unaffected by Company A's IR35 status, as long as Company B is genuinely separate. But if you try to move money from Company A to Company B to avoid the IR35 restrictions, HMRC will see through it. The two companies are separate legal entities, but the director is the same person. HMRC can apply the transactions in securities legislation or the settlements legislation to recharacterise the movement of funds.

Practical Steps to Stay Compliant

Here is what you need to do if you run a contracting company and a separate trading company.

• Keep separate bank accounts. No transfers between the two companies unless there is a clear commercial reason, documented with invoices or loan agreements.
• Separate bookkeeping. Use different nominal codes, different accounting software if practical. Xero or FreeAgent can handle multiple companies under one login, but keep the data segregated.
• Separate VAT registrations. Each company registers for VAT in its own right if its turnover exceeds £90,000. Do not combine turnover across companies to avoid registration. That is illegal.
• Separate payroll. Each company runs its own payroll, files its own RTI returns, and issues its own P60s and P45s.
• Document the separation. Have a written record of why the two companies exist separately. Minutes of board meetings, separate business plans, separate client contracts.
• Consolidate dividend planning. Before declaring dividends from either company, calculate your total anticipated dividend income for the year across both. Factor in the £500 dividend allowance and the basic rate band.
• Monitor associated company thresholds. Know that your corporation tax bands are halved (or worse, divided by three or four if you have more companies). Plan your profit extraction accordingly.

When to Speak to an Accountant

If your contracting company turnover exceeds £90,000 or your separate trading company is growing fast, the interaction between the two becomes more complex. VAT, corporation tax marginal relief, and dividend planning all need coordinating.

If you are considering incorporating a second company while keeping your existing PSC, talk to an accountant before you do it. The structure decisions you make at incorporation affect your tax position for years.

If HMRC opens an IR35 enquiry into your contracting company, and you have a separate trading company, they will look at both. The enquiry will cover whether the two companies are genuinely separate and whether any funds have moved between them improperly. Having clean records from day one makes that enquiry far less stressful.

Our ICAEW qualified team at Holloway Davies works with contractors who have complex structures. We can help you set up the right framework, keep the companies separate, and plan your tax efficiently. Get in touch if you want to run through your specific situation.

For a broader overview of IR35 and how it affects contractors, see our glossary entry on IR35. If you are thinking about incorporating a new business alongside an existing contracting company, our incorporation page covers the key considerations.