Audit Exemption for UK SaaS and Professional Services: How to Qualify and File

How to Qualify for Small Company Audit Exemption in the UK

For UK startups, particularly in the SaaS and professional services sectors, managing cash flow is paramount. A statutory audit, while a valuable exercise in financial scrutiny, represents a significant cost. The good news is that for many small businesses, it is an avoidable one. Audit exemption is a provision under UK law that allows smaller companies to bypass this formal process, saving both time and money. However, claiming this exemption is not an automatic privilege; it requires meeting specific criteria and following a precise filing procedure. Understanding how to qualify for small company audit exemption UK is a critical piece of financial compliance that founders must master to manage resources effectively.

The foundation of this exemption is the small companies regime, established by the UK Companies Act 2006. To be classified as a small company, your business must meet at least two of the following three criteria for a given financial year. This "two out of three" rule provides flexibility for businesses that might fluctuate around one of the thresholds.

Small Company Audit Exemption Thresholds UK

To qualify as small, a company must satisfy at least two of these conditions:

• Annual Turnover: Not more than £10.2 million
• Balance Sheet Total: Not more than £5.1 million
• Average Number of Employees: Not more than 50

A critical distinction to remember is that the Balance Sheet Total refers to your company’s total gross assets, not its net assets (assets minus liabilities). This is a common point of confusion for founders when assessing their eligibility.

Applying the Thresholds: Timing and Consecutive Years

The timing of this assessment is also crucial. For a company's first financial year, the criteria apply directly. If you meet two of the three thresholds in year one, you qualify for an exemption for that year. For subsequent years, the rules are designed to ensure stability. A company must meet the small company criteria for two consecutive years to gain or lose its small company status. For example, if you qualify as small in Year 1 and Year 2, you are exempt for Year 2. If you then exceed the thresholds in Year 3 but not Year 4, you would still be considered small for Year 3. You would only lose the status in Year 4 if you also exceeded the thresholds in that year. For most pre-seed to Series B startups, the reality is more pragmatic: many will comfortably fall within these limits for their first few years of operation.

Furthermore, if your company is part of a group, these qualification thresholds apply to the consolidated group figures as a whole, not just your individual entity. This means you must aggregate the turnover, gross assets, and employees of all group companies before applying the test.

Claiming Audit Exemption: The Official Filing Process

Once you have confirmed that your company qualifies, you must actively claim the exemption in your annual accounts. This is a non-negotiable step in your Companies House filing requirements. The claim is made by including a specific declaration on the balance sheet of the accounts you file.

According to the regulations, this audit exemption statement must be placed on the balance sheet, directly above the director's signature. The wording is prescribed by law and must be reproduced exactly. There is no room for creative interpretation.

The required statement is as follows:

For the year ending [Date], the company was entitled to exemption from audit under section 477 of the Companies Act 2006 relating to small companies. The members have not required the company to obtain an audit of its accounts for the year in question in accordance with section 476. The directors acknowledge their responsibilities for complying with the requirements of the Act with respect to accounting records and the preparation of accounts.

This wording makes direct reference to two key parts of the Companies Act 2006. Section 477 is the legislation that grants small companies their right to exemption (Companies Act 2006, s. 477). The reference to section 476 confirms that shareholders have not exercised their right to override the exemption. Under section 476, shareholders holding at least 10% of the voting rights can formally request an audit, even if the company otherwise qualifies for exemption.

Common Pitfalls and Preparing Unaudited Accounts

Successfully navigating the small company audit rules involves more than just meeting the size thresholds. Several common pitfalls can catch founders unaware, potentially leading to non-compliance.

The most significant is confusing legal eligibility with contractual obligations. Your investor, grant, or lender agreements may contain a clause requiring a full audit, irrespective of your company's size. These contractual terms override the statutory exemption. Always review these documents carefully before deciding to forgo an audit.

It is also important to know that certain types of companies are ineligible for audit exemption, regardless of their size. These typically include public companies, insurance companies, and some financial services firms. For most SaaS and professional services startups, this is rarely an issue, but it is a fundamental part of the rules.

Crucially, audit exemption is not an exemption from preparing and filing statutory accounts. You are still legally required to prepare accurate accounts that provide a true and fair view of your financial position and file them with Companies House. In practice, we see that startups maintaining clean, up-to-date records in their accounting software, like Xero, are best positioned to handle this. This discipline in preparing unaudited accounts is vital for financial compliance for small businesses.

Maintaining accurate records also prepares you for scrutiny. An investor conducting due diligence or a regulator like HMRC might question your figures. Your ability to produce clear, well-organised financial data from your accounting system validates your exemption claim and builds confidence. Without the third-party validation of an audit, the responsibility for accuracy falls squarely on the directors.

Practical Takeaways for Founders

Navigating the audit exemption process is a key step in managing your startup’s financial obligations efficiently. It frees up capital that can be reinvested into growth, but it requires careful attention to detail. Here are the key actions to take:

1. Verify Your Status Annually: Each year, check your turnover, gross assets, and employee count against the 'two out of three' thresholds. Remember the two-consecutive-years rule after your first year of trading.
2. Use the Exact Wording: When claiming audit exemption, place the precise legal statement required by the Companies Act 2006 on your balance sheet before the director’s signature.
3. Check Your Agreements: Review shareholder, grant, and loan agreements to ensure you do not have a contractual obligation to perform an audit, which would override your statutory exemption. Also, keep your PSC and shareholder records accurate.
4. Maintain Diligent Records: Use your accounting system to keep meticulous records. This ensures your statutory accounts for startups are accurate and ready for any scrutiny, demonstrating responsible governance even without a formal audit.

For a complete list of filings and recurring deadlines, continue at the hub on reporting obligations.

Frequently Asked Questions

Q: What happens if my company grows and no longer qualifies for audit exemption?

A: If your company exceeds the small company thresholds for two consecutive years, it will lose its eligibility for audit exemption. You will be required to appoint an auditor and conduct a full statutory audit for the second of those years, with the accounts filed at Companies House reflecting this.

Q: Can shareholders demand an audit even if the company qualifies for an exemption?

A: Yes. Shareholders who collectively hold at least 10% of the company's voting rights can formally request an audit under section 476 of the Companies Act 2006. This request would override the company's eligibility for exemption, forcing the directors to appoint an auditor for that financial year.

Q: Does audit exemption mean I no longer need an accountant?

A: No. Audit exemption removes the requirement for an independent audit, but it does not remove the legal duty to prepare and file accurate statutory accounts. Most startups still rely on an accountant to ensure their accounts are accurate, compliant with UK accounting standards (FRS 102), and filed correctly.

Q: Are dormant companies also exempt from audit?

A: Yes, dormant companies are typically exempt from audit regardless of their size. A company is considered dormant if it has had no 'significant accounting transactions' during the financial year. The process for claiming this exemption is different from the small company exemption and has its own set of rules.