In defence of the flexible workforce: The IR35 rules simply don’t work

By Joshua Toovey , Senior Research and Policy Officer, IPSE - The Self-Employment Association

“We’ve seen a very significant shift in the way our labour market is operating,” said HMRC. This was March 2020. HMRC was appearing before the House of Lords Select Committee on Economic Affairs. It was defending its rationale for introducing the 2017 reforms to off-payroll working in the public sector. Within a year government had pressed ahead with their plans to roll-out the reforms to the private sector.

At IPSE, we would agree that since the reforms, we’ve seen a very significant shift in the way the labour market operates.

Risk-averse public bodies and private sector clients – worried about retrospective HMRC investigations into their engagements – proceeded and continue to implement blanket bans and assessments to contractors. The flexible workforce sidelined as public sector bodies and clients tried to get to grips (and some not even trying) with the complexity of the new rules.

Within a year of their appearance at the Select Committee, HMRC had hit the Department of Justice, DWP, Home Office and DEFRA with eye-watering tax bills for incorrectly applying the rules – all at the taxpayer’s expense.

The impact of the reforms

It’s not just the public sector either, the reforms have also had ruinous consequences for both contractors and clients alike since being introduced in 2021.

Notably, more than a third of contractors have left self-employment since these changes in the private sector were introduced. Many of these have not returned to the labour market or left the UK altogether – at a time when government is repeatedly lamenting the “economically inactive.”

And more than a third of businesses across the UK are reporting that, due to IR35 , it’s now harder to engage the freelance talent that they need to grow, depriving these clients of vital flexible expertise and holding back the UK’s wider economic potential.

The then Chancellor, Kwasi Kwarteng, even acknowledged this during his ill-fated mini-budget, declaring that the 2017 and 2021 IR35 reforms have caused “unnecessary complexity and cost for many businesses.”

One further – and perhaps slightly unintended consequence of the legislation – is the increased use of umbrella companies.

Over a third of all contractors suddenly found themselves forced to operate through quasi-employment models within the supply chain. Treated like an employee for tax purposes but unable to access many of the employment benefits that employee counterparts enjoy.

These umbrella companies remain unregulated despite the use of them growing exponentially since the imposition of the reforms. Whilst government is currently consulting on plans to regulate this sector, the fact that unscrupulous providers have been able to target contractors is deeply troubling.

So, given the vast array of evidence showing that the reforms have had a devastating impact, why are HMRC seemingly content with the impact of the reforms?

Has the legislation achieved it’s primary aim?

It depends what the true aim is.

According to HMRC, the changes to IR35 were intended to tackle so-called ‘non-compliance’ amongst limited company directors. It believed that just one-in-ten ‘inside’ IR35 engagements were being appropriately taxed (though it didn’t provide evidence for this statistic). It therefore follows that, were the changes to be 100% effective, all the instances of non-compliance would be corrected, while the already compliant remainder would remain unimpacted. As many reading this will be all too aware, this hasn’t happened.

What has happened is that a huge number of engagements have been forced on to payroll, regardless of their actual status. The risk-averse actions from clients came as no surprise to contractors who were already all too aware of the complexity surrounding the rules and the potential for retrospective investigations into engagements. Clients should never have been determining engagements.

Instead of non-compliance (again, the amount of non-compliance was debateable to begin with), we now have huge over-compliance. Thousands more individuals on the payroll, including a great number who shouldn’t be. This is greatly beneficial for HMRC. It simplifies their tax administration and it captures hundreds of millions of pounds in Employers NI. Was this the primary aim all along? Perhaps, but we will never know for sure.

Determining status is notoriously complex – How can clients possibly make this decision?

Distinguishing between self-employed and employed is extremely difficult. Courts and tribunals are continually ruling on the exact case law that determines this boundary. Shifting this responsibility to clients only exacerbated the problem.

One of the tests often used in IR35 court cases centres around whether a contractor is in ‘business on their own account.’ If this can be established, it’s considered a strong indicator for outside IR35 work. The emphasis on this test in recent cases throws up a glaring problem with the legislation.

How can a client – now responsible for the status determination – judge whether the individual they are working with is truly running a business? The client’s inability to make a considered decision on the ‘business-on-own-account’ factors fundamentally undermines it’s ability to make a determination, and take reasonable care when doing so.

A continuing plague to contractors

There’s also no end in sight when it comes to confusion surrounding the rules. The sheer complexity of IR35 is still leading to erratic actions from clients when it comes to status determinations.

Contractors don’t know whether they are coming or going when clients seemingly make these blanket decisions at a moment’s notice.

Just last week, IPSE learnt that Transport for London was introducing an immediate blanket ban on all contractors that operate through a limited company.

At the same time, we’ve also heard from an IPSE member, as part of our Secret Contractor series, that Microsoft have now reversed their blanket ban to limited company contractors.

The contradicting approaches from these two clients underlines the continuing confusion surrounding the engagement of the self-employed. Both contractors and clients are left in limbo, unaware of how best to operate within the rules and often in fear of future HMRC investigations.

Despite all of this, the contracting market continues to be a vital source of innovation for businesses, enabling businesses with specialised and flexible expertise, with the solo self-employed contributing an impressive estimated ￡278 billion to the UK economy in 2022.

It is therefore essential that we embrace this contribution for what is: a key entrepreneurial asset for businesses and the wider economy.

In the wake of the financial crisis in 2008, self-employment grew by 53 per cent up until 2019, importantly providing career opportunities to thousands of unemployed but also driving the UK’s economic recovery.

With the UK’s post-pandemic economic fortunes currently stuttering, taking a look (and maybe a hammer!) at the IR35 rules would be a good place to start.