Six reasons why the government was fundamentally wrong to U-turn on IR35

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Just five weeks ago, the then Chancellor, Kwasi Kwarteng, stood up at the despatch box and declared that the IR35 reforms have “added unnecessary complexity and cost to many businesses” and committed to repeal the damaging reforms.

Since then, almost all of the policies announced at the mini-budget have been rowed back on. But one U-turn, above all else, stands to deeply damage both contractors and businesses seeking flexible labour alike: the U-turn on IR35 reforms.

Below, we outline six key reasons why the government was fundamentally wrong to U-turn on IR35.

   1) Impact of reforms on contractors

We know that the reforms to IR35 have had a devastating impact on contractors. It’s notable that since the reforms, over a third of contractors (35%) have chosen to leave self-employment altogether.

Indeed, since 2020, the overall number in self-employment has fallen from 5 million to 4.3 million – equivalent to some 700,000 self-employed individuals.

Of those that remain in self-employment, the overwhelming majority have experienced a damming drop in income, faced a diminishing number of ‘outside IR35’ roles or even forced to operate through an unregulated umbrella company.

In addition, the overwhelming majority of freelancers (80%) have seen their quarterly income decrease since the implementation of the reforms in 2021 – a truly damning indictment.

Many limited company directors have been forced to close their company or seek work abroad as a result the reforms – not only devastating livelihoods but unquestionably damaging the UK’s economic fortunes.

   2) Impact of reforms on clients

It’s not only contractors that have suffered – clients have also fallen victim to the IR35 rules.

IPSE’s survey of over 500 medium and large-sized clients revealed that clients have had to decrease the number of contracts they’ve given to contractors since the reforms in 2021. This is despite 49 per cent of clients reporting that their business could not achieve the same outcomes without the use of contractors.

Perhaps tellingly due to the complexity of the rules, almost half of clients (48%) didn’t know the percentage of contractor engagements that were inside or outside IR35 at their company.

The fact that the government recognised this added complexity and cost to businesses seeking to engage flexible talent in the UK only undermines their decision to row back on the repeal of IR35 reforms.

   3) The approach of risk-averse clients

The actions of risk-averse clients - not willing to risk future HMRC investigations into their engagements - have resulted in contractors working through umbrella companies or not being able to find work altogether.

These clients have implemented blanket assessments of all engagements as ‘inside IR35’ or introduced a blanket ban on contractors operating through a limited company which in turn has diminished the number of contracting roles available to the genuine self-employed operating through a limited company.

The actual action of implementing blanket assessments is also, in itself, a form of non-compliance with the rules. But HMRC have so far seemed reluctant to tackle this.

Some clients, thankfully, have now relaxed their initial blanket approach to contractors. However, the ending of the soft-landing period for IR35 in April 2022 – where HMRC promised not to impose penalties for any infringement of the legislation – could lead to a return of blanket assessments or bans from some clients.

   4) Unregulated umbrella companies

The use of umbrella companies – which act as an intermediary between contractors and clients in the supply chain for payroll purposes – has grown substantially since the reforms to IR35 in the private sector in April 2021.

However, the entire umbrella company market remains unregulated.

Many contractors have been forced by their client to operate through an umbrella company, often with only a handful of umbrella companies to choose from. 

Our research has revealed that over three in five umbrella company workers believe that there are no advantages to operating via an umbrella company and over two-thirds reported that their clients have insisted they operated through an umbrella company as a result of IR35 reforms.

On top of this, we also know that many umbrellas are passing on the liability for both employer’s and employee’s National Insurance contributions to those operating through an umbrella company.

Ultimately, the latest U-turn on IR35 leaves those operating through unregulated quasi-employment models even more worried and increases the likelihood of further work being offshored.

   5) The CEST tool

We know from IPSE research that HMRC’s Check Employment Status for Tax (CEST) tool is not an effective means of assessing the nature of a proposed engagement. What’s more, it can be manipulated by risk-averse clients and third-party HR/solicitor advisors, regardless of the true nature of the engagement, to provide a preferred outcome: namely inside-IR35 determinations.

Firstly, the tool fails to account for mutuality of obligation (MOO), which is a key determining factor for IR35 status according to case law.

Secondly, HMRC’s own statistics on CEST show that it returns an “undetermined” verdict in 22 per cent of decisions.

The clear failures within the tool to accurately determine the IR35 status of engagements will only continue following the U-turn on IR35, leading to more confusion for contractors and clients alike.

   6) Offshoring of talent and loss to UK economy

Prior to the reforms in April 2021, we know that 24 per cent of contractors were already planning on heading abroad as a result of the impending reforms.

Since then, we know many contractors have indeed left the country as a result of the reforms whilst many clients have also looked abroad for their flexible talent to avoid navigating the complex IR35 rules.

Government must be aware of the deep economic cost of losing contractors and flexible labour opportunities to foreign countries. With the UK’s economic fortunes currently stuttering, the opportunity to reverse the IR35 reforms would’ve been a welcome boost to the UK economy.

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Meet the authors

Elizabeth Seymour

Communications Adviser

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Joshua Toovey

Senior Research and Policy Officer