Taking stock: Assessing the impact of IR35 reforms in the private sector

Executive Summary

  • Over a third of contractors (35%) have left self-employment since the changes to IR35.
  • Of those who remain, over a third (34%) are now working through umbrella companies.
  • One in three contractors (36%) are now working in engagements that are deemed ‘inside IR35’.
  • Of those working on inside-IR35 contracts, four out of five (80%) have seen a drop in their quarterly earnings – by an average of 30 per cent.

In April this year, government changed how IR35 self-employed tax regulations worked in the private sector, shifting the complex task of determining a contractor’s IR35 status from contractors themselves to their clients.

This move has led more than one in three contractors surveyed (35%) to leave self-employment. They have closed their companies for retirement, moved into permanent roles, begun contracting abroad or are simply not working.

Of those who remain in contracting, a third (34%) are now working through umbrella companies, eight per cent are on agency payrolls and three per cent are on client payrolls. In total, one in three contractors (36%) are now working in engagements that have been deemed ‘inside IR35’.

Working ‘inside IR35’ seems to have significant financial consequences for contractors: four out of five (80%) who said they are working ‘inside IR35’ have seen a drop in their quarterly income – by an average of 30 per cent. A quarter (25%) even said they had experienced a drop in income of over 40 per cent.

A key reason for this seems to be Employers’ National Insurance Contributions. 72 per cent of contractors working inside IR35 said they were now liable for this and were paying through a reduction in their day rate.

Those contractors who moved into permanent roles also found themselves in a less financially advantageous situation. Nine out of ten (89%) saw a drop in income – by an average of 34 per cent.

Another significant issue is clients’ approach to IR35 status. Clients are now legally obliged to give contractors an IR35 Status Determination Statement (SDS), but two out of five contractors (38%) say their clients have not done this.

Although some contractors revealed their clients had actively assessed their IR35 status, one in five (21%) said their client had blanket assessed all their engagements as inside IR35. Another one in ten (11%) said their client insisted they move onto a payroll without assessing the IR35 status of their engagement and one in ten (9%) said their client simply advertised the engagement as inside IR35.

Umbrella companies

The changes to IR35 led to over a third (34%) of contractors being moved into umbrella companies. As umbrella companies are largely unregulated, contractors’ experiences of working through them varied significantly.

Overall, just under half of contractors (46%) said they were satisfied with their umbrella company, while almost a quarter (23%) said they were dissatisfied (including one in ten (9%) who said they were very dissatisfied).

While contractors seem to be broadly satisfied with umbrella companies’ payment timings (66% were satisfied or very satisfied), they were more concerned about other areas such as their Employers’ NI arrangements, holiday pay and business expenses.

Contractors were most concerned about business expenses (55% dissatisfaction compared to 11% satisfaction – most likely because they can no longer claim business expenses). This was followed by Employers’ NI arrangements (33% dissatisfaction compared to 29%). After this was holiday pay (24% dissatisfaction to 32% - likely because of the reported practice of not informing them they are due holiday pay).

Introduction

The off-payroll working reforms (IR35) were implemented in the private sector on 6 April 2021 and moved the responsibility for deciding the employment status of freelancers, to the end-clients for medium and large sized private business clients. The changes to IR35 in the private sector were originally proposed to be introduced in April 2020 but were deferred by a year due to the pandemic.

Initially implemented in the public sector in 2017, the changes affect how freelancers can engage with clients, predominantly affecting individuals operating though limited companies. The government says the intent of the reforms is to prevent “disguised employment” – whereby employers engage individuals through limited companies and remove the need to pay Employer’s National Insurance Contributions (NI), sick pay and holiday pay with the potential of a reduced tax bill for the individual1 – but these reforms have much wider consequences.

Freelancers operating in major industries such as IT, finance, construction, oil & gas and the creative sectors have reported significant changes to the way they can now operate as a result of the reforms – with many reporting that companies have introduced blanket assessments, deeming all contracts as within IR35 or blanket bans on hiring those operating through limited companies.2

Problems are already starting to emerge in certain sectors, for example, recent media reporting has highlighted that the haulage industry has been particularly affected by the imposition of IR35 reforms, leading to a shortage of HGV drivers whilst they were already navigating Brexit and the pandemic – an unintended consequence of the reforms.3

The reforms are also having an impact on other areas of freelancers’ lives including access to financial products such as mortgages. For example, there have been reports of many lenders requiring at least two years’ of contracting through an umbrella company in the application process.4

Previous IPSE research in February 2021 revealed that, as a result of the planned changes, over half (56%) of freelancers said they would only continue contracting in the UK if they could find contracts outside of IR35. A quarter (24%) were planning to seek contracts abroad and 17 per cent were planning to look for a permanent role.5

With HMRC research into the impact of the off-payroll working reforms only surveying 34 employment agencies on their intentions prior to their reformsand government conceding that they were unable to carry out in-depth research into the off-payroll working reforms due to the pandemic7, this research will seek to provide an overview of the actual impact on freelancers across the sector now the changes have been put in place.

This report will assess the impact of the changes to IR35 across the self-employed sector by evaluating how engagements have changed over the last year, how companies are making status determinations and the impact that the changes have had on freelancers and their incomes. For those who are now working through umbrella companies, the report also explores how satisfied they are with a range of different aspects and highlights some of the areas for concern.

The last 12 months

The last 12 months

In order to gauge the impact of the reforms, we asked freelancers how they have operated over the last 12 months and the experience they have had with IR35 contracts.

Over two in five (43%) freelancers reported that they had worked on contracts deemed outside IR35 over the last 12 months, despite the imposition of IR35 reforms in April 2021.

A further 31 per cent stated that they had refused a contract because the client deemed the engagement to be inside IR35. Similarly, one in five (20%) had stopped working with a client because the client now deemed the engagement to be within IR35.

On the contrary, only 11 per cent reported that they have continued working with a client despite the engagement being deemed inside IR35 – demonstrating the difficulty in continuing to work with previous clients as a result of the reforms.

As a result of the changes, a quarter (26%) had started working via an umbrella company over the past 12 months, a further six per cent had moved onto an agency payroll whereas four per cent had moved onto a client’s payroll.

Concerningly, one in five (20%) stated that they had closed their company over the past year and 14 per cent reported that they have moved over to permanent employment within the last 12 months.

Although freelancers have still been working on contracts outside of IR35 over the last 12 months, it is evident that the changes have led to a diminishing number of roles as clients deem an increasing number of engagements as inside IR35. The results also revealed that, in total, over a third of freelancers (35%) have left contracting over the last 12 months and are now either in full-time employment, working on a client or agency payroll or have closed their companies.

31% of freelancers refused a contract because the client deemed the engagement to be inside IR35

 

14% of freelancers moved over to permanent employment

 

Experiences of contractors over the last 12 months 

Graph01 - Experiences of contractors over the last 12 months

Percentages do not add up to 100% because respondents were able to select multiple responses

Current situation

Current situation

Of those who have not moved to permanent employment in the last 12 months, almost one in five (18%) are not currently working.

Concerningly, a majority (72%) cited the introduction of IR35 reforms as a reason why they were not currently working.

Other reasons contributing to why people were not currently working included that they were in between contracts (31%) or taking a break from contracting (15%). A further quarter (24%) cited the pandemic as a reason why they were not currently working and 15 per cent were planning to retire.

Furthermore, 16 per cent of freelancers stated that they were not working as they had closed their company although only four per cent were actively seeking an employed role.

The remaining 82 per cent are continuing to work for one or more clients. Of these, over half (57%) are working through their own limited company or in a partnership/ limited liability partnership whilst one in three (34%) now operate through an umbrella company – considerably more than was previously anticipated by freelancers ahead of the reforms (19% expected to be operating through umbrella companies)8.

Almost one in ten (8%) freelancers are now working on an agency payroll whilst three per cent are now working on a client’s payroll.

With the way freelancers operate dramatically changing since the introduction of IR35 reforms and with a greater percentage of engagements now deemed within IR35, freelancers exclusively seeking outside IR35 contracts are struggling to find suitable work due to a diminishing number of roles leading to increased competition and as such reductions in day rates to secure such roles.9

Overall, it is concerning that almost one in five freelancers are not currently working with the majority highlighting the changes to IR35 as a key contributing factor. For those who are working, the majority continue to operate through their own limited company, however, the switch to working through an umbrella company, agency or client payroll is far greater than previously anticipated from research prior to the reforms.

18% of freelancers are not currently working

 

34% of freelancers currently working now operate through an umbrella company
 

Current engagements for those contracting

Current engagements for those contracting

Percentages do not add up to 100% because respondents were able to select multiple responses

Determining IR35 status

Determining IR35 status

The shift in responsibility for determining IR35 status from the freelancer to the end-client for medium and large-sized businesses was already starting to alter the way they engaged with freelancers prior to the reforms, with 24 per cent of freelancers reporting that their clients were planning to determine all engagements as inside IR35.10

Looking at the current situation, just over half (51%) of freelancers are now working on contracts which have been deemed outside IR35 with 36 per cent of freelancers stating that their current engagement(s) have been deemed inside IR35. One in ten (10%) freelancers stated that IR35 did not apply to their current engagement(s), this could be because their clients are exempt from the private sector changes as they are small companies or based overseas.* The remaining three per cent were unsure of whether IR35 applied or not.

In order to determine the IR35 status of their engagements, 21 per cent of freelancers reported that their client had simply determined all engagements as inside IR35 – a blanket assessment.

A further 11 per cent reported that their client had insisted that they move onto a payroll without assessing the IR35 status of the engagement – a blanket ban.

Almost one in five (18%) stated that their client had used HMRC’s CEST (Check Employment Status for Tax) tool to assess their IR35 status whereas 21 per cent reported that the client had used a third-party company.

Six per cent also reported that their client had used a tool/piece of software other than the CEST tool and one in ten (10%) stated that their client made the IR35 assessment themselves without using any tools or software.

Additionally, nine per cent of freelancers reported that the contract was advertised as within IR35 when they applied.

The high number of blanket assessments and blanket bans by end-clients, to avoid falling foul of HMRC checks, is a concerning trend for freelancers, making it even more difficult to find contracts deemed outside of IR35.

*If the client is small or based wholly overseas it is exempt from the 2021 changes to IR35 as laid out in Chapter 10 of the Income Earning and Pensions Act (ITEPA) 2003, however, it is still possible that the Chapter 8 legislation (the old IR35 rules) still applies.

21% of freelancers reported that their client had determined all engagements as inside IR35

 

36% of freelancers are currently working within IR35

 

How did your client determine your IR35 status? 

IR35 status determinations

Percentages do not add up to 100% because respondents were able to select multiple responses

Provision of a Status Determination Statement (SDS)

Provision of a Status Determination Statement (SDS)

A Status Determination Statement (SDS) must be provided to the freelancer for every contract that is agreed, based on the outcome of an IR35 assessment. From the 6 April 2021, medium and large-sized businesses are legally bound to carry out the IR35 status determination and complete an SDS for all freelancers.11

Despite medium and large-sized businesses being legally bound to carry out these determinations and complete an SDS for all freelancers, 38 per cent of freelancers reported that their client had not provided them with an SDS.

For the freelancers who were provided with an SDS (56%), as legally required, 69 per cent agreed with the IR35 status determination, however, an additional 29 per cent disagreed with their IR35 status determination.

Of those who disagreed with their IR35 status determination, over three quarters (77%) had challenged their client’s determination whilst a quarter (23%) reported that they did not challenge the determination despite disagreeing with the assessment.

Regrettably, 79 per cent of those who challenged their status determination reported that there had been no change as a result of their challenge, however, 17 per cent reported that their IR35 determination was successfully changed.

When asked about the key challenges since the introduction of the reforms, freelancers repeatedly highlighted the confusion from clients around the changes, including clients quickly and often erroneously producing a status determination in the run-up to the implementation of the reforms, failing to take reasonable care or grasp what was fully required.

Evidently, despite being legally required to provide an SDS and also needing to take ‘reasonable care’ when administering IR35 status12, many medium and large sized businesses are still not providing an SDS and now, due to fear of a investigation, blanket assessments of ‘inside IR35’ are now increasingly common. With IR35 liability automatically transferred to businesses, it is therefore crucial that businesses accurately assess freelancers when deciding on inside or outside status.13

“I was working with a client outside IR35 until they panicked in late March and told me that they had decided I would have to move inside IR35. They didn't provide a SDS, but did offer a choice of temporary employment or to carry on as a contractor. I asked for a SDS and challenged the outcome. It was completed by head office solicitors/HR management with no knowledge of how I was working. My own assessment was outside IR35 with strong indicators such as being in control of how I do the work. The company is very risk-averse and used the CEST tool with answers to suit the required outcome rather than the reality (which they had no interest in understanding).”

Limited Company Director currently in between contracts.

38% of freelancers had not been provided with a Status Determination Statement
Implications of working within IR35

Implications of working within IR35

As a result of the reforms, more freelancers are now receiving inside IR35 determinations with clients often requiring them to operate through umbrella companies or on agency payrolls as a result. A determination of inside IR35 for freelancers means that HMRC classify them as an employee for tax purposes, and they are therefore subject to income tax and National Insurance Contributions.

Financial challenges

90% of freelancers now operating within IR35 report that all their engagements were previously outside of IR35

The majority (90%) of freelancers now operating within IR35 report that all their engagements were previously outside of IR35 prior to the implementation of the changes.

In addition, 6 per cent of those now operating within IR35 reported that some of their previous engagements were outside of IR35 whilst only 2 per cent reported that all of their prior engagements were inside IR35.

As a result of the reforms, 38 per cent of freelancers currently working within IR35 are now reporting that their day rates have decreased compared to before the changes to IR35 were introduced, including over a quarter (27%) who report a significant decrease in their day rates – a devastating reduction.

Interestingly, one in three (33%) actually reported an increase in their day rates since the implementation of the changes whilst another 29 per cent reported that they had stayed the same.

Compared to before the changes to IR35 were implemented, the majority of those now working within IR35 (80%) reported that their quarterly income has decreased including almost two-thirds (64%) who reported a significant decrease.

80% of freelancers have seen their quarterly income decrease since the introduction of the IR35 changes

On average, freelancers working within IR35 experienced a 30 per cent reduction in quarterly earnings, with a quarter (25%) experiencing decreases of 40 per cent or more.

Only 13 per cent of freelancers working within IR35 reported that their quarterly income had increased since before the changes to IR35.

Overall, the fall in day rates and quarterly income since the introduction of the IR35 reforms is one of the most concerning impacts of the changes, with freelancers now operating inside IR35 now suffering financially.

Other costs incurred

With freelancers now increasingly operating within IR35, this also creates a liability for Employer’s NI and, where applicable, the Apprenticeship Levy.

In order to gauge how this liability is being covered and whether it is being passed on to freelancers as a result of the reforms, we asked freelancers currently working within IR35, who foots the bill for this liability?

Concerningly, the majority (72%) of freelancers reported that they themselves are responsible for covering this liability through a reduction in their day rate.

72% of freelancers cover the liability of Employer’s NI and the Apprenticeship Levy through a reduction in their day rate

Since the survey was taken, the government announced that both employees’ and employers’ NICs will increase, each by 1.25%. Those freelancers shouldering the burden of both due to the IR35 changes will therefore be hit by a huge 2.5% increase in their NIC bill once the hikes are implemented next April.

Over one in ten (12%) reported that their umbrella company was responsible for footing the bill whilst eight per cent stated it was their client who was covering this liability.

A further five per cent reported that it was their agency that was responsible for paying Employer’s NI and, where applicable, the Apprenticeship Levy.

Other concerns since the introduction of IR35 in the private sector

To identify and understand the further implications of the reforms, we asked freelancers about the key challenges they have faced since the implementation of IR35 in the private sector.

The most common response from freelancers about the key challenges they have faced was a reduction in work, with many mentioning the difficulty in finding “suitable outside IR35 contracts”. These reports are often accompanied by accounts of blanket assessments or blanket bans by clients which finds all freelancers as ‘inside IR35’ or prohibits all engagement with those operating through limited companies.

Unsurprisingly given the reduced work on offer, many freelancers also reported suffering from reduced income, a fall in day rates or a decline in revenue since the implementation of the changes – supporting our findings in the previous section on the financial challenges experienced.

Further challenges faced by freelancers since the introduction of the reforms included confusion around the changes from clients or agencies and uncertainty around the future of contracting and whether it can even be a viable option to operate through a limited company, leading to some actively seeking permanent employment.

In fact, many freelancers reported that one of the key challenges over the last 12 months was actually having to leave contracting in the UK to seek roles abroad, concerningly in line with our findings on freelancers’ intentions prior to the reforms (24% planned to seek contracts abroad)14.

Moreover, the loss of control and independence was a further challenge for many freelancers, with reports of losing control over payments and purchases. Delays in receiving status determinations and concerns over the prospect of retrospective tax investigations and the associated insurance costs to cover against this were also disclosed as a key challenge by freelancers. Indeed, freelancers also stated that issues around the provision of an SDS and the use of tools such as CEST – used by some clients to find all contracts as inside – presented additional challenges.

On the contrary, a minority of freelancers reported in their comments that they were, as of yet, unaffected by the changes or indeed had been able to benefit from a slight increase in day rate. However, this represented only a minority of freelancers, with concerns over falling day rates far outweighing reports of a beneficial impact.

“New contracts I'm offered are all under blanket 'inside' determinations - New contracts take home pay I'm now offered are at least 40% lower than day rates offered before the legislation and I can therefore not accept them”

Freelancer who refused a contract with a client due to inside IR35 determination.

“Blanket panicked decisions by large organisations, not based on facts or working practices have decimated the market for genuine contractors delivering outcome-based flexible skills and services.  No income and depleted reserves mean that I am 1 month away from making 2 directors and 3 part-time staff redundant before closing the company.”

Freelancer who refused a contract with a client due to inside IR35 determination.

“Clients not understanding ir35 and making blanket decisions, so I've stopped working – the companies now lose out on experience and I don't pay any tax, so all lose out.”

Freelancer who has now closed their limited company.

“A lot of confusion and endless discussion about the regulations.  Some potential clients are afraid of falling foul of the rules, so won't even assess properly - they consider it not worth the risk. I've had to turn down good work due to bad feeling from dealing with inflexible client personnel. I use two day rates: inside IR35 and outside IR35.”

Contractor now operating through an umbrella company.

“The whole contracting market has shrunk dramatically… Will be investigating work opportunities abroad as UK market becoming increasingly tax punitive.”

Freelancer currently on an agency’s payroll.

“Complex and elongated payment chain. Many different contracts in place that I had no control over. Didn't feel I had direct dialogue with client over contract. All the different parties wanted a slice of the income I was generating for no obvious benefit to my company or the client. Difficult to know who in the chain was responsible for what.”

Previous freelancer that has now moved to permanent employment.

“Liquidating company and now losing control of everything at the mercy of an umbrella company.”

Contractor now operating via an umbrella company.

“My client last year made a blanket assessment to put us all inside on the same daily rate, when we had been outside. Forcing us to look for another role, or take the pay cut and risk a HMRC retrospective investigation.”

Contractor now operating via an umbrella company.

 

Working through an umbrella company

Working through an umbrella company

As a result of the changes to IR35 in the private sector, a third (34%) of contractors report that they are currently operating through umbrella companies.

Given that for many contractors, working through an umbrella company is a requirement in order to secure certain contracts, we wanted to understand how much freedom contractors had to choose the umbrella company through which to operate.

Almost two thirds (63%) had some level of choice but were given a limited range of umbrella companies to choose from – particularly concerning given the unregulated nature of these umbrellas and the reports of malpractice over holiday pay.15

A total of 31 per cent of contractors reported that they had the freedom to select any umbrella company whilst, concerningly, five per cent were unable to choose their umbrella company and had to operate through one allocated to them.

“Transferring from limited company to umbrella was stressful for me and my family. Big worries about impact on short term cashflow and future earnings. What to do with my limited company, specifically when to shut it down and tax implications. Reduced cashflow and cash reserves as an umbrella employee compared to limited company.”

Contractor now operating via an umbrella company.

Satisfaction

In terms of overall satisfaction, just under half (46%) reported that they were either somewhat or very satisfied with the umbrella company that they are currently operating through. On the contrary, almost a quarter (23%) were dissatisfied with their umbrella company including almost one in ten (9%) who were very dissatisfied.

In order to understand the different aspects of umbrella companies that contractors were most and least satisfied with, we explored a range of elements such as payment timings, communication, pension contributions, holiday pay, management of business expenses and their handling of Employers NI and where applicable, the Apprenticeship Levy.

Payment timings

Umbrella companies will pay contractors directly into a bank account minus income tax, Employees’ NI Contributions, umbrella fees and, if applicable, Employers’ NI and the Apprenticeship Levy.

Currently, due to the unregulated nature of umbrella companies, there is no legal requirement to pay contractors within a certain timeframe, with umbrellas only responsible for fulfilling their contractual agreements that have been agreed with the contractor on payment.

When asked about the payment timings of their current umbrella company, a third (66%) of contractors were either somewhat or very satisfied, including 42 per cent who were very satisfied with the payment timings of their umbrella company.

Almost one in five (18%) were either somewhat or very dissatisfied with the payment timings of their umbrella company and a further 16 per cent were neither satisfied nor dissatisfied.

Some difficulties cited included missed payments from clients penalising contractors and unfair tax treatment concerning holiday pay and the ability of umbrella companies to miss payments and face no penalties.

“If a payment submission date is missed by the client the umbrella company treats two weeks as one week and salary sacrifice is missed therefore you pay more tax and NI.”

Contractor now operating through an umbrella company.

“The weekly model might not be best e.g., pay is not averaged over the month for Employer NI and the weekly limit will incur unnecessary tax. Likewise accrued holiday is taxed when earned not when paid.”

Contractor now operating through an umbrella company

Pension arrangements

Currently, an umbrella company must contribute to an individual’s pension if they are enrolled on their scheme, with the umbrella contributing at least three per cent – the minimum total contribution set by government.16

Overall, when asked about their satisfaction with the pension arrangements offered by their umbrella company, 42 per cent were either somewhat or very satisfied, including 22 per cent who were very satisfied.

However, over a quarter (28%) were either somewhat or very dissatisfied with their pension arrangements whereas the remaining 30 per cent were neither satisfied nor dissatisfied.

Some of the difficulties that contractors cited included problems transferring their existing pension across after switching to umbrella company work as well as being able to continue paying in when deductions are now at source. Furthermore, there were other concerns about agencies or umbrella companies being unwilling to pay contributions into certain pension providers.

“Managing my personal pension has been a real nightmare to continue paying in to. The agency invoices weekly, the umbrella pays weekly. Yet the pension company will only accept monthly contributions. Neither side (umbrella or pension provider) is setup to accept any changes.”

Contractor now operating through an umbrella company.

Holiday pay arrangements

Currently, when operating through an umbrella company, contractors are entitled to 28 days holiday per year. However, unlike employees, umbrella companies do not fund this holiday entitlement, with 12.07 per cent typically taken out of contractors’ day rates in order to fund the annual leave.17

In terms of how contractors receive their holiday pay entitlement, the majority (79%) of contractors reported that they received their holiday pay as part of their normal pay.

A further two per cent stated that their holiday pay was automatically paid to them at the end of an assignment or period whereas five per cent, concerningly, reported that their holiday pay was withheld by the umbrella company and that they themselves had to claim it back – an additional administrative and time burden for contractors.

Worryingly, seven per cent of contractors were unclear about their holiday pay arrangements, suggesting that they may be missing out on their entitled pay.

In terms of satisfaction, 32 per cent were either somewhat or very satisfied with their umbrella companies' holiday pay arrangements.

Almost a quarter (24%) were either somewhat or very dissatisfied, including 15 per cent who were very dissatisfied – with the dissatisfaction likely linked to reports of negligence from umbrella companies in ‘rolling-up’ holiday pay.18

Concerns were raised over the inability to choose when to take the time off and also when to receive holiday pay. In addition, other concerns centred around contractors themselves funding holiday pay via deductions to their payslips throughout the year and day rates now reflecting the increased cost of holiday pay deductions.

The remaining 45 per cent of respondents stated that they were neither satisfied nor dissatisfied about their arrangements.

 “Unable to control take home pay, making holiday time off expensive. Prefer to take little and often rather than everything earned at once.”

Contractor now operating through an umbrella company.

“My business has collapsed. I am now forced to have taxes deducted at source but have no worker rights. The client insists that I take "holiday", but won't pay me for it, so I'm basically forced to be absent without pay. After over 20 years of contracts across 16 different companies, I am now legislated out of business.”

Contractor now operating through an agency payroll.

Communication

Overall, 44 per cent of contractors were either somewhat or very satisfied with the communication from their umbrella company including one in five (20%) who were very satisfied.

On the contrary, 28 per cent were either somewhat or very dissatisfied with the communication from their umbrella company whereas 29 per cent were neither satisfied nor dissatisfied.

Some of the reasons given for dissatisfaction with their umbrella company’s communication was their inability to adequately respond or explain certain actions.

“The Umbrella company… are tardy to respond when requested for help/guidance to clarify differences or explain payslip information; they are unable to provide data electronically on payroll/payslips in CSV format; they are unable to provide valid explanations (aside from blaming others, HMRC) for variations in pay.”

Contractor now operating through an umbrella company.

Management of business expenses

Unlike when operating through a limited company, business expenses cannot be claimed for those working via an umbrella company with HMRC stating that contractors should be treated in the same way as a permanent employee through a Supervision, Direction and Control (SDC) test. Whilst some expenses can be claimed back through HMRC, most expenses must be approved by an umbrella company for contractors to receive compensation.

When asked about their umbrella company’s management of business expenses, over half (55%) of contractors stated that they were either somewhat or very dissatisfied, including over a third (37%) who were very dissatisfied – likely due to being unable to claim expenses that were previously claimable through a limited company.

Only 11 per cent were either somewhat or very satisfied, and a further 34 per cent were neither satisfied nor dissatisfied.

Multiple contractors reported that one of the main challenges since the implementation of the reforms has been the inability to claim expenses or training and professional development costs as a result of working via an umbrella company or other intermediary. In fact, reports tended to focus on the inability to claim expenses for travel and accommodation which has made certain contract opportunities unviable – potentially exacerbating the lack of suitable roles on offer to contractors and adding to pressures on income and day rates as contractors are now forced to absorb these costs.

“Unable to claim expenses for equipment and training which are not supplied by the umbrella co.”

Contractor now operating via an umbrella company.

“I cannot claim any expenses that I previous claimed as a consultant e.g., Internet costs, software subscriptions, hardware e.g., servers, training costs etc”

Contractor now on agency payroll after closing limited company.

Employer’s National Insurance and Apprenticeship Levy deductions

When operating through an umbrella company, contractors must pay Employers’ NI on any income they receive, with the standard rate at 13.8 per cent. The Apprenticeship Levy is paid by all employers with annual employee contract work exceeding three million pounds at a rate of 0.5 per cent of the company’s total pay in order to fund new apprenticeships and vocational skills in the UK. The umbrella companies then, in some cases, pass on this cost to contractors through a deduction on their payslip.

When asked about their umbrella company’s handling of Employer’s NI and, where applicable, Apprenticeship Levy deductions, a total of 29 per cent were either very or somewhat satisfied and a further 38 per cent were neither satisfied nor dissatisfied.

The remaining one in three (33%) reported that they were either somewhat or very dissatisfied including one in four (25%) who were very dissatisfied.

One of the key reasons for dissatisfaction amongst contractors was that they are now responsible for this liability despite the fact they are not entitled to certain employment rights. Difficulties with taxes being deducted at source, having to contribute for Employer’s NI and the Apprenticeship Levy and also lacking employment benefits, such as holiday and sick pay were also raised.

“Effective reduction in day rate due to having to pay employer's NI”

Contractor now operating via an umbrella company.

“I'm much worse off, tax is eye watering and on top I pay an apprenticeship levy and employer’s NI which is a kick in the teeth”

Contractor now operating via an umbrella company.

Satisfaction with umbrella companies

Graph 05 - Satisfaction with umbrella companies
Moving to permanent employment

Moving to permanent employment

Reasons for moving to permanent employment

The findings revealed that over the last 12 months, 14 per cent of freelancers had moved into permanent employment. These findings are unsurprising given that the ONS reported a drop of 700,000 to the number of self-employed since 2020.19

When looking at why people had taken the decision to move to permanent employment, the majority (81%) of freelancers reported it was because of the changes to IR35 in the private sector.

One in five (19%) stated that they were driven to permanent employment by financial reasons and a further one in five (19%) reported that they had been forced to move to permanent employment in order to continue working with their client.

Another 13 per cent stated they switched due to the security permanent employment can offer whilst a further 13 per cent stated that a reason for moving to permanent employment was so they could access statutory employment benefits.

Interestingly, 18 per cent also report that they moved to permanent employment for ‘other’ reasons, with respondents reporting this was due to wanting to finish projects when a client had now deemed them inside IR35, being unable to find any work outside IR35 or being unwilling to operate through an umbrella company.

“I wanted to finish the project.  Also, looking for a new contract during the start of the pandemic sounded unpleasant, to say the least.”

Previous freelancer that has now moved to permanent employment.

81% of freelancers made the decision to move to permanent employment because of the changes to IR35

Financial implications of moving to permanent employment

The majority (89%) of those who had moved to permanent employment in the last 12 months reported that their quarterly income had either slightly or significantly decreased as a result of the move.

This includes 65 per cent who reported a significant decrease to their quarterly income as a result of making the switch to permanent employment.

Just five per cent reported that their quarterly income had increased since switching and another five per cent reported that their quarterly income had stayed the same since moving to permanent employment.

In terms of quantifying this reduction in quarterly income, over half (55%) reported that their quarterly income had decreased by 30 per cent or more since taking on a permanent role, with the average quarterly income reducing by 34 per cent.

The most overwhelming reasons that freelancers had moved to permanent employment in the last 12 months was because of the changes to IR35 in the private sector. It’s clear that these changes are already having a financial impact with the majority reporting that they are now worse off as a result.

Reasons for moving into permanent employment

Graph 04 - Reasons for moving into permanent employment

Percentages do not add up to 100% because respondents were able to select multiple responses 

Future intentions of freelancers

Future intentions of freelancers

With freelancers still reeling from the impact of the pandemic – which brought about a fall in work and day rates and saw the overall number of self-employed individuals decline by 700,00020 – the added impact of IR35 reforms has exacerbated issues around finding work with more freelancers now unable to find “suitable outside IR35 roles”.

In order to understand the future impact of the reforms, we asked freelancers how they intend to work over the next 12 months.

Over half (55%) of freelancers reported that they intend to continue contracting only if they can find contracts that are deemed to be outside IR35 which closely aligns with freelancers’ predictions prior to the reforms where 56 per cent reported this.21

Similarly, 28 per cent stated that they intend to work for small clients who are exempt from having to make IR35 status determinations.

A quarter (24%) of freelancers reported that they intend to work abroad over the next 12 months.

A further 17 per cent reported that they planned to continue contracting regardless of their IR35 status and over one in ten (12%) intended to operate through an umbrella company.

Concerningly, given the decline in the numbers of overall self-employed, 19 per cent of freelancers reported they intended to work as an employee, 11 per cent planned to retire and six per cent planned to stop working altogether in the next 12 months.

Conclusion & recommendations

Conclusion & recommendations

Conclusion 

This report shows the severe impact the changes to IR35 have had on an already scarred contracting sector – large parts of which did not receive financial support during the pandemic.

It shows that the timing of the changes has added substantially to the decline of the self-employed sector, and that at least a third of contractors have either left the self-employed sector or are considering doing so.

In the wake of the IR35 changes, we also find a contracting sector which, far from being simplified by the reforms, is thornier and more complex than ever before. Contractors are now faced with a maze of different ways to be self-employed – and a host of pitfalls waiting for them, from unscrupulous practice in the unregulated umbrella sector to substantial pay cuts working inside IR35.

The contracting sector is the most productive element of the vital self-employed workforce, which overall has been estimated to contribute over £300bn a year to the economy. It is also utterly essential for recovery from an economic downturn, providing vital flexible expertise to businesses as they adapt and rebuild.

Far from being encouraged in this, however, the contracting sector has been stymied by the changes to IR35. Therefore, to restore the fortunes of the sector – and in doing so, boost the economy, we have made a series of recommendations for government. 

Recommendations 

1. Government should urgently review the impact of the off-payroll working (IR35) reforms in both private and public sector. This research provides an understanding of the impact on contractors but clients, agencies and umbrella companies have also been impacted – the government review should cover all stakeholders. The review should be comprehensive but must as a minimum focus on the following:

  • The extent to which clients are not taking reasonable care when making determinations. In particular government must tackle the widespread blanket assessments and blanket bans highlighted in this report. It must also examine the number of clients that are not undertaking any kind of IR35 assessment whatsoever.
  • This research highlights that IR35 has resulted in work opportunities and taxable income moving overseas. Government should be very concerned by this and the review should examine the impact on tax receipts and economic growth.
  • Related to the point above, the review should examine the impact of the reforms on labour market shortages. Recent reports of a critical shortage of HGV drivers may just be the tip of the iceberg. This report highlights a significant number of contractors ceasing work altogether as a result of the reforms.

The government must not be hesitant to make radical changes to the legislation, including scrapping it altogether, if the review exposes significant damage to taxpayer fairness, labour market shortages, tax receipts and the economy as a whole.

2. Where the government finds engagements have been inaccurately determined as ‘inside’ IR35, government must set out how the tax payments can be unravelled so that taxpayers are fully refunded. This will not be straight forward as those working via umbrella companies have, in many cases, indirectly paid employers' NICs and the Apprenticeship Levy. Nonetheless, in the interest of fairness, it is essential that government ensures that no tax payer is left out-of-pocket due to errors that were not of their making.

3. Where the government finds engagements have been inaccurately determined as ‘outside’ IR35, government will rightly seek the appropriate tax and NI payments. In these circumstances it must introduce a transparent ‘off-set’ mechanism, in line with the ‘Demibourne regulations’, to ensure all taxpayers are paying the correct tax and, crucially, that HMRC will not be at risk of collecting more tax than is due which would conflict with the HMRC Charter.

4. This report highlights widespread confusion and disagreements over status between contractors and clients. To clear up the confusion government should urgently carry forward work it has committed to do on employment status as part of the Good Work Plan. Much clearer rules over when it is appropriate to operate as a company, a sole trader and an employee would go a long way to easing the burden of the legislation.

5. Government should set out detailed regulations for how umbrella companies should operate. In particular, there should very clear rules for how holiday pay should work. It is clear from this report, and other research that the IR35 reforms have led to a huge increase in umbrella working. Government must ensure that umbrella ‘employees’ are treated fairly, consistently and transparently.

6. IR35 should extend beyond just tax. It would be simpler and fairer to ask clients to consider whether the role requires an employee (which in effect they are required to do now) and if they deem that it does, they should directly employ the individual. This would ensure consistent treatment for both tax and employment rights and will result in the ‘employer’ paying employment taxes – as they should.

Sample

This report is based on the results of an online survey conducted by IPSE between Monday 26 July and 29 August 2021. The respondents were a sample of 1,017 freelancers working across a range of occupations in the top three highly skilled Standard Occupational Categories (SOC 1-3). A total of 57 per cent of the sample were operating though their own limited company whilst 34 per cent were working through an umbrella company. Overall, 56 per cent of the sample were currently working with one client, 26 per cent working with two or more and 18 per cent were not currently working.

References

  1. https://www.gov.uk/guidance/understanding-off-payroll-working-ir35 Accessed 07/09/21
  2. https://offpayroll.org.uk Accessed 25/08/21
  3. https://www.bbc.co.uk/news/57810729 Accessed 23/08/21
  4. https://www.ftadviser.com/mortgages/2021/07/27/how-ir35-changes-have-affected-mortgage-affordability/ Accessed 07/09/21
  5. IPSE, The impact of IR35 changes on the self-employed in 2021, 2021
  6. https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/970948/HMRC_Research_Report_-_Off-payroll_agencies.pdf Accessed 25/08/21
  7. https://www.contractorcalculator.co.uk/hmrc_report_fails_vindicate_payroll_563310_news.aspx Accessed 07/09/21
  8. IPSE, The impact of IR35 changes on the self-employed in 2021, 2021
  9. https://offpayroll.org.uk Accessed 12/08/21
  10. IPSE, The impact of IR35 changes on the self-employed in 2021, 2021
  11. https://www.gov.uk/guidance/april-2020-changes-to-off-payroll-working-for-clients Accessed 08/09/21
  12. https://www.gov.uk/hmrc-internal-manuals/employment-status-manual/esm10014 Accessed 08/09/21
  13. https://www.gov.uk/hmrc-internal-manuals/employment-status-manual/esm10014 Accessed 08/09/21
  14. IPSE, The impact of IR35 changes on the self-employed in 2021, 2021
  15. https://www.ipse.co.uk/ipse-news/news-listing/ipse-ensure-fair-holiday-pay-umbrella-workers.html Accessed 25/08/21
  16. https://www.umbrellacompany.co.uk/blog-article-umbrella-contractor-pensions.html Accessed 09/09/21
  17. https://www.contracteye.co.uk/umbrella-companies-holiday-pay.shtml Accessed 09/09/21
  18. https://www.ipse.co.uk/ipse-news/news-listing/ipse-ensure-fair-holiday-pay-umbrella-workers.html Accessed 25/08/21
  19. ONS, Labour market statistics time series, April 2021
  20. https://www.ipse.co.uk/ipse-news/news-listing/self-employed-sector-disadvantaged-economy-opens.html Accessed 14/09/21
  21. IPSE, The impact of IR35 changes on the self-employed in 2021, 2021

Acknowledgements

This report was written by Joshua Toovey, Research and Policy Officer and Chloé Jepps, Head of Research at IPSE. 

 

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