IR35: HMRC “downplayed” impact of off-payroll working rules reform on contractors
SPECIAL REPORT
HM Revenue & Customs (HMRC) has released a report outlining the government’s assessment of the impact of the IR35 reforms on private sector contractors. However, several sources representing contractors contest the report’s findings, arguing that the reported figures regarding the number of affected individuals and the financial burdens imposed by the reforms do not reveal the true picture.
IR35 was created to generate more taxes: it worked but at what cost to economic growth?
The UK government implemented changes to the off-payroll working rules (IR35) in 2021. The aim was to increase income tax revenue from contractors deemed to be working as de facto employees but without the associated employee benefits.
These contractors typically operate through their own personal service companies (PSCs), which can result in lower tax liabilities compared to traditional PAYE employment. This arrangement leaves them without standard employee benefits, job security, or protection against sudden project cancellations. Despite these factors, HMRC proceeded with the IR35 and off-payroll reforms, requiring PSC contractors to pay broadly equivalent taxes to employees and placing an increased National Insurance liability on the organisations engaging them.
This article examines the discrepancies between HMRC’s stated impact of the reforms and the estimations provided by organisations serving contractors, such as insurance providers, recruitment agencies and umbrella companies.
The backbone of the UK economy is being broken
According to the government report, the significant shift of workers from PSCs to umbrella companies suggests that the reform has led to increased employment rather than self-employment through these intermediaries. This is likely due to clients wanting to avoid the administrative burden and risk associated with determining employment status.
The average annual tax increase of £10,000 per worker further supports the premise that contractors are paying more tax as a result of the reform. This is because they are taxed as employees rather than through the more tax-efficient PSC structure.
The Off-payroll rules have created a hostile environment for genuine contractors and the businesses that need their expertise – exactly the opposite of what our economy needs. If our Labour government truly wants to grow the economy, they should start by supporting people who want to be their own boss so they can help UK plc to thrive.
-Dave Chaplin, CEO IR35 Shield
Impact on worker numbers: The government estimates 120,000 workers were affected by the reform, with many moving from PSCs to employee roles. There was also a reduction of around 45,000 in the formation of new PSCs.
Shift to umbrella companies: A significant number of workers moved from PSCs to umbrella companies. This is likely due to the reform, as clients sought to avoid the responsibility of determining employment status. This is commonly referred to in the contracting industry as “blanket banning” contractors who want to work through their own company, enabling them to take on more work with other clients.
Increased tax revenue: The reform generated an estimated £4.2 billion in additional tax revenue. This is because contractors working through umbrella companies are taxed as employees, paying higher rates of income tax and National Insurance contributions.
For those hoping that the IR35 reforms will be repealed, there are 4.2 billion reasons why that is not going to happen.
-Dave Chaplin, CEO IR35 Shield
Monetary impact on workers: The average annual tax increase per affected worker is £10,000. While some workers may have seen an increase in pre-tax income, it’s likely that many experienced a reduction in take-home pay.
The evidence presented in the government document supports the argument that HMRC’s reform of off-payroll working rules/IR35 has forced more contractors to join umbrella companies and pay increased amounts of tax. This is due to a combination of factors, including clients seeking to avoid the responsibility of determining employment status and the higher tax rates applied to employees compared to PSCs.
This is how HMRC has expressed its findings:
We have seen evidence that only a small number of individuals may have moved from working through their own PSC to potentially not working over the time of the reform; and we estimate that more PSC workers have been unaffected by the reform than affected. Overall, we estimate total employments across all types of work for PSC workers have increased when comparing a point in time before the reform to a point in time after the reform.
However, companies serving contractors do not agree with HMRC’s statement or their figures for the number of contractors impacted financially.
This is how people are reacting to the IR35 report
Lucy Smith, Owner and Founder of Clarity Umbrella, responded to the government’s statement in a LinkedIn post:
I think it is unlikely that many of our contractors will agree with this statement, especially when their statistics have stated a move from PSC to umbrella of around 300,000 workers!
Qdos CEO, Seb Maley, said there were some “bold claims” in the report:
The impact of the off-payroll working rules has been continually downplayed. But this document takes it to new heights. To say that there are now more opportunities for contractors following the changes is nonsense.
“The reality is, these rules created confusion, uncertainty and damage to the contracting landscape,” said Maley.
He continued, “Many businesses stopped engaging contractors as a direct result of the reforms. The truth is, it’s taken years for firms to get to grips with the rules – something we are seeing gradually, but there’s still some way to go.”
A short-sighted tax grab at the expense of economic growth?
Maley said, “It’s important to note that £4.2 billion more in tax doesn’t necessarily equate to increased levels of compliance. Far too often, contractors have been placed on the payroll or inside IR35 despite being clearly self-employed. This increases the government’s tax take.”
Dave Chaplin, CEO and founder of IR35 compliance firm IR35 Shield, said HMRC’s newly published report on private sector IR35 reforms “paints a stark picture”.
Chaplin said, “While the exchequer celebrates a £4.2 billion windfall, contractors who once valued the autonomy of limited company operations face the harsh realities. For those hoping that the IR35 reforms will be repealed, there are 4.2 billion reasons why that is not going to happen.
“Firms have forced almost all contractors who were deemed employees for tax purposes onto payroll, effectively shutting down their ability to access natural justice to appeal potentially incorrect tax treatment.
Chaplin argued that the self-employed have consistently proven to be the backbone of Great Britain’s economy, particularly during uncertain times, providing businesses with workforce agility and specialised skills that drive innovation across all sectors:
“The Off-payroll rules have created a hostile environment for genuine contractors and the businesses that need their expertise – exactly the opposite of what our economy needs. If our Labour government truly wants to grow the economy, they should start by supporting people who want to be their own boss so they can help UK plc to thrive.”
The numbers don’t add up to on-the ground experience
Crawford Temple, CEO and founder of Professional Passport, an independent assessor of payment intermediary compliance, said:
The numbers quoted in this latest report simply do not match our experience of what we are seeing on the ground throughout the market. Disguised remuneration schemes are flourishing as a result of the Off-payroll legislation and we would challenge HMRC on its numbers. Just recently HMRC froze the assets of a provider to the tune of £171m for alleged fraudulent NICs activity and there were 30,000 workers affected.
“HMRC has all the information and intelligence it needs to shut down the dodgy schemes but it is failing to do so quickly enough,” said Temple.
He continued, “The sector warned HMRC about the predictable outcomes of their approach. We foresaw that stringent rules, and the subsequent drop in contractors’ earnings, would push contractors towards umbrella companies, inadvertently creating a breeding ground for disguised remuneration schemes. Our warnings were not heeded and the schemes came to pass.”
Temple said the schemes continue to proliferate, “further boosted by the increase in Employers NI from April, offering higher returns than compliant providers and attracting dodgy operators who know they will face minimal consequences so are prepared to take the risk.”
He said, HMRC’s “Name and Shame” list has proven “laughably ineffective” because companies simply relocate workers, exploit the 12-month listing limitation, and continue their practices with minimal disruption.
Temple continued:
HMRC’s ongoing refusal to explore how its existing data can be more effectively used to identify non-compliance across the sector is creating a downward spiral and a race to the bottom where those who are prepared to disregard the rules make significant gains.
This report simply does not reflect reality.
What does “Inside IR35” really mean?
According to Chaplin, “inside IR35” means someone is hired as a “deemed employee” (in law), where they are operating via an intermediary (defined in s61O). What a hiring company is saying is “not available to be hired Outside IR35”, or “Must be on PAYE” or “we will not hire on an Inside IR35 basis, via a PSC”.
Chaplin explained that a fixed term contract is not “Inside IR35” and nor is an umbrella “Inside IR35”.
“A fixed-term contract, however, does bring into play employment law in a different manner to umbrella, hence pay band issues,” he said.
Chaplin said, “One must quote rates differently and make sure the worker is not being put into a non-compliant scheme – since they will get the tax bill eventually. Umbrellas do have some advantages for some workers, e.g. pensions. Agency worker is a perfectly acceptable option too.”
What recruiters are saying about IR35’s impact on talent
Mark Kitchen of Williams Bain, an Interim Management recruitment firm scouting director-level roles, said IR35 has changed the interim landscape, and the rules are still changing.
He said in a LinkedIn post that Williams Bain will not accept an Inside IR35 role if the candidate is required by the client to work through an umbrella company.
“In our opinion, the only choice for Inside IR35 determinations is a fixed term contract with rolled up benefits,” he said.
In this video, Kitchen attempts to break down what it means for both businesses and interim managers when opting for fixed-term contracts with rolled-up benefits not conducted through an umbrella company.
Rolled-up benefits as a cash equivalent
Kitchen says benefits can be rolled up into cash equivalents. For example, a percentage of what would normally be paid as pension contributions.
Now, pension contributions are usually tax-free/ efficient. However, a contractor would be taxed on this rolled-up cash benefit if the contractor did not personally invest it into a private pension, such as a SIPP. Sometimes, a contractor can request a certain pre-tax amount to be sent to their SIPP. Here are some options to consider if the hiring company is on board to help.
Salary Sacrifice:
- This is a common method for making pre-tax pension contributions.
- It involves you agreeing to reduce your salary in exchange for your employer paying a higher amount into your pension.
- This can save both you and your employer on National Insurance contributions.
Net Pay Arrangement:
Similar to salary sacrifice, this method involves pension contributions being taken before income tax is calculated.
The fact that you’re on a fixed-term contract shouldn’t necessarily prevent your employer from making SIPP contributions. However, it may affect their willingness to set up a long-term payment plan. Discuss this when you are formalising your fixed-term contract.
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