The Current State of IR35

  • Charlotte Gregson
  • May 23, 2022

In 2021, IR35 or “Intermediaries Legislation” was amended in an attempt to discourage “disguised employees” from being treated as self-employed contractors. This meant that those deemed as falling within IR35 would need to pay the same income tax as if they were employed and that the employing company would be liable for providing statutory benefits such as sick pay and pensions.

The costs of falling afoul of IR35 are serious for both freelance consultants and clients, but the cost of creating barriers to the marketplace of independent expertise for specialized projects is also significant. 

High-level test cases have given us a clear idea of how HMRC (Her Majesty’s Revenue and Customs) is looking to enforce IR35— and being informed will help clients access independent consultants without violating the legislation. 

What has Changed?

IR35 has been with us in some form since 2000. But, prior to April 6, 2021, the responsibility for determining employment status under IR35 lay mainly with the contractor rather than the client. The exception to this was where the client was a public sector organization, in which case the responsibility was that of the organization (since 2017).

Things changed from April 2021 when the responsibility for status determination fell to the client organization for medium and large businesses. For small businesses, the responsibility remained with the contractor.

For the purposes of IR35, a small company is where at least two of the following apply:

  • Annual turnover of no more than £10.2 million
  • Balance sheet total of no more than £5.1 million
  • No more than 50 employees

If a breach of IR35 is discovered, it is the party that was responsible for the status determination that is liable for the penalties.

However, that cost pales into insignificance compared to the tax and National Insurance back payments, which are borne by both the client and the contractor.

During the last year, there have been rulings on several cases, notably HMRC vs DEFRA and HMRC vs Ministry of Justice for IR35 violations, both of which found in HMRC’s favor. The total cost to these employers, in penalties and tax, was a combined £120 million. 

Whilst these cases were mainly a recirculation of revenue from one government department to another, the easily forgotten losers were the contractors who shared in the tax burden.

What Has Worked Well?

If we remind ourselves that the purpose of IR35 was to prevent the “disguising” of employees as independent contractors, at the expense of the Treasury, then we could take the view that IR35 has worked well so far. 

If we wish to take some positives from how IR35 has been implemented to date, we could consider the recent high-profile cases mentioned above as providing a degree of clarity on how HMRC wishes to interpret the legislation. Those cases have sent a clear message that a “Statement of Work”, whilst being a useful document, is insufficient proof in itself that a contractor is outside IR35. It needs to be backed up with substantive evidence of working practices and demonstrate: 

  • Exclusivity: the contractor can work for others 
  • Substitutability: the contractor’s services could be provided by another person
  • Mutuality of Obligation (MOO): there is no guaranteed follow-on work

The ongoing pending cases will hopefully provide further clarification of how best contractors and their clients can ensure they are compliant should they become subject to investigation.

A positive outcome is that the outsourced supply of services is on the increase. This is where the client company contracts with a consultancy company to provide services. There must be a clear distinction between the supply of services and the supply of labor. For example, if a client company “X” enlists the services of consultancy company “Y” to carry out services rather than simply to supply a number of workers, then the arrangement between X and Y, if framed correctly, can be outside IR35. 

The arrangement between Y and the contractors it supplies would still need to be tested to be IR35 compliant so that Y is not seen as being an employer of those contractors. But the advantage is that the client company, X, has established that it is not in breach of IR35.

For freelance consultants and clients, these arrangements provide some certainty that, if the relationships between the outsourcing agent, the consultant, and the client, are set up so as to be outside IR35, then there shouldn’t be any challenge to the status down the line.

There have been several about turns where large organizations have removed blanket bans on the use of “off-payroll” contractors. Notable of these has been the government-backed company Network Rail. Prior to 2021 Network Rail treated all its contractors as inside IR35. However, in its 2020-21 accounts, Network Rail reported that 70% of its contractors were now outside IR35.

It can be hoped that other major companies will follow suit.

What Hasn’t Worked Well?

HMRC’s Status Determination Tool, “Check Employment Status for Tax” (CEST), claimed by HMRC to be a reliable test of whether a contract is inside or outside IR35, has been shown to be highly subjective. The information fed into the test can be influenced by several parties, the contractor, the client company, or the agency, and an aversion to the risk of non-compliance can mean inaccurate details are provided.

Furthermore, in 21% of cases, CEST has failed to provide a determination, leaving over 250,000 contractors with no clarification of their IR35 status. As a tool to ensure compliance, CEST has proven ineffective as HMRC can, and has on many occasions, overruled its determination.

Increases to National Insurance contributions now in force (13.25% for employees and 15.05% for employers), and the Social Care Levy due in April 2023, will add considerable costs to UK businesses and contractors deemed to be inside IR35.

Fear of non-compliance has led to large numbers of legitimate contractors being caught within IR35, creating additional costs for them and their clients. This inevitably will lead to increased costs of goods and services at the consumer level and add to the growing specter of increased inflation.

A number of clients, in fear of breaching IR35, are actively seeking independent consultants that are non-UK based, and therefore not subject to IR35.

IR35 in its current form is still being tested continuously and, at present, there is more confusion than clarity for clients and contractors.

The Future for Independent Consultants and Clients

Whilst IR35 is clearly an added burden for client companies and independent consultants, it is not something to be feared. 

In the post-Covid world, COMATCH is seeing huge demand for specialized expertise as businesses re-shape themselves for an increasingly digital, fast-paced world.

The need for consultants who bring with them a wealth of knowledge, experience, and new ideas has never been greater.

IR35 was not designed to stop the independent consultant marketplace from thriving, as long as the relationship between client and contractor is within the framework of the legislation.

The implementation of IR35 is far from perfect, but the answer to this is to ensure both client and consultant have a clear understanding of the steps they need to take to comply with the legislation and a clear process of recording how they take those steps.

In short, even in the face of IR35, the future of independent consulting is as bright as ever.

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