Hidden costs of IR35 continue to be ignored by HMRC

Whether the taxman knows that IR35-affected contractors are being asked by us to help with some off-payroll working research, HMRC on Thursday published its own research.

It is an unscheduled update into the impact of IR35, writes Andy Chamberlain, director of policy at IPSE, The Association of Independent Professionals and the Self-Employed.

IR35 = Off-Payroll Working (OPW) rules

Specifically, the HMRC research deals with the impact of the IR35 reforms in the private sector since April 6th 2021.

It’s technically more accurate to refer to these reforms as the ‘Off-Payroll Working’ (OPW) rules. But because many hirers, agencies and others conflate ‘OPW’ with IR35, and because ContractorUK readers broadly know what I’m referring to, I’m going to stick with the old moniker -- ‘IR35’.

HMRC’s 'updated impacts of 2021’s OPW rules' is another teeth-grinder

 A full and forensic read of HMRC’s IR35 impact report, snappily entitled “Update to the impacts of the 2021 off-payroll working rules reform in the private and voluntary sectors,” is on my to-do list for tonight.

But based on a reasonably thorough scan, and not for the first time with government-commissioned IR35 reports, I already find myself grinding my teeth in annoyance at the whole focus, tone, and thrust of this HMRC report.

IR35’s £4.2bn yield, and two other key findings

The six-part document from the Revenue looks at everything through the lens of the UK’s bottom line measured, in this instance, by the taxman claiming he's better off to the tune of £4.2billion.

HMRC further claims that there are fewer ‘PSCs’ (Personal Service Companies) being incorporated since the April 6th 2021 reforms; some 45,000 fewer. And it says there are more people on PAYE than there were previously, including a significant rise in the use of umbrella company payrolls.

Painting IR35 as a success

All of these findings from HMRC are reported with textbook civil service neutrality.

Yet it’s difficult not to infer that these three headline consequences of IR35 are broadly to be considered ‘good’ news by HMRC.

The report might as well say that the Revenue’s evidence indicates the OPW rules have been a ‘success,’ in policy terms.

Actually, OPW has been a disaster

From another perspective – that’s the perspective of what’s happening in the UK labour market ‘on the ground,’ the OPW rules have not been good news at all.

Far from being a success, the IR35 policy since April 6th 2021 has actually been a disaster (except perhaps for umbrella companies). Just ask UK organisations, private sector employers, agencies, and contractors themselves.

The report also fails to acknowledge the very negative impact on the UK’s economic growth.

£4.2bn in tax raised – but is all £4.2bn of it actually owed?

Let’s start with the figure of £4.2bn that the report trumpets, three times.

HMRC says: “We estimate an additional £4.2 billion has been generated in tax revenues overall in the period October 2019 to March 2023 as a result of the reform. This is based on those workers who have moved to another organisation’s payroll because of the reform or have been deterred from working through a PSC during the period October 2019 to March 2022.”   

So the £4.2bn is the net impact of more payroll tax (income tax, both sets of NI and Apprenticeship Levy), and less corporation tax, tax on dividends, between October 2019 and March 2023.

HMRC saying £4.2bn has been raised by IR35 has two big problems

There are two big problems with this £4.2bn figure – the figure HMRC is using to imply IR35 has been a success.

Problem one. It’s almost impossible to imagine that HMRC is technically entitled to all of that £4.2bn.

The stated purpose of IR35 changing four years ago was to improve compliance with the existing rules to tackle disguised employment, but as anyone close to the contractor market will tell you, what we have now is huge over-compliance.

Hirers are terrified of getting IR35 wrong and constantly frightened of being left with a big tax bill from HMRC. So they take the path of least risk and force every contractor who gets vaguely near their operations to pay employment taxes. And HMRC, please note, – that forced employment occurs even where it might be abundantly clear to the end-hirer that it’s not appropriate to do so.

Problem two

Problem two with HMRC’s implied success figure? It’s not clear that all the impacts of IR35 have been considered before arriving at the £4.2bn figure.

For example, our organisation has been inundated with anecdotal reports of clients offshoring projects due to IR35. It’s work intended for the UK that’s instead being done in other territories, by non-UK taxpayers at the expense of the British taxman.

There’s also more work being done by UK contractors for foreign companies outside the UK. Those individuals will be paying tax here, but the companies they work for won’t be paying tax to HMRC. It appears this activity has not been factored into the overall £4.2bn ‘positive impact’ IR35 has had.

‘Fewer personal service companies.’ A good thing?

The finding from HMRC that there are fewer ‘PSCs’ being incorporated is unsurprising.

HMRC says: “We estimate around 45,000 fewer new PSCs formed around the time of the reform, up until the end of March 2022, compared to what we might have expected to happen based on historical trends.”

Let me translate. The IR35 changes have made working with contractors who run their own limited company (which is what a ‘PSC’ actually is) much less attractive to hirers.

Is this dip of 45,000 individuals running their own one-person business a ‘good thing’?

Let me answer it this way. Before IR35 came along, limited companies were the best vehicle we had in the UK for business-to-business activity.

The boon that was the UK limited company model

As a model, the UK limited company protected end-clients from tax liabilities and potential employment rights disputes, and they protected the personal assets of the directors -- in the event the company got into hot water.

The mutual protection afforded by incorporation gave businesses the confidence to enter into contracts with one another. Having fewer limited companies equates to less business being done, which equals less economic activity, which is disastrous for UK growth.

Little wonder that the respected Public Accounts Committee has raised concerns about IR35 ‘deterring legitimate economic activity.’

An HMRC IR35 impact report that has UK fiscal impact blinkers on

 Almost needless to say, there’s no appetite from HMRC to even acknowledge that worrisome finding, let alone face up to the impact IR35 has had on UK economic growth in their so-called ‘impact’ report.

Where have all the people gone that would otherwise be incorporating limited companies?

Well, according to the HMRC report, they’ve gone onto payrolls. This conclusion is consistent with the big rise in payroll tax receipts. While payroll means people are being taxed as employees, that doesn’t necessarily mean they are employed in the traditional sense. HMRC estimates that 31% of those who moved onto payroll around the time IR35 changed in 2021 went into recruitment agencies or umbrella companies.

Three problems with the rise of umbrella companies

Compliant umbrella companies deduct and pay the tax that HMRC wants, but lots (not all) of the people that umbrellas ‘employ’ don’t want to be using them.

There have been problems with umbrella company workers:

• not receiving the holiday pay that they are entitled to;
• not being able to use the pension scheme they already have set up,
• suffering from a lack of transparency around tax deductions on payslips.

Some people are content in their umbrella company – it’s important to not lose sight of this fact. But many other contractors do not like umbrella working, yet they are forced to use a brolly because of IR35.

‘Quasi-employment?’ It’s not exactly very Labour

A Labour government that purports to care about the wellbeing of the workforce should be concerned that IR35, as a policy on its statute book, is pushing people into a form of ‘quasi-employment.’ It’s employment that a significant chunk of people haven’t chosen and are unhappy with.

Nevertheless, the umbrella companies are a solution for supply chains that now have to deal with IR35’s fallout.

When done right, umbrellas are a tax-compliant solution.

However, umbrellas operate in an unregulated sector and, as the HMRC report correctly highlights, there have been problems with tax avoidance schemes at the non-compliant end of the market.

Disguised Remuneration schemes are finally on the backfoot

The report states that disguised remuneration schemes are less prevalent.

In response to the specific issue of umbrellas, the government intends (from April 6th 2026) to prevent umbrellas from being responsible for their own payroll.

This regulatory move against umbrellas is likely to throw another spanner in the works for how IR35 will operate in the future. But that’s a topic for another article!

The real impact of IR35 (is what HMRC seems to continually not face up to)

What HMRC doesn’t explore, or even acknowledge in this IR35 impact report are the numerous but more hidden, largely negative impacts IR35 has had, and is continuing to have.

We’ve already mentioned the issue of big firms offshoring work from the UK. Add to that, the IR35 compliance costs that hirers now have to wrestle with; the insurance costs for agencies that typically have to shoulder the risk, the opportunity costs for businesses that can no longer hire flexible talent, and sadly, the dearth of innovation and enterprise that springs from a no longer truly unshackled freelance sector.

The real impact of IR35 -- the off-payroll working rules -- is that it is suffocating a sector of our economy that was actually doing well, and that was helping other key sectors of the UK to thrive too. Unsurprisingly, HMRC’s report doesn’t face up to that either.