IR35 concerns for businesses, contractors and the economy

25 February 2020 5 min. read
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Beginning in April 2020, new changes to off-payroll working rules, commonly known as IR35, will be introduced. A key goal is to ensure that contractors who work through personal service companies (PSC) pay similar taxes to other employees. Xenios Thrasyvoulou CEO of freelancer management software below examines the potential impacts of the tax changes.

Around the world, history books are peppered with instances of well-meant but ill-conceived legislation. For instance, the 19th century law which stated that all automobile drivers must go no faster than two miles an hour and be preceded by a red flag-bearing footman. The initial philosophy was… if not laudable, at least well-intentioned; the implementation and outcome, riddled with flaws. With IR35 legislation fast-approaching, some are asking if it too could prove to be not fit for purpose.

What are the concerns relating to IR35?

The problem with IR35 isn’t so much that it’s a bad idea, but more that people simply don’t understand what it means or what they need to do. Forty-nine percent of business owners and 65% of freelancers admit to being uncertain about the full scope of IR35. There are still some grey areas which leave a lot of room for confusion and even with The Check Employment Status Tool (CEST) by HMRC there is still room for misinterpretation as it’s only correct 85% of the time, thereby wrongly placing a significant number of people within the scope of IR35.

IR35 concerns for businesses, contractors and the economy

So, what are the areas of concern for each of the different parties likely to be affected?

For SMEs

Small and medium sized businesses have come to rely on skilled contractors to support business growth. The ‘gig economy’ has led to an influx of freelance talent across virtually all sectors. This has been beneficial for the freelance contractors, the SMEs, and the economy as a whole. The concern now is that IR35 will restrict that. If freelance or contract work incurs greater costs it will become a far less appealing and viable option, leading to three potential scenarios:

  • Companies will either minimise their outsourced labour, thus reducing their potential for innovation and growth.
  • Businesses will be forced to review the contracts of their entire freelance workforce, again incurring significant legal costs.
  • Or, they will have to swallow the expense of taking on essential contractors on a permanent basis. Once again, impacting upon the business’ bottom line and capital available for expansion.

When IR35 legislation was applied to the public sector in April 2000, many Government departments took what appeared to be the easy route and placed the majority of contractors under IR35 by default, resulting in massive loss of skilled staff. According to one survey, 62% of businesses admitted[1] that this blanket approach was most likely to be the one that they adopt, viewing it as the most time- and cost-effective method of dealing with the problem.

For freelancers and contractors

Loss of income is the overwhelming concern for contractors and freelancers when it comes to IR35. The reasons for this are clear. If, as is thought, a significant number of businesses go for the blanket IR35 categorisation approach, affected contractors could face a 25% reduction in income. While other businesses will simply abandon the use of the freelance workforce until they can be certain that they are fully prepared to adhere to the legislation.

The upshot of this means that freelance workers would be forced to increase their fees to counterbalance the potential loss of earnings, which would make them a less appealing option for bootstring budgeteers. Or, to consider the easier path, they could return to full-time employment, where taxation is someone else’s problem and they get to enjoy regular benefits.

Either way, there is a significant potential for a loss of freelance talent in the UK in the coming months. Which leads to our third area.

“If IR35 leads to the loss of a buoyant freelance and contract marketplace, it will certainly also lead to a loss of economic value added.”

For the UK economy

It’s estimated that freelancers contribute around £109 billion to the UK economy, which generates an estimated £30 billion a year in “added value” to UK gross domestic product. At a time when the UK is already struggling to come to grips with the financial implications of ‘Brexit’ – and the postulated £1 trillion loss to the UK economy that it will bring as banks and financial institutes look to move their workforce to EU bases – that’s a figure that we can ill-afford to lose.

If IR35 leads to the loss of a buoyant freelance and contract marketplace, it will certainly also lead to a loss of talent and a loss of revenue. In that instance, a loss of growth and innovation will no doubt follow, weakening both the UK’s economy and its place in the global business hierarchy.

IR35 could cause minimal disruption if well-implemented. The fear at this stage is that lack of understanding could mean that that is not the case. And with HMRC only winning 50% of its cases against public sector contractors failing to comply with IR35 to date, it’s easy to see why confidence in the legislation is so low – and why IR35 could well end up being yet another well-meant but ill-conceived political pratfall.