Q&A with Remote’s Roderick van Vliet on the new IR35 regulation

Roderick van Vliet is Head of Legal at Remote, a European HR solutions startup that makes it easier for companies of all sizes to employ global teams. Speaking to Consultancy.uk, Roderick explains how the new IR35 regulation in the UK, which came into force in April, will impact the employment status of thousands of workers and affect hiring practices in the foreseeable future.  

How SMBs will be impacted by IR35?

IR35 is a tax legislation designed to prevent “disguised” employment, where businesses engage workers on a self-employment basis, generally in order to pay less tax or even circumvent employee protections. The changes to IR35, which were meant to come into force in April 2020 but were delayed by 12 months because of the pandemic, meaning that it is now the responsibility of private companies such as SMBs to identify the IR35 status of their contractors – and whether they should be paying the same tax and national insurance contributions (NIC) and receive the same contributions as regular workers. 

The intentions behind IR35 are positive: the government wishes to address a perceived unfairness in the labour market, protect workers and increase tax revenues. But in practice, the biggest impact of IR35, especially on SMBs, will be increased costs as businesses must spend more time and money on formalising work relationships with contractors. 

Most SMBs are likely to be unaffected by IR35. If the client is a small company, the contractor will be responsible for assessing whether IR35 applies. The Companies Act 2006 defines a company as a small business if it has at least two of the following features: turnover of £10.2 million or less; a balance sheet total of £5.1 million or less; or 50 employees or fewer.

However, if a contractor falls within the scope of IR35 – for instance, because a business employs them on an ongoing basis, or offers them benefits such as paid leave or sick pay – they are deemed an employee for tax purposes. The company will need to deduct income tax and employee NIC from payments to the contractor’s limited company and pay employer NIC to HMRC.

However, the deemed employee is not automatically entitled to employment rights. This means that the worker gets all the disadvantages of being an employee without the advantages. Rather than solving an issue of inequality, IR35 may simply put workers at risk for significant costs. 

Prior to IR35, using contractors was an easy way to hire a talented worker for a specific project, now employers will need to put more effort in order to get help with short-term project-based work. 

What options are available to SMBs affected by IR35?

It is a priority for businesses of all sizes to assess their relationships with contractual workers to determine which are working on a project basis – and so can continue working as contractors – and which are working similar to regular employees. 

SMBs could look to hire contractors employed by an umbrella company, instead of contractors operating their own limited company. We are likely to see a rise of umbrella companies, which employ workers who are then hired out to work with businesses on a temporary basis.

This is a practical solution that will enable businesses to continue working with contractors in the UK without bumping into the IR35 issue. However, it may mean that contractors continue working for an employer without reaping the benefits of being a full-time employee. Alternatively, what the UK and foreign businesses could consider is hiring the persons as employees via Employer of Record (EOR) services, which means a third party takes care of the payrolling, benefits, taxes and compliance, and circumvent the IR35 issue altogether. 

Some businesses may decide not to work with contractors at all, and just hire employees full-time. I understand that it can be a difficult decision to hire an employee when extra support is needed only with a specific project, and companies may be wary of the increased costs and paperwork that this involves. However, there are specialist service providers that can help with employing people.

How have other European countries dealt with similar legislation?

Elsewhere in Europe, similar legislation has been tried before which aimed to address the issue of contractors, but usually it hasn't worked out as planned. The Netherlands, for instance, changed its legislation regarding the misclassification of contractors in 2018 but ended up putting in place an enforcement moratorium because it created too much legal uncertainty for companies and contractors. The law was replaced last year.

IR35 runs the same risk, as the classification of in or out of scope is checked afterwards, exposing parties to the risk of misclassification.

It is worth highlighting that IR35 legislation is not unique – in many countries, if you want to be a contractor, you need to act as an independent company. That's a very logical solution. You should either have your own business or be part of a company as an employee. 

How does the gig economy feed into the legislation?

It is highly likely that part of the reason IR35 was drafted in response to the gig economy, which allows employers to hire workers on a highly flexible basis, without the risks and costs of permanent employees. 

Using contractors is fine and above board when people are hired on a project-by-project basis. But the gig economy implies workers are hired on an on-going basis, without the benefits or protections of permanent employment. That’s a prime example of corporations using contractors for the wrong purpose: it's cheap labour, there are complaints about work pressures, and workers may end up in unhealthy situations. IR35 is a new solution to this older problem. 

Will IR35 make the UK quite unattractive for certain jobs and limit access to the talent pool?

While IR35 mainly focuses on domestic companies hiring local contractors, it also applies to foreign companies hiring local contractors. This latter category is unable to employ those contractors as employees because of the lack of local presence and understanding of the local market. The risks created by IR 35 for foreign companies to hire local UK contractors, that those are deemed employees, may disincentive foreign companies to work with UK contractors. 

IR35 may make the UK quite unattractive for certain jobs. For instance, if a country struggles to hire engineers, companies abroad will make it possible to contract there. This could see an exodus of talent moving to other countries. On the other hand, it could increase competition, or offer the opportunity for international companies to generate revenue via outsourcing contractors and services. Overall, the market will adjust.

On the lower end of the job range, where IR35 is supposed to have a positive impact, you may expect companies to circumvent the rules via umbrella companies or other structures and keep underpaying their cheap labour workforce. 

What impact will this legislation have on overseas businesses trying to hire contractors in the UK, or UK businesses hiring contractors overseas?

IR35 could make it harder to hire contractors internationally. This is poor timing by the government: in today’s digital cross-border world, remote workers can be based anywhere, so making it harder to hire them is counterproductive. 

Fundamentally, businesses hire contractors instead of full-time employees because it can work out cheaper. If governments do not understand the mechanics behind this decision-making process, then they are just trying to address a symptom, not fighting the cause. And that never works. 

So, what should governments do instead? Rather than placing the burden on companies to assess the status of their employees through IR35, the solution is to bring the government check to the front. For example, this could be done by standardising contractor arrangements that are out of scope of IR35. Next to this, the causes of unwarranted use of contractors should be addressed by reducing the cost difference between contractor and employee.

Overall, I am more in favour of having employees compared to contractors – I think it’s better for both parties. At the end of the day, businesses need a talented and stable workforce and employees receiving their rights and benefits. It can be much easier to hire whoever you need through a specialist company that deals with all employment issues, including law, taxes, and HR. Post-pandemic, the labour market requires new ideas and solutions, not new tax legislation.