IR35 private sector reforms one year on: Assessing the impact on the UK’s tech talent pool

IR35 private sector reforms one year on: Assessing the impact on the UK’s tech talent pool

Before the IR35 reforms were rolled out to the private sector on 6 April 2021, speculation and debate were raging about the long-term impact the changes would have on enterprises’ ability to recruit the flexible IT talent they needed to deliver digital transformation projects.

Now, as the first anniversary of the changes coming into force approaches, this speculation has given way to anecdotal accounts and hard data that suggest enterprises are facing an uphill struggle when it comes to recruiting IT contractors with the reforms in place.

This is because the reforms ushered in changes that made medium to large private sector companies responsible for determining whether the limited company contractors they engaged should be taxed in the same way as salaried workers (inside IR35) or off-payroll employees (outside IR35).

Realising the reforms would markedly increase their administrative burden and compliance costs, many firms in scope of the reworked IR35 rules tweaked their hiring policies to try to minimise the disruption the changes would cause to their businesses.

In some cases, this meant enforcing hiring bans that prohibited the use of limited company contractors and instead favoured the use of freelance workers who provided their services through umbrella companies.

Other risk-averse organisations, however, opted to play fast and loose with HM Revenue & Customs’ (HMRC) calls for private sector organisations to use “reasonable care” when assessing the tax status of their contractors by declaring all of them to be working inside IR35.

This led to anecdotal reports of limited company IT contractors leaving companies in their droves, in hot pursuit of the shrinking number of outside-IR35 jobs available in the market – or in search of work abroad.

Before the Covid-19 pandemic prompted the UK government to delay the original April 2020 start date for the reforms by 12 months, Computer Weekly spoke to dozens of IT contractors about the impact the impending reforms were having on their livelihoods.

Impact of the delayed IR35 start date Despite repeated calls for the roll-out date for the reforms to be delayed, it was the onset of the Covid-19 pandemic that eventually prompted the government to confirm it was pushing back the start date for the reforms by 12 months to April 2021.

For the companies that had yet to start preparing for the reforms, this 12-month reprieve would have been most welcome, but for IT contractors working for firms that started enforcing hiring bans (or rolling out blanket determinations), the delay arrived too late.

That is certainly true for one contractor Computer Weekly spoke to, who specialises in the implementation of “multimillion-pound communications projects” in various vertical markets, and agreed to share her experiences of the IR35 reforms on condition of anonymity.

In response to her client – which operated in the oil and gas sector – rolling out a blanket ban on limited company contractors in late 2019, she resolved to shut down her limited company at the end of March 2020. “They banned all limited company contractors indiscriminately and without affording anyone the right to contest their IR35 status,” she said.

“Within two months of leaving, though, I was contacted about returning because they had so many people walk out in response to their attempt to force contractors to work through an umbrella.”

By the time the government announced the delayed start date, the contractor’s support staff had already served their notice, and she had ceased working for her client.

“My company ceased trading and my employees were let go, and the timing of the announcement about the delayed start date meant it was too late for me to rewind the decision to close down my limited company and keep them on, so I could put them on furlough,” she said.

The contractor is now on a long-term, full-time contract for the first time in her career, which has allowed her to avoid the “fallout and chaos” of the reforms going live. She also has no plans to return to contracting any time soon.

“In the communications sector, what we are seeing now are clients offering up to £200 to £300 per day less for people like me who are at the top of their game, and are typically brought in to lead on huge programmes,” she said. “And there are dozens of vacant senior roles out there in the market now.”

Many of the individuals that Computer Weekly spoke to at that time talked about how the contractor hiring bans had left them feeling “ostracised” and “demonised” by private sector hirers, and that it felt like the government had “declared war” on the self-employed.

Others talked about the difficulties they faced when trying to find work, as some private sector firms had sought to sidestep the reforms by outsourcing their digital functions to overseas firms, or were offering permanent or inside-IR35 roles that paid much less than they were used to.

Some contractors said the upheaval caused by the reforms had prompted them to consider moving overseas for work or take early retirement, fearful of the impact that IR35 would have on their ability to find work in the long run.

Another group said they might be reluctantly forced to take on an inside-IR35 position – or work for an umbrella company – because their family and financial situations were such that they could ill afford to turn down work. Others, meanwhile, said they would consider taking a permanent position for similar reasons.

Almost all of the contractors Computer Weekly spoke to at that time have since followed through with their plans, and the impact those decisions are having on the wider UK workforce can be seen in the employment statistics regularly published by the Office for National Statistics (ONS).

The ONS’s latest Labour force survey data shows that the number of payrolled employees hit a record high of 29.5 million in January 2022. This constitutes a year-on-year increase of 4.8% and equates to about 1.35 million people becoming payrolled employees since January 2021.

Included in this group would be any contractors who, in the wake of the reforms, opted to close their limited company to take on a permanent position or join an umbrella company.

On the flip side, the ONS data reveals that 793,000 people stopped identifying as self-employed between the first quarter of 2020 and the final quarter of 2021.

Number of contractors engaged through umbrella companies soars Blanket-banning private sector firms told contractors they could continue working for them if they agreed to shut down their limited companies and provide their services through a pay-as-you-earn (PAYE) umbrella company instead.

For the end-user organisation, the benefit of this is that umbrella company contractors are considered employees of these payroll-processing firms. This means private and public sector firms that rely on umbrella company contractors are no longer responsible for carrying out status determinations for these individuals.

It is difficult to say exactly how many contractors have moved to close their limited companies in the wake of the reforms. However, the 2022 House of Lords Economic Affairs Finance Bill Sub-Committee’s inquiry into the private sector roll-out noted a “concerning” uptick in the number of contractors employed through umbrella companies, post-April 2021.

HMRC made an admission, documented in the minutes from a meeting of the IR35 Forum members in June 2021, that supports this observation.

The Forum is overseen by HMRC and is concerned with finding ways to improve the way the IR35 rules are administered, with the help of external stakeholders. The June 2021 meeting, for example, featured input from the Association of Independent Professionals and the Self-Employed (IPSE), the Freelancer and Contractor Services Association (FCSA) and the Institute of Chartered Accountants in England & Wales (ICAEW).

During the session, a representative from one of the contracting organisations present said their members were now “in the main” engaged through umbrella companies.

HMRC responded by sharing data, accrued through its real-time information system that tracks the tax and other deductions taken by employers, that suggests the number of contractors engaged through umbrella companies has risen in the wake of the reforms.

“There are relatively low numbers using the RTI [Real-Time Information] indicator for an off-payroll worker at this point in time… which supports the anecdotal evidence that more contractors are moving to umbrella companies… rather than continuing to operate through personal service companies,” the IR35 Forum minutes state.

A further trawl through the employment-focused part of the annual population survey data published by the ONS and its NOMIS arm reveals a steady downturn in the number of self-employed people who categorise themselves as working in IT or telecommunications since April 2016 – 12 months before the IR35 reforms were rolled out to the public sector.

The data shows that in the 12 months from April 2016 to March 2017, there were 130,700 self-employed people working as IT and telecommunications professionals in the UK. This number fell to 116,000 during the 12 months to March 2018, which covers the period after the public sector reforms came into force.

This number has continued to fall, with the most recent cut of the data – spanning October 2020 to September 2021 – showing there are 97,700 self-employed people working in the IT and telecommunications sector.

The impact this is having on the ability of private sector firms to attract and retain high-quality tech talent was talked about by several contributors to a recently concluded inquiry into the long-term impacts of the government’s decision to extend the IR35 reforms to the private sector.

Overseen by the House of Lords Finance Bill Sub-Committee, the inquiry’s call for written evidence concluded in mid-November 2021, with the committee publishing 37 of the responses it had received from a mix of IT consultants, contracting-related trade body representatives, accounting specialists and employment law experts.

Although the final conclusions of the inquiry are yet to be published, much of the evidence gathered by the committee has been released into the public domain, with participants asked to share their take on the “behavioural effects” of the reforms in terms of how the new rules have affected the private sector’s approach to hiring contractors.

Evidence shared with the inquiry reinforces the view that blanket bans and blanket determinations are in common use across the private sector because firms are fearful of finding themselves embroiled in lengthy (not to mention costly) tax investigations at the hands of HMRC years later.

A side-effect of this behaviour is a marked downturn in the number of self-employed people now available in the market for private and public sector firms to hire – and a reluctance among those who remain to take on inside-IR35 roles or work through umbrella companies.

That is according to feedback shared with the inquiry by representatives from the Association of Professional Staffing Companies (APSCo), who specifically flagged the reforms as having a detrimental effect on private sector firms’ ability to attract top tech talent.

“Members across sectors such as IT… report that skills remain available – however, the rate and contract tenure need to be much more attractive to encourage workers to engage,” said APSCo’s feedback.

It also shared with the sub-committee feedback it had received from one of the tech industry’s “largest cloud specialist recruiters”, which said it sees contractors “consistently choosing” outside-IR35 roles over inside ones, while clients are now increasingly looking outside the UK to fill roles.

“Clients got used [during Covid] to remote working, bringing European and expat workers far more into play,” it said, “and I would say we are seeing clients almost view this non-UK talent pool place as far more attractive post-IR35”. 

Not another IR35 inquiry The House of Lords Finance Bill Sub-Committee inquiry into the toll the reforms have taken on end-clients and contractors since their introduction in April 2021 is a follow-up to a report it published in April 2020.

That inquiry concluded that the government should not extend the reforms to the private sector, on the basis that the IR35 rules are “flawed” and have “never worked satisfactorily”.

The report called for the government to call a halt to its plans to extend the reforms to the private sector so that the legislation could be revamped.

The April 2020 inquiry said one of the fundamental flaws with the IR35 legislation is that it treated an individual’s employment status as two separate things, from a tax and employment law perspective, which resulted in contractors bearing “all the risk” of their engagements.

It also accused the government of under-analysing the “behavioural consequences” of extending the reforms, and failing to grasp that some private sector firms might respond to their new-found responsibilities by introducing hiring bans or by making blanket status determinations.

Despite these concerns, the government pressed ahead with extending the reforms to the private sector in April 2021.

One of the inquiry’s respondents, Mark Brassington, who describes himself as an IT contractor with experience in hiring temporary workers for tech projects, said the reforms had made it harder for firms to recruit and retain freelance tech workers.

“It has resulted in hirers losing a lot of contractors – impacting their ability to get projects done on time,” he said.

IT contractors are not interested in working for companies that only have inside-IR35 roles on offer, and are seeking work abroad. Meanwhile, many of the affected end clients are outsourcing tech projects overseas to plug the skills gaps that have emerged since the reforms came into force, said Brassington.

“The UK is losing out to foreign companies who don’t have this [IR35] problem,” he added. “I am on both sides of the fence, and I currently have a number of offshore contractors who I hire offshore because the rules [on hiring contractors] are much simpler.”

This certainly tallies with the feedback of several IT contractors Computer Weekly has spoken to in recent months, all of whom had relocated overseas ahead of the reforms coming into force.

Incidentally, they all work for financial services companies based in mainland Europe, and agreed to speak to Computer Weekly on condition of anonymity.

The first is a database SQL specialist who has been contracting for 25 years, having previously carved out a living working as a contractor for a wide range of London-based financial institutions, many of which have since insisted that all contractors engage with them on an inside-IR35 basis.

If he remained in the UK and worked for his client on an inside-IR35 basis, the contractor’s take-home pay would be 40% lower – on account of being subject to the same income tax and national insurance deductions as a permanent employee.

“HMRC’s argument is that two people doing the same job should pay the same amount of tax, and if you know nothing about IR35 that probably sounds reasonable, but what it ignores is that all the risk of the engagement lies with the contractor,” he told Computer Weekly.

“It ignores the fact that contractors don’t jump from one contract to another. You have to provide your own pension, and you don’t get paid holiday or sick leave. All these things are covered for employees.

“On top of that, I am paying VAT and corporation tax, and I’m employing an accountant and taking out public liability insurance. And when you start adding all these things up and realise you’re going to be 40% worse off each month, you soon realise it’s just not worth it.”

The contractor left the UK before the original April 2020 start date for the reforms, fearing that the end of the Brexit transition period on 31 December 2020 would make it harder to relocate to Europe.  

“I feel I had to make a sacrifice for my financial wellbeing by leaving the UK, and if anyone asks me, based on my experiences, about working as a contractor in the UK, my advice would be, ‘Don’t do it’,” he said.

“All I can see is that the economy and opportunities for contractors will continue to shrink. Contractors don’t want to work inside IR35, and companies will get fed up with waiting around for people with the right skills to emerge. And that will encourage further outsourcing, which means more jobs leaving the country.”

In contrast, other countries are offering resettling incentives, in the form of tax breaks, as well as comparatively higher day rates to skilled workers.

A return to Europe The onset of the IR35 reforms, coupled with Brexit, has also prompted foreign IT contractors who previously relocated to the UK in search of work to return to their home countries, said another contractor, who specialises in mobile app development.

“Demand for developers with mobile development skills has got bigger and bigger in the past 10 years, and if you got in early, you were very sought-after,” he said. “Being a mobile developer in London meant your skills were in high demand, but most of the talent was not from the UK.

“And the reason that London is a tech centre in Europe is that it used to be the case that anyone could come here to work, and – on an outside-IR35 contract – it was a friendly tax regime. That all changed massively – first with Brexit and then IR35.”

The contractor added: “I used to know most of the people that I was up against [for outside-IR35 roles] in terms of talent, and they all said they would stay in the UK to make as much money as possible and then, when things went wonky, they would go home. A good friend of mine relocated back to Romania with £250,000 in the bank.”

Because of how few mobile developers there are and how in-demand his specific set of skills are, this developer now has several outside-IR35 projects on the go with different end-hirers, and claims to be banking “two to three times” the money he used to make before the reforms came in.

“I genuinely love what I do, and I can do it really fast, and what I’ve come to realise through being a contractor is that most companies are fundamentally inefficient, and I can do what they consider to be a lot of work in two hours a day,” he said. “I deliver exactly what people want and work three jobs at once.

“On the one hand, you could say the IR35 reforms are the best thing that ever happened to me, because I’m working three jobs at the moment and I’m earning £1,600 a day, but this isn’t sustainable long term, in terms of cultivating tech talent in this country.”

This IT contractor has no plans to leave the UK any time soon, but the fact that so much tech talent has left the country in the wake of Brexit and the IR35 reforms is concerning. Not just because it will make it harder for enterprises to fill specialist IT roles, but it could also have a stifling effect on the UK’s tech startup scene.

He added: “The consequence I’m most worried about is that we have lost a lot of IT talent over this, and, yes, I’m profiting because it’s supply-and-demand economics at the end of the day, but on a long-term basis, is London still going to be the tech centre of the UK?

“The chancellor has gone on record as saying he is very pro-tech, but he hasn’t realised that the talent you need to do that has now left the country. What worries me is what is going to happen in five years’ time? Yes, a lot of UK startups fail, but where will the ones come from that go on to make hundreds of millions of pounds?”

Tax incentives to stay abroad Another IT contractor Computer Weekly spoke to was already working in Europe for a client before the reforms took effect and had been weighing up a return to the UK. However, having found the job market to be noticeably more inhospitable post-April 2021, he decided to take up a position in the Netherlands instead.

“Post-reform, the working options that were open to me were very limited in the UK, compared to what I’d seen during my previous 16 years as a contractor,” he said. “There were no outside-IR35 contracts available at all, so I decided to stay on in Europe – especially as the amount I would make on an inside contract would be a lot less than I would make on an outside-IR35 basis.”

On top of that, the Netherlands has a scheme whereby skilled workers who relocate to the country on a temporary basis do not need to pay tax on up to 30% of their salary. This tax break expires after five years.

“It’s a big incentive to draw people to the country, and another reason for me to stay here or, conversely, another reason not to go back to the UK,” said the contractor. “I don’t imagine there is the same sort of incentive on offer for a Dutch person who is thinking about working in the UK.”

Why does IR35 cause a reduction in contractors’ take-home pay? The IR35 off-payroll working rules were introduced at the turn of the millennium to ensure contractors that provide services through intermediaries, such as limited companies or personal service companies (PSCs), are paying the correct amount of tax based on the work they do and how it is performed.

When the rules were first introduced, it was the intermediary’s responsibility to decide whether the nature of the work the contractor did for their end-client meant they should be taxed in the same way as a permanent employee (inside IR35) or as an off-payroll worker (outside IR35).

An inside-IR35 designation essentially means that if the contractor was providing their services directly to the client (and not through an intermediary), they would be considered an employee, and so must pay the same income tax and NICs that a salaried worker would.

On an inside-IR35 engagement, the intermediary would be responsible for ensuring the correct income tax and NICs were deducted from the contractor’s gross pay. The intermediary would also be liable to pay employer’s NI.

In recent years, the government has set about revamping the way the IR35 rules work on the basis that letting contractors decide how they should be taxed – and leaving it up to them to ensure the correct employment taxes are paid – is a system that is open to abuse.

In April 2017, HMRC introduced changes in the public sector so that responsibility for deciding how contractors should be taxed shifted away from intermediaries and onto the end-clients that engaged them. Similarly, responsibility for ensuring that the correct employment tax deductions were taken shifted onto the employment agency or umbrella company that paid the contractor’s PSC on inside-IR35 engagements. 

According to HMRC estimates, 180,000 individuals who work through their own PSC would be considered employees if they were engaged directly by their private sector end-clients.

HMRC also predicts that these changes will generate an additional £1.02bn in tax revenue during the 2021-22 tax year – and the bulk of the unpaid tax that HMRC is seeking to recoup through the reforms will be employer’s NI.

This is because when a limited company contractor is working outside IR35, they have the option to draw a relatively small salary from the business and make up the rest of their income in dividends. Employer’s NI is not payable on company dividends, but it is on salaried income.

Therefore, drawing a lower salary from their business gives contractors a way to minimise the amount of employer’s NI they have to pay.

As exemplified by the accounts of the contractors above, one of the major reasons why some contractors have sought work overseas is for financial planning purposes because of the uncertainty about how end-clients will respond to the IR35 reforms.

That is according to Thomas Wallace, director of tax investigations at London-based tax advisory WTT Consulting. Since the reforms were introduced, his company has seen a marked uptick in the number of contractors looking to liquidate their limited companies and set up shop overseas.

Dubai, Abu Dhabi and Cyprus are proving to be among the most popular destinations for contractors to move to, with Wallace citing the congenial tax regimes that all three countries operate.

“Abu Dhabi is a 0% tax country and is considered to be quite a westernised part of the United Arab Emirates, so is quite expat-friendly,” he said. “Cyprus has always been popular with UK expats and has a low tax rate compared to the UK, and it’s also a little bit closer to home.”

The pandemic has also prompted many contractors to rethink their working arrangements, said Wallace, and embrace a more “nomadic existence” when seeking out new work contracts.

“There will be governments that will almost bid for people to come to their shores, and you will start to see more incentive schemes like the one in the Netherlands that will say, ‘We will give you tax breaks for x number of years if you’re in any number of trades,’ because they see the benefit of people coming over and contributing to their economy,” he said.

This could have dire consequences for the UK economy from a tech skills perspective by exacerbating and accelerating the “brain drain” that IR35 appears to have kick-started.

“You can look at it two ways,” said Wallace. “This is, on the one hand, exactly what the UK government wants. They want to push people away from pursuing this entrepreneurial, self-employed-type existence by putting everyone on payroll and taxing them at source.

“On the other hand, you could say this is truly short-sighted and actually, while trying to plug the tax gap that Covid has created, this is driving people out of the economy, and probably creating a larger hole in the budget [for the government].”

Has the bounce-back begun? Concerns about the long-term impact the reforms will have on the availability of tech talent in the UK could be considered a little alarmist, given the reports of some firms backtracking on their previous decisions to enforce blanket bans on contractors.

Anecdotal accounts from contracting stakeholders suggest that U-turns of this nature began within months of the private sector reforms coming into play, based on feedback shared during a June 2021 meeting of the IR35 Forum.

The forum is overseen by HMRC and is concerned with finding ways to improve the way the IR35 rules are administered, with the help of external stakeholders. However, as the minutes from the June 2021 meeting show, there was some scepticism at the time about whether this trend was playing out or not.

“There were anecdotal reports of some organisations U-turning on blanket bans, but [the member who raised this] wasn’t sure if this was really the case,” the minutes stated.

On this point, Dave Chaplin, CEO of compliance assessor IR35 Shield, said his firm had seen an uptick in the number of private sector organisations requesting help with reassessing the employment status of the contractors they work with, which is indicative of U-turns taking place.

His company specialises in providing software that enables enterprises to assess the IR35 status of their workforce, while also gathering evidence about the steps they need to take to ensure ongoing compliance with the IR35 rules. 

Chaplin told Computer Weekly that there are signs the market is starting to respond to the fallout from IR35, with many firms that resorted to issuing blanket bans now looking to reverse those decisions.

“We are being approached by firms that are saying they can no longer simply ban contractors because it makes them uncompetitive compared to firms that have compliance mechanisms in place to hire off-payroll contractors,” he said.

Matt Fryer, head of legal services at IR35-specialising law firm Brookson Legal, said his firm has carried out “tens of thousands” of IR35 contractor status reviews for its clients and about 70% of those have returned an outside-IR35 result.

This is one of the reasons why firms that took a blanket approach to IR35 determinations have typically lost contractors – and may have found it difficult to recruit new ones to replace them.

Conversely, private sector firms that used the 12-month delay to the start date of the reforms to hone their compliance strategies are reaping the rewards now, said Fryer.

“These organisations have educated their businesses in what good looks like from an IR35 compliance perspective, and have changed how they manage their contractors and recruit new ones into the business because they understand what an outside status determination statement looks like,” he said.

Read more about IR35 Contractors working for public sector bodies that have fallen foul of the IR35 rules could be entitled to a pay-out from HM Revenue & Customs, it has emerged. HM Revenue & Customs’ “haphazard” handling of the initial roll-out of the IR35 reforms to the public sector contributed to high levels of non-compliance by government departments, resulting in some being hit with multimillion-pound tax bills. Another sign, perhaps, that firms are reconsidering their IR35 compliance procedures is the bounce-back in volume of outside-IR35 roles market watchers claim to be seeing now.

Ricky Whitfield, founder of the Outside IR35 Roles website, which advertises currently available outside-IR35 roles on behalf of recruiters and end-hirers, said his site has tracked a rise in the number of off-payroll opportunities over the past 12 months, which he expects to increase into the coming tax year.

“With a lot of the inside-IR35 roles being 12 months [in length] and contracts coming up for renewal at the end of March/early April, I think we will see more resistance [from contractors about accepting inside-IR35 roles] now, whereas last year, Covid caused a lot of uncertainty and concern from a financial point of view,” Whitfield told Computer Weekly.

“More contractors will be looking to move on, and then this should start more of a domino effect. So I am confident we will see an increase in the number of outside-IR35 contractors over the next 12 months.”   

Similarly, IR35 compliance and insurance consultancy Qdos published research at the back end of 2021 that noted a surge in the number of contractors working outside IR35 eight months on from the private sector reforms coming into force.

The company polled 1,248 contractors, and 64% of them said they had managed to successfully secure an outside-IR35 contract, while only 35% of them had been placed outside by their end-client in the lead-up to, and arrival of, the private sector reforms in April 2021.

At the time, Qdos CEO Seb Maley said the increase in contractors securing outside-IR35 roles could be interpreted as a sign that businesses were starting to manage the reforms in a more “pragmatic way” – with fewer forcing their contractors onto payroll.

Maley told Computer Weekly he imagines the number of contractors who have secured outside-IR35 roles has only increased further since the Qdos research was made public.

“Many [firms] are reversing ill-thought-out contractor bans,” he said. “One year on is a good opportunity to take stock and reflect on how things have played out. It’s no secret that IR35 has caused major disruption not just for contractors, but also businesses – plenty of which are clearly still struggling to make accurate IR35 status determinations.

“However, speculation – and in some cases needless scaremongering – that IR35 reform would end contracting as a way of working are way off the mark. True, we still have some distance to go until the market fully recovers, but contracting outside IR35 is still very much a possibility as more businesses get to grips with the changes.”

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