The impact of the 2021 IR35 reforms

HMRC recently issued an update to their review of the 2021 off-payroll working reforms, commonly known as IR35, to assess the impact on the private and voluntary sectors.

The 2021 changes, which transferred the responsibility for determining IR35 status from contractors to the hiring organisations, have had a significant effect on businesses and contractors alike. While intended to ensure fair tax treatment, the reforms have sparked both opportunities and challenges for those affected.

The IR35 reforms, which came into effect in April 2021, shifted the burden of determining whether a contractor should be taxed as an employee (inside IR35) or as a self-employed individual (outside IR35) from the contractor to the engaging business where that business was a medium or large sized entity. This change affected contractors across various sectors, particularly those in industries like IT, engineering, and consulting.

For contractors classified as inside IR35, their clients were obliged to deduct income tax and National Insurance contributions (NICs), as if they were employees. This increased the tax burden for contractors, reducing their take-home pay significantly.

HMRC’s review of the reforms provides valuable insights into the immediate impacts of the changes and according to the report:

• Approximately 120,000 workers were impacted by the reforms.
• Businesses have made changes to the way they engage contractors since the reform, with many converting contracts to permanent PAYE positions.
• Businesses also admitted to adopting a more cautious approach, classifying contractors as inside IR35 to avoid the risk of non-compliance, even if they may have qualified as outside.
• For contractors, many report a decrease in their income due to the new rules, primarily because they are now classified as inside IR35 and unable to plan their remuneration as effectively.
• There has also been a steep reduction in the number of new personal service companies being set up, with HMRC estimating a reduction of 45,000 companies in the first year of the reforms.

The review also highlights that, while some businesses have adapted to the changes, a large number are still unsure of how to assess IR35 status accurately. This uncertainty is driving many businesses to either avoid hiring contractors or limit their use, especially in sectors that rely heavily on flexible work arrangements.

The importance of getting it right

With the stakes so high, both businesses and contractors must make sure they are fully compliant with the updated IR35 rules. Misclassifying a worker or failing to make a proper assessment can result in penalties, interest, and backdated tax liabilities.

HMRC estimate that, for those who moved to another organisation’s payroll around the time of the reform, the average annual increase in tax, NICs and Apprenticeship Levy paid by the worker, their PSC and their employer, or deemed employer was around £10,000 —and this cost is set to increase from April 2025 as the rate of Employers NIC rises to 15%. With £4.2 billion raised in additional payroll taxes to the end of March 2023 this is an area in which there is going to be continued interest.

Need help?

We are able to help businesses and contractors navigate the complexities of IR35. Whether you're a business trying to assess your contractors' status or a contractor looking for advice on your tax obligations, we’re here to guide you through the process. Please contact your usual Larking Gowen advisor on 0330 024 0888 or email enquiry@larking-gowen.co.uk. You can also find contact details on the Our People section of the website.

Tessa Brown