Too bad, contractors: UK government reverses decision to axe IR35 tax reform

Latest U-turn follows a series of clown-car maneuvers that spooked financial markets

The UK government has reversed its decision to axe IR35 tax reforms — announced little more than three weeks ago — following a volatile market reaction to its planned tax cuts.

Among a package of tax cuts, the move to cancel IR35 tax reforms — controversial measures which mean fewer contractors can claim work outside employee status — was announced on September 23.

But today, Jeremy Hunt — who replaced Kwasi Kwarteng as chancellor of the exchequer on Friday — announced he planned to reverse most of the tax cuts introduced in the so-called mini-budget, a humiliating U-turn for the government. His plans include reversing the repeal of IR35.

"A central responsibility for any government is to do what is necessary for economic stability," said Hunt, following the financial markets' negative reaction to the "mini-budget".

Matt Fryer, MD of accounting firm Brookson Group, said: "Uncertainty isn't helpful for hirers or contractors, particularly in today's economic climate. At least retaining the current off payroll working rules takes us back to the position we were in a few weeks ago and gives us a bit of certainty. However, it is clear now that the government acknowledges the current rules aren't working as expected.

"If the rules stay in place exactly as they are, more needs to be done by HMRC in terms of education and support for the entire flexible labour market," he said.

IR35 reforms were introduced for businesses in April 2022 following a year's delay caused by the COVID-19 pandemic. They put the onus on determining tax status on employers, some of which were unwilling to accept the risk and put blanket bans on the use of contractors. The rules were introduced in the public sector in 2017.

IR35 reforms had proved challenging for the government's own departments, which owed, or expected to owe, the UK tax collector £263 million (c $298 million) in 2020–21 due to incorrect administration of the rules, a report from Parliamentary spending watchdog the Public Accounts Committee said.

What is IR35?

IR35 is a reform unveiled in 1999 by the UK tax authorities. The latest regulation change – which came into force in April 2021 – forced medium and large businesses in the UK to set the tax status of their contractors and freelancers. Previously this was set by the contractors themselves.

Contractors found to be within the scope of the legislation – i.e. inside IR35 – will have to pay more tax than they might expect.

The reforms are part of the government's crackdown on so-called disguised employment, where workers behave as employees and are able to slash their tax bills by billing for their services through Personal Service Companies (PSCs), which are taxed at lower corporate rates.

The measures first came into effect in the UK public sector in 2017. The British government hoped the reforms would recoup £440 million (c $486 million) by bringing 20,000 contractors in line.

HMRC reckons that only one in 10 contractors in the private sector who should be paying tax under the current rules are doing so correctly. It estimates the reforms will recoup £1.2 billion (c $1.33 billion) a year by 2023. Both public and private sector reforms had been set to be repealed before today's U-turn. Now both are back on the books.