IR35 timeline: how it has changed since it came into force in 2000

Following his previous explainers on IR35, Danny Batey, senior tax consultant at Markel Tax, now plots the chequered history of IR35 from the legislation’s conception in 1999 to the present day furore over its contentious reforms.

Please note, this article is written before Autumn Budget 2022 on November 17th, which could add another twist or turn to the already bumpy journey of the IR35 off-payroll rules, or the Intermediaries legislation.

IR35: A new framework to tackle disguised employment (1999/2000)

The Inland Revenue had long perceived a problem of ‘disguised employment’ – its term for contractors being paid to undertake the same work as employees, but benefitting from a less taxing regime by operating through their own limited company or ‘personal service company’ (PSC).

In April 2000, the Intermediaries legislation was introduced as the taxman’s response. First tabled in 1999 by then-chancellor Gordon Brown of the Labour party, the legislation requires the creation of a ‘hypothetical contract’ by asking the question:

‘If the individual worker was engaged directly by the end-client; what would that relationship look like?’

The answers can only be ‘Employment’ i.e. Inside IR35, or ‘Self-employment’ i.e. Outside IR35.

The early years: HMRC’s uphill struggle after winning Dragonfly in 2008

Initially, there was sufficient IR35 enquiry activity by HMRC – including notable successes such as the Dragonfly case, with its then-newsworthy £99,000 assessment. The case made contractors sit up and take notice, becoming genuinely concerned about the risks of IR35.

However, the tables turned. The limited company contractor population increased, only for the number of HMRC enquiries to fall dramatically -- from over 1,000 in the earliest years, to around 250 on average 10 years later. There were only 12 IR35 investigations in 2010/11!

At around the same time, HMRC began losing too many enquiries. A House of Commons Research briefing noted that: “In 2011/12 around 10,000 people paid tax under IR35, an estimated 10% of those who should have paid tax on at least part of the income their PSC receives under the legislation.”

The HMRC fightback begins: mid-2011

Unsatisfied, in June 2011, HMRC introduced the IR35 Forum to make improvements to the way in which IR35 was administered.

The forum was conceived a few months earlier in March as a useful mechanism for HMRC to publish its intentions with feedback from industry, but perhaps it was not the two-way information flow that was wanted by the contractor industry.

In 2012, HMRC created “specialist” IR35 teams; its compliance activity increased, but tax offices were never fully staffed, and so it didn’t have much bite.

Business Entity Tests were introduced in April 2012, supposedly to help contractors test their risk of HMRC investigation, but after only two years, the ‘BETs’ were abandoned under a torrent of criticism.

Then, in July 2012, we saw the creation of a new IR35 enquiry process commencing with the issue of a ‘Check of Employer Records’ letter, which asked if the taxpayer had considered whether IR35 applied to their engagement(s).

Contractors would then – with independent specialist assistance – review contracts and working practices to formulate an initial response to HMRC.

In the initial enquiries, HMRC seemed to accept around one-third of the responses and closed the enquiry. But it didn’t take long before HMRC returned to type and moved routinely to an enquiry phase, requiring the end-client’s view on matters. Inevitably, IR35 enquiries returned to the long, drawn-out affairs.

The clampdown on contracting intensifies: 2012 to date

From mid-2012 onwards, a disproportionate number of IR35 enquiries into public sector engagements played out, as well as the introduction of the requirement for contractors to provide ‘tax assurances’ to the government bodies with whom they were engaged.

Further restrictions to the benefits of PSC contracting were introduced in 2013:

• Align tax treatment for ‘office-holders’ confirming them as automatically inside IR35 for tax purposes .
• Contractors inside IR35 no longer able to claim travel and subsistence for their commute.

Not specifically IR35-related, but nevertheless, similarly making PSC contracting less attractive, we saw:

• A toughening of dividend tax rules
• Adverse changes to the VAT Flat Rate scheme
• Restrictions to Business Asset Disposal (formerly Entrepreneurs’) Relief

The next big change in IR35’s bumpy journey came on April 6th 2017.

Public sector off-payroll working reform, 06.04.17

The responsibility for determining IR35 status shifted in the public sector on 06/04/17 from contractors to the taxpayer-funded bodies engaging them, entirely replacing the ‘assurance process.’

This new off-payroll framework introduced the concept of the ‘fee-payer’ -- the party physically paying the PSC and which, from now onwards in the public sector, assumed liability to HMRC.

So quite suddenly (and be aware, HMRC has been widely criticised for rushing the implementation of the framework), the contractor had no decisions to make, no liability and no control over their IR35 status.

These 2017 Off-Payroll Working rules (or ‘OPW’ rules) were quickly deemed a success by HMRC – at odds with the conclusion that the labour market reached and continues to reach. There was further disquiet. Notably, since 2018, a number of government departments have had to pay over a quarter of a billion pounds to HMRC for IR35 compliance failures, very often because they used (but misapplied) HMRC’s own IR35 status-testing tool, which the tax authority offered taxpayers to help determine IR35 status in March 2017, ‘CEST.’

Unfortunately, the tool (‘Check Employment Status for Tax’) has been widely criticised ever since, partly because it doesn’t test for Mutuality (a key IR35 status factor), and partly because it can’t reach a conclusion in upwards of 15% of cases.

But not one for accepting criticism, HMRC ploughed on. Indeed, many onlookers said it was only a matter of time before the private sector would face similar reform of IR35, now that the public sector had its own new, shiny, HMRC-approved solution.

Private sector IR35 reform, 06.04.21

Initially scheduled for April 2019, but postponed twice and only introduced quite recently on April 6th 2021, the OPW reforms in the private sector have added greater transparency to IR35 decision-making. But the framework (which today mirrors the public sector framework bar a carve out for ‘small’ commercial end-users), has had a well-documented, largely negative impact on contractors.

Seeming to recognise the harm caused, in August 2022, the then-foreign secretary Liz Truss said she would review IR35 if she became prime minister.

On September 23rd 2022 at Mini-Budget, the Liz Truss-led government finally seemed to accept the many IR35 criticisms of the past, including those levelled by the House of Lords, the National Audit Office and the Public Accounts Committee, by saying it would outright repeal both the public and private sector IR35 reforms. The government publicly acknowledged in the House of Commons that the reforms to IR35 had “added unnecessary complexity and cost for many businesses.”

But the hopes of PSCs that the legislation of 2000 would return, putting them back in the IR35 decision-making role, in place of the unwieldy IR35 reforms of 2017 and 2021, were quickly dashed.

Only a few weeks later, because Mini- Budget sent the markets into meltdown for containing £40billion in unfunded tax cuts, the majority of its contents – including the revocation of IR35 reforms – got shredded. This shredding was done by the current chancellor Jeremy Hunt.

In fact, on October 17th 2022, Mr Hunt announced the IR35 reforms of both April 2017 and April 2021 would be staying, and he said so in a televised statement to the nation. Not bad coverage for a tax rule recently categorised by a BBC presenter as too “niche” to even warrant talking about!  

The future of IR35

A repeal of the IR35 reforms now seems highly improbable. People will no doubt call for the reforms’ revocation, or even the Truss-promised IR35 review, ahead of Autumn Statement on November 17th 2022.

More likely is a turning of the screw by HMRC which surely will at some stage consult to remove the ‘small’ company exemption (mentioned in the previous section). This would add to small company red tape, but would certainly make IR35 decision-making more transparent. Unfortunately, virtually all PSC contractors would lose control over their IR35 status, and those limited company suppliers whose clients are neither large nor mid-sized can only hope that their customers embrace the legislation sensibly and without risk-aversion.