The case against IR35
IR35, introduced in 2000 and significantly tightened in 2017 and 2021, purports to tackle ‘disguised employment,’ contractors who work like employees but structure themselves as limited companies to reduce their tax burden. The case against it is substantial.
It taxes hypothetical income because IR35 deems a contractor to be an employee for tax purposes even when no employment relationship actually exists. The contractor has no employment rights, no sick pay, no holiday pay, no pension contributions from the ‘employer,’ yet is taxed as though they were an employee. They bear all the burdens of employment tax with none of the benefits.
It creates crippling uncertainty because the tests for IR35 status, such as control, substitution, and mutuality of obligation, are notoriously ambiguous. HMRC's own Check Employment Status for Tax (CEST) tool gives indeterminate results in a large proportion of cases. Contractors and the firms that engage them cannot know with confidence which side of the line they fall on, and the cost of getting it wrong is enormous: back taxes, interest, and penalties.
Off-payroll rules shift liability perversely. Since the 2017 and 2021 reforms to public and then private sector engagements, the determination of IR35 status was transferred to the end client. Risk-averse companies responded not by making careful assessments but by blanket-banning limited company contractors entirely, a crude, administratively convenient response that destroyed the market for genuine independent professionals.
It suppresses a legitimate and economically valuable labour market. Genuine contractors, those who work for multiple clients, take on commercial risk, invest in their own equipment, and are genuinely in business on their own account, provide the flexibility that the economy needs. IR35 makes this model fiscally unviable for many, pushing skilled workers either into permanent employment (reducing labour market flexibility) or pushing them out of the UK altogether.
It damages British competitiveness because the UK tech, engineering, and financial services sectors depend heavily on specialist contractors. Tightened IR35 has accelerated the departure of highly skilled workers to jurisdictions with more rational contractor tax regimes, including Ireland, the Netherlands and Portugal, at precisely the moment Britain, post-Brexit, needed to demonstrate it was a nimble, attractive place to work.
And the revenue gains themselves are modest and disputed. HMRC's estimates of the tax gap from IR35 non-compliance have repeatedly been questioned. The compliance costs imposed on businesses, including legal fees, HR overhead, and contractor management restructuring, are real and substantial, and largely unaccounted for in HMRC's arithmetic. When these are included, the net fiscal benefit becomes far less impressive.
IR35 penalises the prudent. Many contractors structure themselves as limited companies not primarily for tax advantage but for liability protection, professional credibility, and commercial flexibility. IR35 treats this entirely normal business practice as presumptively suspicious.
The underlying problem is that the boundary between employment and self-employment in British law is genuinely unclear, a legacy of decades of piecemeal legislation. IR35 does not solve this. It papers over it with a punitive tax measure while leaving the underlying definitional chaos intact. A rational system would reform employment status law directly rather than imposing a parallel tax regime to catch those who exploit the ambiguity.
The Adam Smith Institute has long argued that the right response to blurred employment boundaries is clarity in law, not complexity in taxation. IR35 is a characteristically British solution. Instead of fixing the problem, it makes the consequences of the problem more expensive. Its days are numbered, and if this government does not rescind it, the hope must be that the next one will.
Madsen Pirie