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Down but certainly not out: IR35 will hinder vital economic growth post-coronavirus

Across the world, economies are suffering from the spread of the coronavirus. In the UK alone, nearly 20 percent of small and medium sized businesses are unlikely to survive into May, in spite of unprecedented government support. 

The UK is home to 5 million freelance workers; a community which has felt the impact of coronavirus perhaps more than any other. 

The Treasury’s “self-employed income-support scheme” pledged to protect freelance workers, providing up to 80% of an individual’s average earnings or profits for those eligible for up to three months. Whilst unquestionably essential, this support looks set to cost tens of billions; a cost which will have to be financed through the government taking on huge amounts of debt.

At the moment, it’s difficult to look beyond coronavirus and the immediate problem of how to keep our economy alive. However, when travel restrictions are relaxed and daily life returns to some semblance of normality, the UK will need the freelance community to thrive. Firstly, for the sake of the millions of freelance workers who call the UK their home. Secondly, to bolster government revenues in tax returns from this same workforce to ensure that the state is able to maintain vital services. 

Legislative reform may not be top of anyone’s agenda right now, but it won’t be long before we’re talking about how to kick the economy back into gear.

What is IR35?

In essence, IR35 is a piece of UK legislation designed to reduce tax avoidance by freelance workers whom HMRC believes to be “disguised employees” and the organisations who employ them. “Disguised employees” are people who work in a similar way to full-time employees but charge for their services via their limited companies to make their businesses as tax efficient as possible.

Whilst the majority of these arrangements are genuine, there are some organisations who pay people in this way to avoid paying employers’ National Insurance contributions or providing employment benefits. Likewise, “disguised employees” receiving payments via their limited companies earn a higher income through not paying National Insurance contributions.

Where do we stand?

IR35 has been in place since 2000. As it stands, employers in the public sector must decide a worker’s employment status whilst in the private sector, workers charging via a limited company must decide their employment status.

In late March, the government took the decision to postpone reforms to IR35 for twelve months until April 2021 to avoid putting additional pressure on freelancers and small business owners already grappling with how to deal with the coronavirus pandemic.

From April 2021, medium or large-sized private sector employers will be responsible for deciding a worker’s employment status and deducting National Insurance contributions from a worker’s salary.

The proposed updates are designed to ensure that freelance workers working via their limited companies, doing the same work as an employee, pay broadly the same tax and so employers pay National Insurance Contributions and provide employee benefits accordingly.

Why does this change matter?

Whilst the ideas behind the updates to IR35 are sound, it is feared that the reforms will have unintended consequences. 

One concern is that businesses will be reluctant to work with freelance workers as the hirer will be fined if they incorrectly identify someone as a freelance worker. Indeed, in a bid to avoid this, some public sector bodies including HMRC, NHS and the MOD already have a policy of not working with freelance workers. 

Another concern is that over-cautious employers may automatically deduct PAYE and National Insurance, so freelance workers earn less than they are truly entitled to and have to claim back tax. 

Furthermore, freelancers deemed to be employees will have to pay more tax despite not necessarily getting the same benefits as existing employees. 

Lastly, it is likely that the proposed reforms will discourage people from starting their own businesses. Freelance workers benefit from flexibility and higher wage rates than salaried employees yet the reforms look set to remove both these incentives.

Looking to the future

It is feared that the roll out of the IR35 reforms in 2021 may hinder the revival of the freelance sector and the recovery of the UK economy post coronavirus. 

Prior to coronavirus, the freelance economy was booming due to demographic changes, technological advances and shifting work paradigms. Indeed, our recent survey of over 7,000 freelancers showed that Millennials and Gen-Z represent the vast majority of the global freelance workforce (almost 90% percent of those surveyed), highlighting just how significant a role young freelancers play in the future workforce.

Freelancers themselves say they benefit from greater autonomy and flexibility, whilst companies who hire freelancers gain the ability to easily scale and connect with top talent from across the globe. As the barriers for companies and freelancers to work together have come down, we’ve seen incredible growth in economic opportunity on both sides of the equation.

As companies look to recover following coronavirus, the ability to hire freelancers in a frictionless manner as demand ebbs and flows will be more important than ever. 

What’s more, the ability to take on ad hoc work as a freelancer may well allow workers to earn an income when full time jobs simply aren’t available. 

The reforms to IR35 threaten to bring complexity and anxiety to the flourishing relationship between freelancers and enterprise. The decision to essentially reclassify some of these freelancers as staff risks hindering the freelance economy’s enduring success and could have wide-reaching consequences across the globe. This is particularly significant given that the global economy will need every possible stimulus as we rebuild following coronavirus, and as remote working becomes a reality for so many. The agility and dynamism of the freelance sector as a truly modern industry means it could play an integral role in the global recovery. 

In theory, this extra time should allow businesses to put in place fair procedures so that they can avoid blanket bans on working with freelance workers, but if the public sector is anything to go by, there is no guarantee that this will happen.

In conclusion

The government’s wish to simplify and rationalise our taxation system and generate additional revenue should be applauded, but this cannot be at the cost of future economic growth. 

In the years to come, businesses will not want to be challenged by tax officials on whether a freelance worker who is running a digital marketing project, for example, should be classed as an employee because of the length of their contract.

The government must take the time to revisit IR35 and update the instrument to alleviate the fears of freelancers and businesses. If the UK is to recover and move forward following coronavirus, we cannot afford to put barriers in our own way.

James Allum is VP and Region Head for Europe at Payoneer

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