Does Microsoft’s IR35 rethink show the tide is turning in IT freelancers’ favour?

IR35 is still a huge problem for technology freelancers -- ‘IT contractors’ -- here in the UK, as well as end-users -- ‘clients.’

But, asks Andy Chamberlain, director of policy at The Association of Independent Professionals and the Self-Employed (IPSE), might the tide now be turning in favour of these workers?

What is IR35?

For the uninitiated, IR35 is a tax rule introduced in 2000 which permits the assignment of an IT freelancer to be taxed much more heavily -- on a fully-employed basis, should HMRC determine that if not for the use of the freelancer’s limited company, the freelancer’s relationship with the client would be one of employment.

Well, last week we shared the first-hand account of an anonymous IT contractor working at tech giant Microsoft, revealing what seems to be an incoming but significant shift in the way which Microsoft handles its IR35 compliance.

Microsoft and IR35 (continued)

Like many big end-users, Microsoft has been reluctant to engage with limited company workers ever since IR35 -- outlined above -- was changed in the private sector on April 6th 2021.

The upshot is the tech giant may now be softening its ‘non-approach’ to limited company-using IT freelancers, a move which is likely to benefit both them -- as contractors -- and the technology projects they work on.

Whether these IR35 goings-on at the UK outpost of the world’s largest software maker are an isolated example, or could be a sign of things to come across the IT contractor market, is a very interesting question to consider.

The changes to IR35 since April 6th 2021, in a nutshell…

Since April 6th 2021, end-clients in the private sector have had to wrestle with the difficulties of making IR35 determinations (and the same is true for end-clients in the public sector, albeit since April 6th 2017).

Previously, under the ‘old’ IR35 of 2000, it had been the contractor’s obligation.

In particular, when the original IR35 rules were introduced (full name; the Intermediaries legislation), contractors had to assess each one of their engagements, and consider whether it was a business-to-business contract, or something more akin to an employment.

The determination they made would affect how, and how much, tax they paid on the income. If they got it wrong -- or if HMRC believed they got it wrong -- it would be them, the contractor/freelancer, and not the end-client which HMRC would take to task.

Why have UK organisations taken risk-averse actions on IR35 since April 6th 2021?

Commercial clients of IT freelancers, like Microsoft, have had two big motivations for taking this drastic course of action -- not engaging limited company (also known as Personal Service Company) workers, at all.

Firstly, making IR35 status determinations, effectively working out whether an engagement is inside or outside IR35, is notoriously complex. That may be why (so far) the government has said clients who qualify as ‘small companies’ are exempt from the April 6th 2021 rules (meaning ‘old’ IR35 applies for them, instead).

Nonetheless, all medium-sized and large companies in the UK which engage limited companies have to grapple with nebulous concepts, such as ‘mutuality of obligation,’ and even if a well-informed, legally competent approach is taken, there’s always a chance HMRC will disagree anyway!

Secondly, the rules create an in-built incentive for clients to make ‘inside IR35’ (i.e. caught by the rules and so owing employment taxes) determinations, as there is only ever a tax risk for the client (or the agency), when the determination is ‘outside IR35’ (i.e. not caught).

‘No thanks,’ said the blanket-banning big banks

Once it became clear the legislation was changing, many large clients of IT freelancers -- the very big banks in particular -- put out statements saying they would no longer be working with limited company contractors whatsoever.

These clients didn’t even want to have to explore or get involved with IR35 determinations. They preferred just to ensure that every worker they engaged was on a payroll, sidestepping the need to engage with the Apil 6th IR35 rules (full name; the Off-Payroll Working rules) altogether.

This approach to the OPW legislation has become known as a ‘blanket ban.’

The blanket ban on PSC /limited company workers undoubtedly reduces risk for clients, and it removes the undoubted administrative burden of undertaking status determinations. But it comes at a cost!

UK organisations unable to utilise flexible expertise

End-users that implemented a blanket ban have admitted that it has been harder to recruit and retain the talent they need to deliver their projects.

They still need that flexible labour and they can still potentially get it, sometimes, via payroll and umbrella companies, but it typically costs them more money.

And some contractors -- like the IPSE member who revealed the Microsoft rethink which looks like it will apply from April 6th 2024 -- outright refuse to go ‘on payroll,’ regardless of how much the day rate is inflated as compensation.

Contract and freelance technologists who have run their own technology businesses for years, and who know full well that they work independently, outside IR35, are often unwilling to enter umbrella employment. Just ‘because the client doesn’t want to shoulder any IR35 risk’ won’t cut it for them. Such risk-averseness is not compelling enough to make these bonafide businesses just stop being bonafide businesses.

What the Microsoft recruiter memo actually says

Perhaps then, clients are beginning to realise the blanket ban approach just isn’t good for business. Indeed, the Microsoft exposé quotes a recruiter for the company telling our contractor-member that he’d have to “sit on a PAYE model” for now “but come April next year,” the tech company “will be moving to [Personal Service Companies] again.”

Of course, it might also be true that medium-sized and large end-clients are recognising it is perfectly possible to engage a contractor on an ‘outside IR35’ basis and still be entirely compliant with the OPW legislation.

To IT freelancers’ clients I’d like to remind them -- the IR35 rules of April 6th 2017/21 do not say ‘thou must put everyone on payroll!’

In fact, the rules encourage clients to think about their engagement and apply the appropriate tax treatment to each one. If clients want genuine tech contractors/freelancers, working autonomously, on a contract/freelance basis, there is nothing in the rules which prevents them from doing so.

Are clients beginning to get to grips with IR35?

Our hope is that clients are beginning to get to grips with IR35, much as contractors had to do in the early 2000s, when the burden of status-assessing was all on their shoulders. If clients get some advice, get a good written contract and ensure the working practices align with that contract, our belief is that it’s going to be very, very difficult for HMRC to successfully challenge the determination.

There may be some risk of an HMRC investigation. But an IR35/OPW probe by the taxman is reasonably straightforward to mitigate by having robust processes in place. And the business benefits of working with IT contractors/freelancers again speak for themselves -- flexible expertise, helping clients to manage peaks and troughs in demand and ultimately helping those businesses be more innovative and able to grow.

Final thought

Maybe this is why Microsoft might be reversing its blanket ban, and if they are doing it as the recruiter memo strongly indicates, perhaps it won’t be long before their competitors follow suit. We certainly hope so.