IR35 and the Growing Divide Between Contractors and HMRC

A turning point for the flexible workforce

Recent reports of record contractor insolvencies have brought an uncomfortable truth to the fore: IR35 reforms, intended to curb tax avoidance, have reshaped the market in ways that deepen financial risk for independent professionals. Rather than simplifying compliance, the rules have driven many workers away from limited company models and into umbrella arrangements that often reduce take home pay while increasing exposure to opaque pay structures.

How policy design shifted behaviour and risk

The extension of IR35 to the private sector prompted many medium and large clients to adopt risk-averse stances, defaulting to blanket determinations or refusing off-payroll engagements altogether. Contractors who once worked compliantly through personal service companies were pushed towards umbrella companies to maintain continuity of work. This change did not remove complexity. Instead, it redistributed it, adding layers of cost and reliance on third parties whose models and margins are not always transparent.

For many workers, the result has been a noticeable drop in net income after umbrella fees, employer’s National Insurance passed through rates, apprenticeship levy calculations, and duplicated holiday pay accounting. Reduced earnings, combined with higher living costs and sporadic engagement availability, have strained cash flow. When income falls yet expenses persist, insolvency risk inevitably rises. The picture is not one of widespread intent to avoid tax, but of professionals navigating a system that has made compliant working less viable and less rewarding.

The growth of umbrella dominance has created fertile ground for bad actors. Some schemes present as fully compliant while embedding disguised remuneration or artificial deductions. These arrangements can be marketed as convenient, tax-efficient, or higher take home solutions. In practice, they shift risk to the worker, who may only discover the true cost years later when facing retrospective tax demands. IR35’s complexity, compounded by frequent regulatory updates, has encouraged disengagement and made the promise of simple pay too compelling for those under financial pressure.

Trust, complexity, and unintended market consequences

HMRC’s approach relies on intricate status tests, evolving guidance, and post-event enforcement. This model undermines trust because rules are hard to interpret consistently, and outcomes can be challenged long after engagements have ended. The perception of retrospective risk discourages investment in compliance and normalises defensive behaviour by clients and contractors alike. In this climate, individuals become apathetic about the nuance of status, or they take higher risks by choosing umbrellas that advertise better short term returns.

The assumption that tighter controls automatically increase tax yield does not always hold. When complexity pushes people into models where they misunderstand liabilities or suffer reduced take home pay, voluntary compliance weakens. Insolvencies yield little or no tax revenue, increase enforcement costs, and damage the UK’s reputation as a flexible labour market. Meanwhile, compliant umbrellas and recruiters face competitive pressure from operators who edge into avoidance, creating a race to the bottom that punishes transparent practices.

There is a particular irony here. IR35 was designed to counter perceived avoidance within limited companies. Instead, it has accelerated the dominance of umbrella companies, expanded the surface area for avoidance schemes, and heightened financial harm to workers who were trying to operate legitimately. The policy did not simplify the contractor economy; it redirected it into channels with more intermediaries, more fees, and more confusion about responsibilities.

What would improve outcomes and compliance

A simpler, fairer, and more predictable tax framework would rebalance incentives. Clearer statutory tests, stable guidance, and fewer retrospective shocks would foster engagement rather than avoidance. Aligning tax and employment law outcomes, ensuring transparent umbrella practices with enforceable standards, and giving clients safe harbours for good faith determinations could all reduce disputes. Most importantly, policies should be judged by real-world outcomes: higher voluntary compliance, fewer insolvencies, and a healthier, more competitive contractor market.

Contractor News view

Contractor News observes growing evidence that IR35’s practical effects have diverged from its aims. The data on rising contractor insolvencies and the shift towards umbrellas suggest a need to reassess how policy interacts with market behaviour. A balanced approach that prioritises simplicity, predictability, and transparent pay would likely support compliance and stability across the sector without undermining legitimate flexible working.