The Engager's Levy: How a new tax on your clients could end the IR35 nightmare

Wiping these rules from the statue book raises the question of what, if anything, would replace them. At IPSE, we’re keen to demonstrate that alternatives are possible. We’ve previously discussed the concept of a new corporate entity dedicated to freelancers and as part of this new series of blogs looking at potential alternatives to the IR35 legislation, we outline below another suggestion – for clients to pay a new levy on their freelance engagements.

Would IR35 leave a void if we scrapped it tomorrow?

One might argue that we shouldn’t ‘replace’ rules which have had such an overwhelmingly negative impact on contracting in the UK.

But from the point of view of HMRC and policymakers at HM Treasury, one thing that would need ‘replacing’ is the revenue that these measures raise. The 2017 and 2021 ‘Chapter Ten’ reforms are currently estimated to raise an extra £1.5bn per annum for Treasury coffers – more than double previous estimates, according to the Office for Budget Responsibility.

Ultimately, we face a situation where government is content to raise this revenue from individual contractors, rather than directly from engagers; whether we believe this money is being raised ‘correctly’ or ‘fairly’ is a separate discussion.

If government won’t part with this revenue, could it instead be convinced to ask the ‘work creators’ – the clients – to pay a larger share of it?

The missing piece of the pie in contractor engagements

It’s all too easy to say “someone else should pay”; but there is a reasonable justification for a greater contribution by clients.

On IR35, the line we hear from HMRC is that when an individual works like an employee, they should be taxed like an employee. But this rationale overlooks the cost borne by employers when hiring an employee, who become liable for Employer’s NICs and the Apprenticeship levy – both of which are absent in self-employed engagements, but present in the quasi-employment arrangements of inside IR35 contracting.

The difficulty is that contractors working inside IR35 typically cover the cost of this extra revenue through a reduction in their day rate, and their umbrella company’s ‘employment costs’ charge. Many contractors (though not all) have successfully increased their rates to offset real terms reductions; but ultimately, it’s not clear that clients are paying for the creation of these quasi-employment arrangement to the same extent that they would when hiring a full-time employee.

Perhaps the line should really be: “hire someone like an employer, and be taxed like one”?

What about an ‘Engager’s levy’ for freelance contracts?

The proposal involves applying a tax charge to the fee paid by a client when engaging a freelancer or contractor, calculated as a percentage of the freelancer’s rate (be it an hourly, daily or project fee).

This wouldn’t come without some impact on contractors and their hiring prospects. It could lead to some downward suppression on day rates, in the same way that Employer’s NI acts as a drag on wages (some would argue). It’s also possible that some clients could perceive this payment of tax when hiring freelancers to be more ‘wasteful’ than an equivalent sum spent on business-to-business transactions and become more reluctant to work with them as a result.

However, the relative strength of an Engager’s levy is that its immediate impact can be mitigated and smoothed over multiple years. This can be done by launching the levy at a low level – 2.5%, for example – and gradually increased over time, until the tax differential between employee and self-employed engagements are sufficiently minimised.

The off payroll working reforms, on the other hand, could not be ‘phased in’ as such, and clients negotiated this cliff edge approach to the change as expected. In the aftermath of the 2021 reforms, 21 per cent of contractors reported being subject to blanket inside IR35 assessments by their clients, whilst a further 11 per cent were moved onto a payroll without any kind of status assessment, according to IPSE research.

Contractors have since been motivated to close their companies, retire early or even seek contracts abroad, rather than adopt an unsatisfactory, quasi-employment arrangement.

Let’s stop tax interfering with how you work

Ultimately, we know that people enter self-employment for overwhelmingly positive reasons – whether it’s to exercise greater control over the work they do, the clients they work with or the time they spend working. Similarly, clients work with freelancers for the wealth of experience, expertise, and flexibility they can offer.

But too often, IR35 interferes with the free exchange of services and payment between these parties. It is creating a new kind of employee that misses out on most of the benefits of employment whilst also losing their status as an independent business. This is because, being tax legislation, IR35 isn’t interested in employment rights – it only cares about the tax it can raise, much of which would normally be paid by an employer. Why not raise the tax without compromising the independence of hardworking freelancers and contractors?

New taxes typically bring complexity along with them. But compared to the rigmarole of IR35 status determinations, navigating the umbrella company market and the perpetual fear of an HMRC investigation, a simple levy on freelance engagements would seem to be a simple solution.

Taking the proposals to policymakers

Since developing the idea of an engager’s levy in 2018 in partnership with Demos, IPSE has presented these ideas to the Taylor Review of Modern Working Practices and the recent Future of Work review led by Matt Warman MP. We have also submitted this idea as part of Labour’s National Policy Forum consultation which directly feeds into their manifesto.

Whilst this is only one possible alternative to the deeply damaging IR35 legislation, we believe that this proposal would remove the unnecessary complexity of IR35 from the sector.

We are currently in discussions with our Policy & Research Committee about employment status reform and what IPSE's campaigning should be focused on.

We also want to hear your views on the proposal for a new legal entity for freelancers - please write to policyqueries​​​​​​​@ipse.co.uk to share your feedback and ideas for consideration.