Umbrella Reform and IR35: Why Outside IR35 Could Re-Emerge in 2026

For engineering and manufacturing organisations already grappling with skills shortages, the accelerating umbrella company reform could force a fundamental rethink of how contract talent is engaged in 2026. With tighter scrutiny of umbrella models and growing pressure around IR35 determinations, hiring managers may find that the default ‘inside IR35’ approach no longer provides the flexibility, cost control or access to specialist expertise their projects depend on.

IR35 After the Reforms: Where the Market Stands

Since the 2021 IR35 reforms, many businesses have adopted a risk-averse approach, blanket-assessing contractors as inside IR35 to avoid potential tax liabilities. This has pushed the majority of contractors toward umbrella company arrangements, creating what many see as a compliance safety net.

The umbrella company sector has grown exponentially, but so have concerns about transparency, worker rights, and tax compliance. HMRC's increased focus on umbrella companies, coupled with proposed regulatory reforms, is creating an environment where the "umbrella default" may no longer be the most attractive option for businesses or contractors.

Why Umbrella Reform Changes the Game

The government’s commitment to regulating the umbrella company sector is more than just rhetoric. Several factors are converging to reshape the contractor engagement landscape, particularly in sectors such as aerospace, defence, advanced manufacturing and energy, where contractors are frequently engaged for clearly defined projects, specialist design work, or time-bound delivery milestones.

Enhanced Regulatory Oversight: Proposals for umbrella company regulation include licensing requirements, financial safeguards, and greater transparency around deductions and net pay. While these measures protect workers, they also increase operational costs for umbrella providers, costs that will inevitably flow through to end clients.

Supply Chain Responsibility: Pressure is mounting on organisations to demonstrate compliance across their entire supply chain. For hiring managers, this means greater accountability for how contractors are engaged on their projects. Decisions around engagement models, working practices and rate structures will increasingly sit with those responsible for delivery, rather than being delegated solely to finance or compliance teams. The practice of passing contractors to an umbrella company and assuming risk has transferred is coming to an end; due diligence on umbrella providers and fee structures will be a direct hiring manager's responsibility.

Contractor Sentiment: Many highly skilled contractors have been vocal about their dissatisfaction with umbrella arrangements, particularly around transparency and take-home pay. As the market for specialist skills remains competitive, businesses that offer genuine outside IR35 opportunities may find themselves with a significant recruitment advantage.

The Outside IR35 Resurgence

So why might we see a revival of outside IR35 engagements in 2026? Several factors point in this direction:

1. Economic Realities

Umbrella arrangements aren't cheap. When you factor in umbrella margins, apprenticeship levy, and employer NICs, the cost difference between inside and outside IR35 has narrowed. For genuinely contract roles that meet outside IR35 criteria, businesses may find they can offer more competitive rates while maintaining similar overall costs, making them more attractive to top-tier talent.

2. Risk Reassessment

Five years on from the IR35 reforms, businesses have a much clearer understanding of HMRC's approach to status determinations. Case law has evolved, guidance has improved, and there's less unknown territory. This clarity enables well-advised businesses to make outside IR35 determinations with greater confidence, provided the working practices genuinely support the status.

3. Competitive Advantage

In specialist markets where contractor talent is scarce, offering outside IR35 roles becomes a powerful differentiator. Contractors working outside IR35 through their own limited companies typically see better take-home pay and have greater control over their tax efficiency. For hiring managers competing for the best talent, this matters.

4. Compliance Maturity

While understanding of IR35 has improved, many organisations still face uncertainty around assessments and working practices. Some have made progress, but ongoing support is often needed. Specialist agencies such as Owen Daniels continue to help hiring managers through education, compliant frameworks and practical guidance, reducing risk and increasing confidence in IR35 determinations.

What Engineering and Manufacturing Hiring Managers Need to Consider:

If you're responsible for engaging contractors, 2026 could require a strategic rethink. Here's what to consider:

• Review your default approach: Blanket inside-IR35 assessments may no longer be appropriate, especially for senior or specialist roles.
• Understand genuine outside IR35: It requires genuine project-based working practices, not role substitution or cost-driven decisions.
• Use robust assessments: Move beyond tick-box tests and consider specialist advice for complex roles.
• Expect increased scrutiny: Strong documentation and audit trails will be essential.
• Communicate clearly: Be transparent about IR35 status and how determinations are made.

The contractor market is maturing. For hiring managers, this evolution presents an opportunity to build more flexible, attractive, and compliant contractor engagement strategies. Outside IR35 isn't right for every role, and attempting to force inside IR35 working practices into an outside IR35 box remains a significant risk. But for genuinely contract roles that meet the criteria, 2026 could mark a return to limited company contracting.

Need Guidance?

Navigating IR35 and contractor engagement strategies can be complex. At Owen Daniels, we work with engineering and manufacturing hiring managers to review contractor engagement models, assess role suitability for outside IR35, and ensure working practices align with project delivery needs. If you are planning contract hires for 2026, now is the time to review what approach will give you the best access to specialist skills.