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So long, farewell to the Contract Market? Taking the Ire out of IR35

image of David Upton David Upton
David Upton 19 Mar 2020 Time to read: 

Raindrops on roses, and whiskers on kittens. Bright copper kettles and warm woolen mittens. Brown paper packages tied up with strings. These are a few of my favourite things” …it’s unlikely that these iconic lyrics from the Sound of Music are going to have an additional verse including HMRC anytime soon; in fact the introduction of changes to what are known as the IR35 regulations – which apply to the private sector from April – are likely to have many a contractor and business wishing the tax man was banished to the Tyrol.

These new regulations are likely to have a radical impact on the UK flexible labour market. The changes have, for a long time, gone under the radar, and have struggled to make it into mainstream news media, although the recent high profile legal case involving news broadcaster, Lorraine Kelly, and the rapidly approaching date when these regulations come into effect, have started to raise the public consciousness.

The changes impact the way in which Income Tax and National Insurance is paid by what are termed as ‘off payroll’ workers – more commonly known as contractors. One of the key changes is the shifting of legal responsibility for deciding tax status and ensuring the right taxes and national insurance are collected, to hiring businesses. Up until now, it has been the contractors’ responsibility to prove their status and ensure they were paying the right tax.

People can find themselves ‘contracting’ for a variety of reasons. Sometimes it’s a conscious decision to seek greater freedom and variety in the work they do, maybe working for multiple ‘clients’ at the same time, but sometimes it is out of necessity as the right permanent position wasn’t available when it was needed. Whatever the reasons, four things are certainly true about this way of earning a living:

  1. There is a significantly higher risk to income. Contracts frequently get cancelled, delayed, postponed or changed in some other way and this, combined with the downtime sometimes associated with finding new work, can create ‘income gaps’;
  2. There are costs which ‘normal’ employees who pay tax through PAYE may not have, potentially including accountants / legal fees, Private Healthcare, increased pension costs etc.
  3. There is an opportunity to pay less tax and National Insurance as a percentage of gross income overall than those on PAYE, although it must be said that some of these advantages have been eroded in recent years; and
  4. Contractors have far fewer employment rights and benefits

There are also significant benefits to hiring companies in having these flexible arrangements as an option. Contractors often work on one-off change projects which need either a short-term increase in capacity or niche skills that it would be unrealistic to retain in-house. Contract workers are often funded from CapEx budgets whereas internal resources are seen as OpEx spend and this can be a key factor for many businesses where there is major focus on reducing operational expenditure. Contractors are also often the first to lose their work when a downturn, or even a budget squeeze comes along and this gives hiring companies significant flexibility.Contractors being the first to be targeted for enforced furlough at Christmas or business aligned seasonal quiet periods

So, what’s changing…and what is the best way to deal with the changes?

For some time, these factors have broadly been in balance. Those who choose a contracting lifestyle understand how these factors interact and they made their own decisions about risk appetite, reward, flexibility etc. Likewise, hiring companies know they may have to pay a little more for contract resources, but it’s a great way to access specialist skills and meet peaks in demand without permanently increasing costs. The IR35 changes, first implemented in the Public Sector in 2017 and from April 2020 in the rest of the economy, change this equilibrium and we’re seeing the effects across the marketplace.

How are hiring companies reacting?

The Blanket Approach

The more risk-averse hiring organisations are taking a blanket approach to dealing with the issue, and determining all contract roles as ‘Inside IR35’. By insisting that contract workers either join the payroll (although interestingly this is rarely as a permanent employee with all of the employment rights and benefits this attracts) or work through an umbrella company, they are seeking to maintain the flexibility they have enjoyed in the past whilst insulating themselves from any of the tax / NI risk. From HMRC’s perspective such blanket decisions may not constitute the reasonable care they expect from employers in checking workers’ status for tax, so ironically, they could be in breach of the legislation. A recent ContractorCalculator survey indicated that contractors believed only 13% of hiring organisations were carrying-out compliant assessments on an individual basis.

The effect on Contractors is to impose a significant reduction in net income without a corresponding change in the other balancing factors described above. I understand why organisations would take this ‘risk-free’ approach, but the blanket way some companies have implemented this is, I believe, having an immediate effect on this part of the employment market and could potentially come back to bite businesses through a loss of flexibility in the workforce.

The irony is that there is a real risk that all three parties (contractor, hiring organisation and HMRC) will lose-out in the medium term. The individual loses because there is either less work, or it is in effect less well paid. The hiring company loses out because they may find it more difficult to attract the right contract workers to support their change programmes, and HMRC will lose out because less work and / or less well-paid work means a reduction in tax and NI takings. Some work may even be undertaken by Offshore outsourcers, meaning a decent chunk of the money leaves the UK economy altogether, potentially never to return. The ContractorCalculator survey suggests 41% of hiring organisations had placed at least some work offshore as a result of IR35

There’s a personal impact here as well. Many of these workers are highly skilled and experienced but they are really struggling to find work whilst the market is in turmoil/state of transition. The ContractorCalculator survey indicated some 18% of contractors are currently out of work, and of these 75% attribute this to IR35. For some, this is having a knock-on impact on mental wellbeing, which increases the longer they go without work. The prudent amongst them will have a ‘war chest’ to see them through income gaps but current market conditions are testing this for many.

Whatever the motivations of HMRC in making these changes, the effects are far-reaching. This isn’t just about ‘fair tax’; it’s having a material impact on the flexible labour market and this impacts all parties. In time, the market will adjust – it always does – quite how, and by when, is less easy to see. Maybe there will even be adjustments to the changes themselves as unintended consequences become apparent.

Personalised Fair-assessment Approach

In the Lorraine Kelly case, she successfully appealed a £1m+ tax bill – arguing that her work for ITV was a contract for services and therefore outside of the scope of IR35, however most people don’t have the budget to hire a highly paid team of lawyers to mount their defence. At Peru Consulting, we’re seeing the effects of IR35 from a number of angles, and we’re trying to make it work for all concerned.

For our clients, we’re having a number of discussions about how we may be able to support some of the Transformational change that might historically have been undertaken by contractors. I don’t see this as taking work away from contractors as I’ll explain below. We can typically undertake this work in a risk-free way as we contract on an outcomes basis, and where we do use contractors ourselves alongside our permanent employees, we’ll always make a thorough and honest assessment of the status; we use IR35 Shield to do this but there are other tools available. For some clients, just moving the responsibility to complete the assessment from them to us is a significant benefit. Please contact me directly at david.upton@peruconsulting.co.uk if you think we may be able to help.

For contractors, we make the commitment that we’ll undertake an individual, fair assessment which should protect everybody in the supply chain; we’ll never make a blanket assessment. We’re confident that we can secure work that they may struggle to directly – as a Small Company we have some exemptions that the bigger guys don’t. We’ve reviewed our contracts and made some changes to ensure all parties are protected wherever possible.

We’re also having a number of conversations with contractors who have decided that the IR35 changes and uncertainty just change the equation too much for them, and they’re interested in permanent employment. Smaller consultancies such as ours are a ‘half-way house’ between the corporate world and working alone. If you are in this position, contact us at contact@peruconsulting.co.uk to explore permanent roles with us.

For many companies, the option to move to “statement of work” based consultancy arrangements – essentially a packaged piece of work with specific deliverable milestones, where the focus is on the project, not the individual, may be the answer. We believe there is a way for all parties to retain some of the balance that has been in the market for some years through taking a positive approach and challenging the possibility that everybody will lose-out because of these changes. If you’d like to discuss, get in touch.

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