Last updated on 09/03/2021
The upcoming IR35 tax changes have emerged as an unexpected battleground in the run-up to this year’s general election.
The reforms are contentious as they will affect a large swathe of the population who are self-employed, as well as businesses that rely on the skill sets of contractors.
The IT sector, in particular, is heavily dependent on the skills that contractors can provide to help them complete projects.
Their numbers began to rise after the financial crisis, but last year saw that number fall for the first time in a decade, and incoming tax reforms could cause them to take a nosedive.
The new off-payroll working rules, known as IR35, shift the responsibility of determining employment status from workers to the organisation hiring them.
This means that self-employed individuals who are contracted by a company and operate like the company’s employees will pay the same income tax and national insurance contributions as those employees, regardless of the structure through which they work.
From April 2020 all public sector and medium to large organisations will be subject to the new tax rules. Small private businesses – those that have a turnover of under £10.2m and no more than 50 employees – are exempt from the changes.
HMRC can conduct an inquiry into the nature of the contractual relationship, and decide whether there has been non-compliance with the rules.
Those contractors found to be in the scope of IR35 following an inquiry by HMRC must pay income tax, national insurance contributions (NICs) and any interest due. On top of that, those who are found not to have “exercised reasonable care” in completing their tax returns may also be liable for a penalty.
If an employer is found not to have taken the requisite care in deciding the contractor’s employment status, they can become liable for payment of any tax and national insurance contributions.
Those found within IR35 following an HMRC inquiry must pay income tax and NICs due, as well as any interest due. Those who “didn’t exercise reasonable care in completing [their] tax and NICs returns” may also have to pay a penalty. Reasonable care must be taken when a client makes decisions about a worker’s employment status for IR35 purposes; otherwise, the client can become liable for any tax and NICs payable.
So what are the political parties’ policies towards IR35? The SNP and Liberal Democrat manifestos commit to reviews of the changes.
Secretary of state Liz Truss verbally committed to a review at a recent debate on policies for the self-employed and small businesses, though there is no mention of carrying out a review in the Conservative manifesto.
Labour’s stance is still unconfirmed, as Bill Esterson, shadow spokesperson for small business, vowed to “pause” the changes, but then back-tracked by deleting his tweets on the issue.
Recent research by global recruitment firm Hays showed that a third of private sector organisations that engage non-permanent contractors are unaware of the IR35 reforms.
With so many contractors working in the IT space and many tech companies dependent on their work, how will these rules affect the channel?
What an employer needs to do
James Milligan, director of technology for EMEA at Hays, explained that the majority of its 31,500 survey respondents worked in the IT space and it is the area that has the “greatest demand”.
He stated that the first thing a business needs to do is to make the contractors they are employing aware of the changes and help them understand how they will affect their status.
“Organisations should be careful to consider the communication of any changes in the interest of anxious contractors that are out there,” he said.
“It will be sensible to have a communications framework to ensure that the contractor is aware of the changes well before they are made and it is very sensible to partner with IR35 specialists, like ourselves or another organisation with that expertise.”
The number of self-employed individuals contracted by an employer must also be taken into consideration when allocating resources to ensure compliance with HMRC’s new tax rules.
“Organisations that aren’t preparing leave themselves open for exposure to risk,” declared Milligan.
“To ensure they are compliant, it would be sensible for them to allocate resources to implement the legislation. Obviously, that depends on the size of the organisation and the contractor numbers they have.
“The amount of resources has to be proportionate and they need to do this by identifying specialist needs the organisation may have to meet their business objectives.”
Patricia Winter, interim head of HR at Softcat, said that the VAR tends to do most of its operations in-house or through an umbrella company, so engages with only a handful of contractors, she explained.
From her experience so far, though, many of them have “very scanty” knowledge about the off-payroll working rules.
“They don’t have a good understanding of IR35 – they don’t understand the government’s tests, so to speak,” she said.
“When I’ve asked those contractors, they’ve never heard of it, which I find really surprising.
“They’re obviously trying to push back and say, ‘well, that doesn’t apply to me’ or ‘Can’t we do this, that and the other for me to be compliant’ and we have to say ‘No, because we as a company are not prepared to take on that risk’.”
Who feels the impact more?
IR35 reforms could curtail the level of flexibility currently enjoyed by contractors and employers; the former earns a higher salary than they would in a permanent position and the latter attains much-needed technical skills to fulfill projects.
Under the new rules, many contractors will have to pay the same amount of tax as permanent employees, without the benefits of holidays, pensions, and so on.
Hays’ Milligan posited that any impact felt would be on a case-by-case basis, depending on the relationship that currently exists between the parties.
“If an organisation is compliant then it shouldn’t have any impact really, in terms of being able to continue as they are,” he said.
“For employers, the impact will be felt if they are using contractors who are in scope for IR35 and, potentially, there’s going to be an implication in terms of cost; an increase in the rates they have to pay or they may lose talent, if the people who are in scope for IR35 choose to go and work or engage with an organisation where they’re out of scope.”
Highly skilled contractors or those with a niche skill set shouldn’t worry too much either, Milligan added, as they will have the power to choose an organisation that doesn’t fall under IR35.
“However, if a contractor is working with a skill set that is more readily available, they might have to move to a different status or they might have to take the impact of the taxation themselves.
“These are worst-case scenarios because my understanding is most organisations use contractors in a compliant way and if they do so and are sensible about how they manage that, then they’ll continue to be out of scope.”
Public sector exodus
HMRC rolled out IR35 in the public sector in 2017 due to what it perceived as people taking advantage of the self-employed tax status. This caused an exodus of contractors from the public to the private sector.
Milligan predicted that the private sector won’t see such as many contractors leaving as the public sector did, both because private sector companies can learn from their public counterparts’ mistakes and because private organisations are “more objective and less risk-averse”.
“There’s potentially a risk and an opportunity: the risk is if you’re not sensible you’re going to lose your talent, and the opportunity is if you do take a sensible approach, you’re going to get access to a bigger talent pool versus the organisations that don’t – we saw that in the public sector,” he explained.
“We also saw lots of organisations in the public sector determining that everyone was in scope and then having to roll back because of either cost increases, or the fact they can’t access the talent to complete their projects.
“In the beginning, some public sector organisations were quite draconian, and then there was a realisation of ‘We need to be quite sensible about how we do this and so long as we’re compliant with the legislation, there’s no risk here’.”
Impact on the number of permanent jobs available
Hays reported that 56 per cent of respondents said that they were concerned about the loss of key talent as a result of the new rules, with 46 per cent believing that the legislative changes will make it harder to engage non-permanent contractors.
Softcat’s Winter is nonchalant about the changes, stating that the firm is ready for them and that she can see the pros and cons from a business perspective.
“It’s obviously cutting off the pool of talent that we can tap into, but you could argue that it’s creating a fairer playing field. We’ve just got to adapt,” she said.
Milligan forecast that the need for contractors will always be there and therefore the demand will not go away.
However, Marc Sumner, managing director of channel recruitment firm Robertson Sumner, disagreed with his sentiment.
He predicted another decline in the number of IT workers next year. He said that the number of permanent roles won’t increase, rather that they will start to fill quicker by contractors who are swayed by the benefits on offer.
“We’ll see a lot of contractors start to move into a permanent job; they’ll suddenly think, ‘if I can negotiate just a bit less on the contract, if I could still get the holidays and I can still get the pension contributions I’ll go into a permanent role’, or they’ll start going through the umbrella companies,” he stated.
“We’ll now start seeing a slow decline over the coming years of IT contractors working for themselves.”