For any IT professional who has managed to make a living as a contractor for the past 20 years, the acronym IR35 must be like a crucifix held up to a vampire. The tax reforms were considered controversial when first introduced in 2000, and now – just when you thought you’d got used to how it works – the taxman is nailing two pieces of wood into a cross once more.
Let’s recap: IR35 is designed to prevent individuals who work in much the same way as a regular employee from unfairly reducing their tax burden. It’s common practice for contractors to set up a company with one employee – themselves – and charge clients for their time through that company. As a result, they avoid PAYE by paying themselves a nominal wage and earn an income by taking dividends as a director of the company, which accrues tax at a much lower rate. But they miss out on benefits such as National Insurance and pension contributions, holiday and sick pay.
Generally, this is seen as a fair exchange – the contractor takes extra risk and so earns more money, while the organisation that procures their services pays more than they would to a salaried employee but without the added costs and can terminate their services at short notice if needed.
IR35 effectively says, this is fine as long as you are not working exclusively for one company, long term, in a job that would otherwise be done by a regular full-time employee, in which case you should be taxed on PAYE and receive employment benefits. Contractors that work for multiple clients are considered outside IR35.
Now, the administrative burden of IR35 is shifting from contractors to the organisations that hire them. HM Revenue & Customs (HMRC) reckons that too many contractors are claiming to be outside IR35, when in truth they are “inside” IR35, and as such are avoiding tax to the tune of £1bn-plus every year.
The reforms have already hit the public sector, and affected thousands of IT contractors, as well as delaying important digital government projects. In April 2020, it hits the private sector too, and employers will have to certify whether or not any contractor they use is IR35 compliant.
For big firms, such as banks, which use thousands of contractors, this will be too much of a burden, and already those companies are reviewing policies to avoid that administrative overhead. Contractors face a choice of becoming employees, with a consequent drop in income, or working for umbrella companies such as recruitment agencies, which will take a cut of their fees.
Contracting is potentially a rewarding move, but it’s also high risk. Contractors are first out the door when budgets are cut. But they also bring great flexibility for IT departments, and especially now when skills shortages threaten to derail digital transformation initiatives.
Contractors claim that HMRC is being heavy handed and unfair, saying it is inevitable that employers will take the easy route to the detriment of freelance workers. Some claim the reforms will backfire, as contractors’ reduced income means the overall tax take will be less anyway.
In uncertain economic times, employers value a flexible workforce, and the agility to respond quickly to business change. Contractors willing to risk the job insecurity offer that – and as such this protects the full-time workforce from the vicissitudes of business. As the private sector reviews how to manage its contractors, they must keep the benefits of that flexibility in mind and not punish contractors for the added complexity demanded by HMRC.