Assessing the effects of IR35

The short-term effects of the Government's new tax regime for freelance IT staff are clear - higher tax bills. But what are the...

The short-term effects of the Government's new tax regime for freelance IT staff are clear - higher tax bills. But what are the likely longer term effects on the industry as a whole? Bill Goodwin reports

IR35 - even the name of the Inland Revenue's tax reform plan is enough to send most IT directors to sleep. But that could be a big mistake. With the date for its implementation fast approaching, it is becoming clear that IR35 could have serious implications for every company that employs freelance IT staff.

IR35 is an attempt by the Inland Revenue to close the loop-hole which allows self-employed contractors to avoid national insurance contributions by paying themselves share dividends rather than a salary.

Under the new tax regime, which comes into force in April, nearly all freelance IT staff will be faced with a significantly higher tax bill. Although few IT directors are likely to shed tears for the contractors, there are real fears that the knock-on effects of IR35 could prove problematic for employers.

The Inland Revenue's revised guidelines, published last week, offer little comfort for freelancers. Under the guidelines, every contractor engaged on a full-time agency contract for a month or more - and that means most of them - will be classed as an employee for tax purposes.

Contractors will also find it more difficult to offset their training costs against tax, making it harder for them to keep up with the latest IT skills.

In effect, say critics, contractors will pay the same tax as permanent staff but will share none of their perks - such as paid holidays, sick pay or pensions.

Faced with these obstacles, some contractors may decide to give up contracting altogether. Others may seek work in more lenient tax regimes overseas. Employers are likely to find themselves paying more for the contractors that remain, as freelancers seek to recoup at least some of their extra tax and training bills.

Employers may have no choice other than to foot the bill for training their contractors themselves. And at a cost of £10,000 to bring someone up to speed with Windows 2000, the costs could be significant.

That IR35 will have an impact on employers is beyond question. How great that impact will not become clear for some time. No one, not even the Inland Revenue, has analysed its long-term consequences.

Estimates from the Institute for the Management of Information Systems, suggest that, in the worst case scenarios, IT departments may have to shell out anything from an extra 10% to 25% to pay for contractors with critical skills.

In the meantime, employers will need to keep a close eye on IR35 if they want to avoid being caught by some very unpleasant surprises.

Possible impact of IR35

  • Employers will come under pressure to give contractors employee status - pushing costs up by 10%
  • Employers may have to hire contractors through expensive consultancy firms. Costs could rise by 25%
  • Contractors may offer their services through companies in more lenient offshore tax regimes
  • Employers may be forced to set up their own offshore companies to provide contractors
  • Most contractors are single or married without children. They may seek more lucrative work abroad, leading to skills shortages in the UK
  • Source: Philip Virgo, Institute for the Management of Information Systems

Read more on IT jobs and recruitment