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IR35 private sector preparation: What the banks’ take on the reforms means for IT contractors

With six months until IR35 tax avoidance reforms are extended to the private sector, a number of financial services firms are thinning out their contractor workforce – is that the way to ensure compliance?

This article can also be found in the Premium Editorial Download: Computer Weekly: IR35 reforms – the difficult decisions facing IT contractors

With just over six months to go until the IR35 tax avoidance reforms come into force in the private sector, IT contractors are waiting with bated breath to see how the organisations they engage with intend to respond to their new-found responsibilities.

Under the terms of the reforms, which come into force in April 2020, medium to large private sector firms will assume responsibility for determining whether the contractors they engage with should be taxed in the same way as salaried staff (inside IR35) or off-payroll workers (outside IR35).

At present, it is up to contractors to self-declare their tax status, and in the run-up to the changes, numerous concerns have been raised about how the private sector will cope with the added administrative burden of making these determinations.

For IT contractors working in financial services, the picture has become increasingly clear in recent weeks and months, as a number of the sector’s biggest hitters have outlined plans to wind down their reliance on limited company contractors, ahead of the reforms coming into play.

Lloyds Bank and Barclays are known to have favoured this approach, which essentially absolves organisations from having to make case-by-case tax status assessments of every single contractor they engage with, as per the terms of the IR35 reforms.

This follows reports that banking giant HSBC allegedly told its contractors earlier this year to choose between becoming permanent employees or quitting altogether, and Morgan Stanley is understood to have given its contractors a similar ultimatum.

In the case of Lloyds, as exclusively revealed by Computer Weekly, the bank is conducting one-to-ones with its limited company contractor workforce to determine whether they want to continue working for the company as permanent employees, provided the work they do fits in with the bank’s long-term business objectives.

Contractors who are unwilling to become permanent employees will cease their work for the firm once their current engagement ends, although there may be scope for them to remain on a short-term basis if they are prepared to engage with Lloyds via an umbrella company.

An example of the latter is an IT consultancy or recruitment agency that will take over responsibility for ensuring individuals who go down the umbrella route are compliant with the IR35 rules.

Barclays, meanwhile, is known to have started taking action earlier this month to scale back its use of limited company contractors, as well as those engaging with the bank via personal services companies (PSCs) and other intermediaries.

This is with the aim that, by the start of 2020, all new contractors who do work for the firm will be taxed on a pay-as-you-earn (PAYE) basis.

Banks ‘risk-averse and cautious’

John Bell, a chartered accountant and licensed insolvency practitioner at Manchester-based debt advisory firm Clarke Bell, described the behaviour of these banks as risk-averse and cautious, and suggested their understanding of the IR35 reforms maybe somewhat lacking.

“Hirers are not prepared to take risks when it comes to assessing employment status for fear of getting it wrong,” he told Computer Weekly. “Rather than review and assess each contract, which would be a time-consuming and admin-intensive process, firms are taking the cautious approach.

“It’s a knee-jerk reaction in response to legislation that hirers perhaps don’t fully understand. Genuine self-employed contractors will miss out [on job opportunities], and so will the hiring firms.”

“Hirers are not prepared to take risks when it comes to assessing employment status for fear of getting it wrong. Rather than review and assess each contract, which would be a time-consuming and admin-intensive process, firms are taking the cautious approach”
John Bell, Clarke Bell

Given how complex the IR35 legislation is, and the sheer number of contractors the banking sector employs, it is hardly surprising that these firms have taken this stance, said Julia Kermode, CEO of the Freelancer and Contractor Services Association (FCSA).

“Just recently, in the case involving BBC presenters, two tribunal judges took opposing views, so the conclusion was decided by another judge,” she said. “Surely this illustrates how unfair it is to expect businesses to make IR35 determinations.

“If the judiciary fails to reach an easy conclusion, how on earth can firms without access to such expertise hope to?”

While this approach is likely to make life easier for the banks, the same cannot be said for the contractors involved, who now face a stark choice between remaining where they are and taking a permanent position or seeking employment elsewhere.

“Many people choose contracting for the flexibility it offers, but this flexibility will be lost [if they go permanent], so they will have to decide if that is a compromise worth making,” said Kermode.

“To some extent, it will depend on whether they believe they genuinely operate outside IR35, can prove this, and can find other clients offering suitable outside-IR35 assignments – and how in-demand their specific skills are.”

Weighing up their options

But even if a contractor has the technical skills and experience for which the organisation they work for has a permanent, ongoing need, individuals who go down that route could see a significant drop in their take-home pay, said Charlie Cox, commercial manager at technology-focused contractor recruitment company SThree.

This is a direct consequence of the fact that their permanent employee status means they will have to pay PAYE tax, as well as national insurance contributions, but they will also be entitled to paid holidays, sick leave and enrolment in the organisation’s pension scheme, which contractors are not.

“There was an example I saw the other day where a contractor on £675 a day, which equates to around £160,000-170,000 a year being paid into the limited company, would see their permanent salary cut to £100,000,” said Cox.

“People have a lifestyle, they live according to their means. And if you’re on £160,000 and then you’re told that is being cut to £100,000, that’s a pretty big drop.”

Not all contractors would be willing or able to take the kind of lifestyle compromises that could come with taking such a pay cut, yet some might have to until a more favourable opportunity comes along.

That might be the reality for individuals with specific skills that may not transfer beyond the banking sector. People with the flexibility to pursue opportunities in other industries stand a better chance of being able to carry on contracting as they have before.

Dave Chaplin, CEO and founder of IR35 advisory ContractorCalculator, said: “You have to remember that many self-employed contractors relish the challenges of moving from project to project and don’t want to become a permanent employee.

“Many of them travel around the country, and if they are put on payroll, they will need to charge considerably more to cater for their expenses. Firms that cannot attract the talent they need locally will soon learn that hiring contractors on payroll will cost them considerably more.”

Working out the next steps

At the same time, there are still huge numbers of medium to large firms in the private sector that are yet to show their hand on how they plan to approach the IR35 changes.

It could be argued that some of them might be inspired by the approach taken by Barclays and Lloyds, and follow suit, particularly if the firms operate in the financial services sector and also engage with a lot of contractors, said Bell.

However, on the whole, the “blanket approach” being favoured by the banks is not one that appears to prevail throughout the rest of the private sector.

“Other firms are choosing to review the contracts and working practices of the contractors they use, which is, I think, the more desirable approach,” added Bell.

Cox is of the same view, saying SThree’s clients appear to be taking a far more “pragmatic and reasonable” approach to addressing their responsibilities under the IR35 reforms, particularly those working for organisations outside the City of London.

For IT contractors willing to travel, there might be a wider choice of outside-IR35 roles beyond the City, but competition will be high and could increase further as more private sector firms work out their stance on IR35.

Read more about the IR35 reforms

For this reason, Cox says organisations that shun the “blanket approach” and take a more reasoned and measured route to complying with the IR35 rules will have the pick of the IT contracting talent.

For an industry as highly competitive as financial services, there is also an opportunity for other banks to position themselves as more accommodating to IT contractors who want to remain outside IR35 – and, in turn, will clean up in tech talent recruitment.

As previously and frequently reported by Computer Weekly, HSBC, Lloyds and Barclays are all in the midst of sizeable digital transformation projects, large portions of which are likely to rely on access to tech contractors.

“If you’ve got, say, Lloyds onside and then another bank, which has the completely opposite viewpoint and is prepared to set everything up compliantly to engage with a limited company contractor outside of IR35, then obviously the contractor is going to go to the bank that has set itself up in that way,” said Cox.

“The only issue with the banks is that there’s only ever going to be a set number of roles, and there are a lot of contractors in those bigger banks at the moment that have been forced into a way of engaging that they don’t necessarily want.

“They’re not all going to be able to leave those top banks and move into middle tier ones, because there will only be a certain number of opportunities available to them.”

Why HMRC is pressing ahead with IR35 reforms

And with all this at stake, what exactly do HM Revenue & Customs (HMRC) and the Treasury stand to gain by pushing ahead with their plans to extend the IR35 reforms to the private sector next year?

According to figures jointly published by the departments around the time of the May 2018 consultation on extending the reforms to the private sector, the cost of non-compliance with IR35 in that part of the labour market stood at £700m, and was expected to rise to £1.2bn by 2022-2023.

The pair also assert that about one-third of contractors who operate through personal service companies should be classified as operating inside IR35, when, in reality, just 10% are.

HMRC and the Treasury are intent on redressing that with the private sector reforms, while also hoping that the £3bn the government claims will be generated by 2023-24 as a result of this work does materialise.

“As the flexible workforce shrinks considerably, the knock-on effect on other firms that service the market could be highly damaging. A shrinking flexible workforce cannot be good for the UK economy”
Dave Chaplin, ContractorCalculator

But at the moment, the jury is still out on whether the reforms stand any hope of generating anywhere near as much tax revenue as the government departments are projecting.

One of the reasons for this is that it is likely that contractors of a certain age and financial standing might respond to the reforms by taking early retirement, said Bell, or cut their losses in the UK and seek work abroad. “As I understand it, the revenue increase will be negligible,” he added.

And while it is true to say that HMRC is likely to receive an uptick in PAYE tax and national insurance contributions, if large swathes of the UK’s contractor community switch to permanent employment, it stands to miss out on the corporation tax and VAT these individuals generated previously.

“Many professional contractors are generating more tax for HMRC by working as contractors, compared to employees,” said ContractorCalculator’s Chaplin. “HMRC will be getting a smaller slice of a bigger pie. Therefore, the effect on the Treasury will be negative.

“Then you have to consider all the peripheral consequences of thousands of workers who will not be travelling as much, and cancelling the services they were using before, such as accountants, insurance companies and overnight accommodation.

“As the flexible workforce shrinks considerably, the knock-on effect on other firms that service the market could be highly damaging. A shrinking flexible workforce cannot be good for the UK economy.”

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