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IR35 private sector reforms: IT contractors weigh up their post-April 2020 work options

There are eight weeks to go until the IR35 reforms come into play for the private sector, but the IT contractor community is already feeling the effects of HMRC’s latest disguised employment clampdown

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The UK government stands accused of overlooking the toll its latest disguised employment clampdown is taking on the livelihoods of private sector IT contractors, as doubts are cast about whether the initiative will raise the £3bn tax revenue HM Revenue & Customs (HMRC) claims it will.

Medium-to-large private sector organisations are currently in the throes of preparing for the onset of legislative changes that will put the onus on them to ensure any contractors who provide services to them through a limited company or personal services organisation (PSC) are paying the correct amount of tax, based on the work they do and how it is performed.

Previously, it was down to the contractors themselves to declare how they should be taxed, but from 6 April 2020 that responsibility will pass to the organisations which hire them, as part of a revamp of a 20-year-old piece of tax avoidance legislation known as IR35.

According to HMRC, the shift in responsibility is necessary to clamp down on individuals deliberately misclassifying themselves as self-employed, freelance contractors to lower their employment tax liabilities, while doing the same job or working in the same way as a permanent employee.

To ensure compliance with the new-look IR35 rules, HMRC wants each contractor a private sector organisation engages to be individually assessed to see if they should be taxed in the same way as a permanent, salaried employee (inside IR35) or as an off-payroll worker (outside IR35).

“We estimate that two-thirds of people working through a [limited] company are genuinely self-employed and not affected by these rules. But around one-third are working like employees,” claims HMRC, in an IR35 guidance document.

But there is mounting evidence to suggest that “genuinely self-employed” people are being affected by the incoming changes, including thousands of IT contractors who are preparing to leave their posts.

“At the end of March, my sub-contractor and I are closing our business. The business is 100% IR35 compliant, but my clients do not care,” one IT contractor, whose consultancy provides support to digital projects at several major banks, including the Royal Bank of Scotland and HSBC, told Computer Weekly.

“Major IT projects are at risk within the financial services sector, and the whole financial system could collapse as people will not be there to support these systems anymore. Many contractors, including myself, will seek work elsewhere or go abroad.”

As in the case above, many of the affected individuals are being forced out by employers which are banning contractors from their workforce. Or telling them if they want to remain working there, they can only do so on an inside IR35 contract or by working via an umbrella company.

And none of these options are particularly attractive propositions for the IT contractor community.

Computer Weekly has spoken to dozens of IT contractors in recent weeks about the knock-on impact these ultimatums stand to have on their ability to find work in the future, support their families and even remain in the UK.

All of them agreed to talk to Computer Weekly on the understanding their anonymity would be protected, as some are still in the throes of negotiating new contracts or simply weighing up what their next move will be in the post-IR35 world of self-employment.

Blanket bans on IT contractors

Many private sector firms are choosing to simply ban the use of PSC contractors, rather than assess the status for every individual. This has a knock-on effect on the decisions contractors have to make about their future.

Presently, it is a strategy that is known to be rife in the financial services community, with Lloyds Bank, Barclays, HSBC and the Bank of America all favouring this approach.

Within the pharmaceutical space, GlaxoSmithKline is also phasing out limited company contractors from its workforce, while tech giant IBM, and oil and gas behemoth BP are also known to be following suit.

The reasons why are not difficult to fathom. The IR35 reforms are placing a huge administrative burden on the private sector firms within its scope, and they may not have the resources or time to complete these assessments.

Also, the financial costs an organisation could end up shouldering if they get these determinations wrong is a risk many are not willing to take, fearing it may result in them being subjected to a time-consuming and arduous investigation into their tax affairs by HMRC.

For example, NHS Digital made headlines in November 2019 when it emerged that HMRC had hit it with a £4.3m tax bill for allegedly misclassifying its contractors in the wake of similar reforms being rolled out to the public sector back in April 2017.

The downside to these bans is that contractors who have worked hard over the years to ensure the work they do puts them outside IR35 are being shown the door too.

This has resulted in numerous IT contractors telling Computer Weekly about how they feel “demonised” and “ostracised” by private sector organisations which now seem to view the hiring of IT contractors as too big a risk to their businesses, despite the specialist skills they provide.

“I’m a finance contractor working in IT within investment banking, and due to the blanket bans being pushed through by most banks now, I’m struggling to secure any form of contractor role, either inside or outside IR35”
IT contractor

“I’m a finance contractor working in IT within investment banking, and due to the blanket bans being pushed through by most banks now, I’m struggling to secure any form of contractor role, either inside or outside IR35,” one contractor told Computer Weekly.

“Most permanent roles are now paying a fraction of what I earned as a permanent [member of staff] 20 years ago, and most contract roles are being offshored to India and Europe.”

Many of the IT contractors Computer Weekly has spoken to said the IR35 reforms feel like an attack on their livelihoods, and share the view that it feels as though the government has “declared war” on the self-employed.

That is certainly the view taken by another IT contractor Computer Weekly spoke to, who specialises in the implementation of “multimillion-pound digital transformation programmes” within a variety of different vertical markets.

“This is unprecedented and aggressive behaviour that is entirely at odds with anything I have ever experienced since I began freelancing in 2000. It’s as if we all are having action taken against us,” she said.

As a result of blanket bans on contractors becoming ever more prevalent in the private sector, this contractor is now gearing up to close their limited company at the end of March 2020.

“The final straw for me has been that my biggest client announced a blanket ban on all personal services companies. This has happened at a time when companies are collectively driving out contractors, so there are few other places for people like me to go,” she said.

The rationale behind the 28 February blanket ban deadline

In almost all cases where blanket bans on contractors are being introduced, those affected have been told these firms will no longer require their services from 28 February 2020 to ensure their contractors’ final invoice will be processed and paid before the reforms coming into play on 6 April 2020.

However, a last-minute tweak to the reforms may have bought some enterprises a little more time in this regard. This is in the wake of an announcement made by the government on 7 February 2020 confirming the IR35 rules will now only apply to payments made for services provided on or after 6 April 2020. Previously, the rules applied to any payments processed after this date.   

The change effectively gives enterprises a bit more time to prepare for the reforms, but Dave Chaplin, CEO of IR35 consultancy ContractorCalculator, said the change has come too late in the day for most firms.

“It is a cynical attempt to buy more time because the politicians are aware they have a problem that they need to solve,” he said, with regard to the prevalence of blanket bans on contractors in the private sector.

“Whilst the extension to the deadline by which companies are likely to terminate contractors has extended, many firms will not bother changing anything at such a late stage anyway. And the government has very little chance of clearing up the mess and creating a path through the debris created by HMRC’s terrible draft legislation in the extra month they have effectively given themselves.”

Unless, that is, they are willing to negotiate a new inside IR35 contract or opt to resume their engagement via an umbrella company. 

Accepting a contract on PAYE terms, or enrolling in an umbrella company, is likely to result in a reduction in their take-home pay, due the additional tax liabilities and admin costs that contractors who go down the latter route will have to shoulder.

In an example shared with Computer Weekly, either of those two options will result in the contractor’s take-home pay decreasing by more than 40%, as they will be taxed in the same way as an employee, but with none of the benefits – for instance, paid holiday, sick leave or a 30-day notice period.

“I don’t know anyone who has 42% of their salary left after bills have been paid each month. The impact on people, and my family, is going to be severe,” the contractor said. 

“The problem is this: if a worker accepts the reduced pay and can’t cover their monthly outgoings anymore, they’ll sink into debt, which no one wants to do.”

According to data accrued from nearly 1,500 users of the anonymous contractor feedback portal, OffPayroll.org.uk, 63% of respondents said they would be in line for a similar drop in pay if they accepted an inside IR35 contract. As a result, 15% said they would end up defaulting on their mortgage.

“There are individuals who might have been contracting for longer, have seen this coming and built up the cash reserves to weather this, but on the other side you’ve got people whose outgoings have kept up with their increasing income over the years [as they’ve built their career as a contractor], and those are the people who are going to be feeling the crunch in the next few weeks if they are pressured into inside IR35,” said OffPayroll.org.uk founder James Poyser.

Countdown to mass contractor disruption

Aside from the drop in pay, switching from an outside to an inside IR35 contract while working in a similar role for the same company is considered a risky move for contractors for other reasons too.

First, an outside IR35 contractor who is required to work away from home during the week can claim expenses to cover that, but they will not be able to if they move inside, said Dave Chaplin, CEO of IR35 consultancy ContractorCalculator.

“Those contractors typically have in the region of £1,000-£1,200 expenses a month. Under the new rules, if they are engaging with a firm that’s running a blanket policy and they have to go on payroll, that makes that particular engagement completely unviable for them,” said Chaplin.

“It’s okay for those who are working and living in the big cities, but for those who aren’t and who used to travel, it represents a huge pay cut.”

There is also little appetite in the private sector to increase the day rates of inside IR35 contractors to make up the shortfall, because companies want complying with the reforms to be “cost-neutral” for them, he added.

Contractors are also wary of switching from outside to inside because of concerns it might mark them out to HMRC as individuals who may have previously mis-classified their engagements to avoid paying tax.

“The ones that were on outside IR35 contracts at companies that have now rolled out blanket inside IR35 determinations don’t want to have to fight to prove their innocence, even though they are innocent, because it’s expensive. So they would rather have a clean break,” added Chaplin.

HMRC has previously said it will only open investigations into contractors who switch from one side to the other if there are reasons to “suspect fraud or criminal behaviour” has taken place, said Andy Chamberlain, deputy director of policy and external affairs at the Association of Independent Professionals and the Self-Employed (IPSE).

“Although it suggests quite heavily that it won’t do that, there is actually nothing to stop HMRC from doing it. And it certainly happened that way in the public sector [post-2017],” he told Computer Weekly.

“Over the next two to three months, there’s going to be an awful lot of disruption and a lot of contracts being terminated”
Andy Chamberlain, IPSE

This is another reason contractors in this position will terminate contracts rather than roll over and accept an inside IR35 determination, he added.

“Lots of our members are saying they won’t stay in those engagements if clients insist that IR35 applies, so they will leave, terminate those arrangements and seek a contract elsewhere. Hopefully, with a client which takes – what the contractor considers to be – a more realistic approach to IR35 assessments,” he said.

“Over the next two to three months, there’s going to be an awful lot of disruption and a lot of contracts being terminated.”

With good reason, said Chaplin, given HMRC has shown that it’s not averse to pursuing contractors for back-dated tax, as its controversial loan charge policy neatly highlights

“HMRC has said there will be no automatic trigger for historic cases [to be investigated], but based on everything we’ve seen with the loan charge and how it has behaved there, I think it’s very difficult for HMRC to gain anybody’s trust on that matter,” he said.

“Unless an amnesty is written into statute, there is historic tax risk for contractors. That’s just how tax law works.”

Enforced downtime

A good number of the contractors Computer Weekly has spoken to are planning to sever ties with their current employer, and take some time-off over the next few months to work out what their next move will be.

Those with the financial means to do so told Computer Weekly they intend to live off the savings accrued within their limited companies, as they seek out their next outside IR35 engagement.

“Veteran contractors will be able to take six months off with no problems, and carry on, but those who are in more of a financial pickle might just have to lump it and take whatever work they are offered,” continued Chaplin.

Some are “benching” themselves in this way in the hope the companies enforcing blanket bans on contractors will come to see the error of their ways.

Particularly once they see the knock-on impact losing a sizeable chunk of their workforce will have on projects and their wider digital transformation plans, said Poyser.

His organisation’s research revealed that 85% of contractors working in programme and project manager roles said their clients did not have mitigations in place to cover a mass walkout of off-payroll workers. 

“Projects are predicted to fail to meet regulatory deadlines leading to fines, incur hefty penalties for late delivery, and are putting revenue and reputation at risk,” the OffPayroll.org.uk research stated.

So long and farewell   

Some IT contractors indicated to Computer Weekly that their post-IR35 plans will include a move overseas to find work because their UK day rates are being undercut by overseas outsourcing firms already.

While outsourcing work overseas might plug some of the gaps that open up within companies as a result of the reforms, there are some industries where doing so will not be an option at all or a sustainable solution in the long run.

“There is a belief in some financial services companies that they can offshore to plug the gaps in their workforce caused by the reforms, but it is a short-sighted approach,” said one contractor. “The talent is in London for a reason. London has some of the best IT talent in the world and from across the world, and they won’t be able to offshore this immediately.”

A sizeable portion of the contractors Computer Weekly has spoken to are also responding to the looming threat of disruption by opting to permanently remove themselves and their IT skills from the market by taking early retirement.

“There are people of my generation, who have been self-employed more or less since the late 1980s, who have the luxury of saying no, and taking retirement,” said one IT contractor, who shut down his limited company in the summer of 2019.

“It was mainly a case of wanting out, and I am old enough to retire with an OK pension pot, but IR35 was a big worry. I’ve never got caught, and I’ve had contracts that could have attracted attention [from HMRC] but I quit before it happened.”

Counting the cost of contractor reform

It is difficult to say with any degree of clarity at this point how many IT contractors will retire, move abroad or go inside IR35, because there is still so much uncertainty in the market.

However, John Bell, a chartered accountant and licensed insolvency practitioner at Manchester-based debt advisory firm Clarke Bell, said – based on the case referrals his firm is receiving – the number of limited company contractors operating in all sectors is likely to be 20-30% lower once the reforms take hold.

“It’s going to be that across the board. In some sectors, it maybe more, but 20-30% is the average, and that is a lot of companies. It’s going to be interesting to see how the insolvency world copes with the flood of members’ voluntary liquidations (MVLs) that are potentially coming,” he said.

“The view is that 20-30% of the contractor market [overall] will disappear. They will be cut, and they’ll be closing their limited companies, and they’ll either become employees or – as happened when they applied these changes to the public sector in 2017 – people will move abroad.”

And through closing their limited companies, there will be a whole ecosystem of supporting service providers – such as accountants and insurers – which will lose clients and custom, if large swathes of the UK’s self-employed workers are forced onto payroll or work via umbrella companies.

At the same time, there is a misconception – perhaps – that limited company contractors operate as one-man-band-type setups, when many of them also employ people directly in-house to manage their admin and accounts.

One IT contractor Computer Weekly spoke to said the dissolution of their limited company would result in three full-time members of staff being made redundant at the end of February. It is a similar tale across the board for others too.

“I’m currently looking at losing my job, as the government has not taken into account the other people who work in these limited companies, because it is not as straightforward as people think,” Computer Weekly was told by another individual, who holds the position of company secretary at the limited company operated by their partner.

“I do all the accounts and admin for our business, but the focus [of the government] is who my partner works for and his role.”

Meanwhile, a handful of contractors told Computer Weekly that they might be better off financially not working at all and living off the state, given the damage the reforms are set to inflict on their earning prospects in the future.

“For the first time in my life I’m actually considering that I should look at what would be available to me on benefits, because if I’m unemployed and our household income is below ‘X’ we will be entitled to handouts and our ‘status’ will give us some moderate cushioning from going bankrupt,” one contractor told Computer Weekly.

Counting the cost of reform

Considering all this, it is perhaps unsurprising that doubts are being cast about how likely it is the government will succeed in generating the £3bn in previously unpaid tax revenue it anticipates the reforms will bring by the 2023-24 financial tax year.

This forecast appears to assume that all 60,000 private sector organisations within the scope of reforms will following HMRC’s IR35 guidance to the letter, and individually assess the tax status of every contractor they engage with. But as the growing prevalence of blanket bans show, that is not necessarily happening.

Not that the government seems in any hurry to acknowledge that, based on a letter the finance secretary, Jesse Norman, wrote to Poyser in response to concerns he raised about the private sector’s growing reliance on blanket bans.

“You express[ed] concern that organisations might take a blanket approach to applying the off-payroll working rules to contractors without looking at the facts of the individual cases,” wrote Norman. “Independent research suggests this has not generally been the case to date.”

In response, Poyser said HMRC might be in for a rude awakening when it starts totalling up the tax receipts the reforms bring in versus the amount of money it predicted the move would generate.

“HMRC’s business case is too one-sided and too preoccupied with tax revenue at the expense of the wider economic picture”
James Poyser, OffPayroll.org.uk

At the same time, the government seems blinkered to the impact the reforms stand to have on the wider economy, and the UK’s productivity too, he added.

Based on his firm’s calculations, there are 500,000 self-employed contractors within the scope of the reforms, with an average day rate of £512, and 52.5% have indicated they will leave their posts. Therefore, the UK could be set to lose up to £2.2bn worth of contractor productivity as a result.

“It all comes back to HMRC’s business case, which is too one-sided and too preoccupied with tax revenue at the expense of the wider economic picture,” he added.

IPSE’s Chamberlain said it could take up to 18 months for the picture to become clear about the true impacts the reforms have had on contractors and the economy as a whole.

“It may not appear straightaway that there’s a problem because, if contractors decide to take a career break for an extended period as they weigh up their options, they will not show up in the unemployment figures, for example, like they would if it was [permanent] employees walking away from those engagements,” he said.

In due course, though, there is a chance the government will notice a marked downturn in the amount of “tax take” generated by the self-employed sector, as contractors shut up shop for good or move overseas, he added.

“If people aren’t working and earning money, they’re not paying tax, and the whole point of this exercise is to increase revenue for the tax man,” he said.

“The new tax year starts in April, but people won’t have to file their self-assessments and do their tax returns until January 2022, so it maybe a while before the government realises the impact.”

Read more about IR35 and the loan charge

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