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Some government departments lost up to 40% of IT contractors after IR35 changes

Differing approaches to IR35 tax reforms meant some Whitehall teams were harder hit than others by the changes introduced in April 2017

Some government departments lost up to 40% of their IT contractors as a result of changes to IR35 tax rules introduced in April, Computer Weekly has learned.

The reforms to IR35 were introduced by HM Revenue & Customs (HMRC) to clamp down on an estimated 20,000 contractors who essentially work as permanent employees, but use their off-payroll status to avoid making PAYE and national insurance contributions.

Computer Weekly has since talked to IT professionals across Whitehall and suppliers of contract staff to gauge the impact.

Different departments took different approaches to introducing the changes. Some decided to take a blanket decision to place all contractors into IR35 – or sometimes only those above an equivalent civil service pay grade – while others did not. Some departments were heavily affected, but others have seen much less impact – one large ministry lost only two IT contractors, according to one of our sources.

One example, confirmed by multiple sources, demonstrated the problems caused by such an apparently haphazard approach.

Four contractors working as part of a team rolling out a new network in one Whitehall department were informed they would be classified as inside IR35, and therefore taxed as if they were permanent employees.

As a result, those four individuals subsequently switched to work on a similar networking project in another department, where they were classified as outside IR35 and taxed as such.

An executive at one supplier said several digital projects in government had been put on hold or even scrapped because of IT contractors leaving after being told they were inside IR35. Some departments have offered contractors up to 20% more money to offset the extra tax they have to pay, in order to retain their services.

The reforms were intended to prevent contract workers paying less tax for doing a job that would otherwise be done by a permanent employee. Previously, it was up to contractors to self-declare if their public sector engagements meant they should be taxed in the same way as salaried workers (inside IR35) or as off-payroll staff (outside IR35).

Read more about the IR35 reforms

The reforms meant that public sector bodies became responsible for declaring contractors’ IR35 status instead. HMRC estimated that the activities of non-compliant contractors cost the Exchequer £440m during the 2016/17 tax year. The Treasury expected the changes to generate about £185m in additional tax during the 2017/18 tax year.

“Public sector organisations and contractors are free to work with each other in a manner that suits their circumstances,” HMRC said in a statement to Computer Weekly when the reforms were introduced in April. “However, it is fair that two people doing the same job should pay the same taxes. These reforms will ensure that happens.”

In May, health service body NHS Improvement, which oversees the work of various NHS trusts and care providers, admitted it had made mistakes in how it interpreted the new rules, and as a result reversed its original decision to take a blanket approach to all contractors, instead assessing each case individually.

Departments are meant to publish monthly updates on workforce numbers, although some do so more frequently than others. Figures for the Home Office showed it used 2,316 contractors during March 2017, but this fell to 1,355 in April, after the reforms. HMRC used 215 contractors in March, and 181 in April.

However, these numbers refer to all off-payroll staff, including everything from cleaners to interim managers, so it is difficult to relate them directly to IT workers.

Significant impact

Former Home Office chief data, digital and technology officer Sarah Wilkinson told Computer Weekly in an interview in March that IR35 reforms could have a significant impact on digital projects at the department.

“There is no doubt in my mind that, if we are realistic, we are going to have a year of significant pain because you will see a degradation of the contractor population,” she said at the time.

“It will take some time to embed new pay structures, even if they were approved tomorrow. It will take some time to recruit, even if we started tomorrow. So 2017 is going to be extraordinarily difficult. I don’t know if there is a way of imagining the IR35 problem isn’t going to have a delivery impact – but once it’s done, it’s done.”

In October 2016, Computer Weekly revealed that 30 out of 32 IT contractors at the UK Hydrographic Office, a Ministry of Defence agency, had left after being ruled inside IR35.

In March 2017, research by tax adviser Qdos Contractor suggested that 85% of respondents would cease working in the public sector if the organisation they worked for concluded that they should be considered inside IR35.

Recruitment firms providing contract staff to government warned before the April reforms that the IR35 changes could harm public sector projects.

The loss of IT contractors in some departments comes as Whitehall takes on a growing digital workload, with the government transformation strategy announced in February and preparations for Brexit both likely to require significant resources in the next two to three years.

Read more on IT for government and public sector

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1) "The reforms to IR35 were introduced by HM Revenue & Customs (HMRC) to clamp down on an estimated 20,000 contractors who essentially work as permanent employees".
2) "The reforms were intended to prevent contract workers paying less tax for doing a job that would otherwise be done by a permanent employee."
3) HMRC says "However, it is fair that two people doing the same job should pay the same taxes. These reforms will ensure that happens.”

Re (1) - actually the figure was 26,000. Majority of contractors are working on pre-agreed project work, rather than in do-whatever-you-tell me roles like employees. Bit like when you hire an electrician to rewire your house, as opposed to hiring a full time ongoing odd-job person.

Re (2) and (3) Once again we see what is the "fair" amount of tax being linked to the actual type of work. HMRC have the view that two people doing the same type of work should pay the same tax, irrespective of the relationship of their engagement. But it is not the actual law. Decades of employment case law has no mention whatsoever in relation to the actual type of work being done. It's all about the relationship with the employer and the standard tests of employment. 

This false underlying assumption by HMRC is one of the drivers behind the failing IR35 reforms.

And as predicted, the IR35 Reforms are turning into a massive extra tax on public sector organisations, and those that can are leaving the sector.

HMRC are starting to look like a group of climate change deniers with their constant denials in the face of overwhelming evidence.

Dave Chaplin
CEO, ContractorCalculator
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