IR35 – the unintended consequences of the 2017 Finance Act

23 January 2017

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IR35 TaxSince her elevation to the post of Prime Minister, Theresa May has made much of the need for big business to reform some of its behaviour, largely as a result of the effect it has had on the general population, the so-called “just about managing” man or woman in the street. Populism across Europe, the Brexit vote and the election of President Trump are (partly) seen as reactions to an unfair world where the rich do well and the rest of the world’s population, while in many instances actually benefiting on average, have been actively disregarded by a so-called governing elite, or, if you prefer a more emotive phrase, what some might call the stitch-up between government and big business. 

When translated into the world of the companies as opposed to individual men and women, this applies in much the same way. The ”global elite” who recently enjoyed the mountain air of Davos don’t include many of the “just about managing” SMEs that account for c. 99% of all employment in the UK and around/just under 50% of the GVA.

Consequently, it is to be hoped that the launch of the government’s Industrial Strategy today, with an emphasis on the long-term, will help everyone who values the contribution that business, of all kinds, makes to the economy and society.

With Mrs. May reportedly emphasising the importance of improving Britain’s technical education so as to compete with Singapore and China, as well as boosting STEM generally and announcing (in my opinion, a rather paltry) £170M to be invested in creating new Institutes of Technology, this new approach to industry will be seen by many as “a good thing”.  In some ways it is, but in others it demonstrates the lack of joined-up thinking to which all governments are prone.

Now while it’s easy to point to many areas of non-joined-up thinking where politicians contradict themselves, it is the job of government to try to get things right.  One policy or strategy should, as a general rule, not undermine another one. Yet when we come to look at the forthcoming change to IR35 legislation as it affects the public sector that is exactly what is happening. Let me explain…

The background

Introduced in April 2000 by the Labour government, IR35 took its name from number of the Press Release announcing it.  As the House of Commons Library notes in its potted history on the subject “this legislation remains unpopular among freelancers who use this corporate form to provide services … Individuals working in a number of fields often provide their services to clients through a personal service company (PSC), rather than taking up employment with that client. The client pays the service company for the work they have done, without deducting income tax under PAYE or National Insurance contributions (NICs).”

To cut to the chase, this creates a number of potential tax advantages – or opportunities to avoid tax if you prefer – for those contractors using the system.  HMRC as a rule does not like this sort of thing.  In 2012, there were concerns about the numbers of senior staff in the civil service being employed through a PSC and the Minister announced a consultation on amending IR35, with the seeming intention that anyone providing their services through a PSC who had been taken on with a senior, controlling role for their client would be taxed as an employee. In the event, this did not happen as HMRC felt they could mitigate any losses to the tax take through this “disguised employment.”

After the Conservatives won power in 2015, they decided to consult on how “to improve the effectiveness of existing intermediaries legislation … One question raised was whether the onus for determining whether IR35 applied or not should be placed on the client, rather than the PSC: under such an arrangement, those who engage a worker through a PSC would need to consider whether or not IR35 applies (in the same way as they would need to consider whether a worker should be self-employed or actually be an employee), and, if so, deduct the correct amounts of income tax and NICs as they would for direct employees.”

In other words, the contractor becomes an employee, not a contractor, and as such the employer is liable for deducting tax and NI. As the House of Commons Library report notes,  “Finally, in the 2016 Budget Government proposed that from April 2017 public sector bodies would have new duty to ensure any contractors that they took on were complying with IR35 rules. A consultation exercise was launched in May 2016, and in the Autumn Statement in November the Government confirmed it would proceed with this reform.” (my underlinings)

This is where we are now.  The consultation has passed.  The key recruitment industry bodies did make strenuous representations, but the die is seemingly now cast. In fact the changes to IR35 form Clause 1 and Schedule 1 on the draft notes (referred to in the paragraph below) for The Finance Bill 2017, which should be law on 1st April. I have been in touch with Deirdre Brock, our local MP for Edinburgh North and she has asked the taxation & competition policy specialist at the House of Commons Library to comment.  The relevant section of his answer is below:

It is the Government’s intention to include legislation to this effect in the Finance Bill 2017, to be published after the Budget – which is set for 8 March. Last month the Government published the majority of the Bill in draft, including these provisions. The purpose of this exercise is to ensure the legislation will work as intendedit is not an opportunity for stakeholders to challenge the underlying policy decision. The closing date for comments is 1 February.” (my underlinings).

Why is this wrong?  Well, it’s quite simple.

The public sector is struggling to make ends meet. The pressure on A&E departments may be the most obvious manifestation of this but there are many, many other areas where the money available just won’t go far enough. 

There are, as I see it, two likely outcomes for the public sector if/when these changes go through. Firstly, they could, in theory, simply change from hiring temporary employees to hiring permanent employees.  However, as anyone with any knowledge of the public sector is well aware, its various bodies simply do not have the budgets to do this and, moreover, there are competing priorities (care being the obvious one) which are far higher up the political agenda. The alternative is to carry on with the existing system and hire through intermediaries, but accept that contractors, realising that as they are no longer self-employed their costs will increase and their incomes fall, will seek a 20%+ hike in their rates to compensate. And of course, the public bodies do not have the budgets to do this…. 

For contractors, who would become full-time employees, with all that implies in terms of having to pay NI, pensions, etc., unless they have a visceral commitment to the public sector there is one easy solution; to wit, they will rapidly make tracks for the private sector.

See what I mean about a lack of joined-up thinking?

In turn, all of this will mean fewer contractors working in the public sector – in our line of work this means the people with the IT skills that are required for completion of major projects (of which more below) – and that will put pressure on the public authorities to find a solution.  One obvious one will be to go to the very big international players –the “SIs”– who will increase the numbers coming in under Tier 2 visas to make good the deficit.  That may be a possible stop-gap solution, but in due course those coming in under the visa scheme will invariably leave the country, taking their expertise with them. None of this is good for the economy as a whole.

Given the state of public sector finances, tough choices will have to be made by FDs about how, where and to whom to allocate money. While these may be unintended consequences, they are not exactly difficult to foresee and should certainly have made the legislators pause for thought before promising this will hit the statute book this April.

It isn’t as if they haven’t been warned. In August last year, research by the Recruitment & Employment Confederation showed that the public sector itself wasn’t exactly brimming with confidence at the prospect.  Some 70% of public sector HR managers believe this change “will have a negative impact on councils, hospitals and schools … (and) a survey of 95 HR managers in June and July this year shows that 69.5% fear that the proposals will either put up such outfits’ wage bills or reduce their ability to attract talent.”

Even if all this didn’t cause the government to take stock, there are yet other factors that ought to have… 

In her address to the CBI in November last year, the Prime Minister (rightly) stressed the importance of science and technology. Included in that speech were the following comments:

We’re ambitious for Britain to become the global go-to place for scientists, innovators and tech investors.

“Today, Britain has firms and researchers leading in some of the most exciting fields of human discovery. We need to back them and turn research strengths into commercial success….

“A new Industrial Strategy Challenge Fund will direct some of that investment to scientific research and the development of a number of priority technologies in particular…”

When it comes to our area of IT, this then creates a further problem. There is a huge demand for really skilled and experienced people to help create and drive forward digital government services. At present, the contracting model under IR35 works well for this – providing short-term expertise when it’s needed but without landing the public sector with all the costs (and some rights) of employment.  Some of the public sector IT projects are critically important, particularly in areas such as cyber-security.  How will Britain become the global go-to place for IT professionals, scientists, innovators and tech investors in these circumstances?

 A final irony – which might give a breathing space?

Finally, in a supreme case of irony, one of these new public sector IT projects involves the need for a new Employment Status Individual online tool. At present, HMRC has such a tool which “enables you (employers) to check the employment status of an individual or group of workers – that is whether they are employed or self-employed for tax, National Insurance contributions (NICs) or VAT purposes … Individual workers can also use the tool to check their own employment status.

Then, in the HMRC consultation document from last summer on the changes to IR35 we can read…

The government intends to develop a new online tool for determining whether an engagement is in scope for the rules. An important part of building the tool will be input from stakeholders and the government welcomes expressions of interest in working with HMRC to develop and test the new tool.

The irony is that this tool is supposed to be being updated to allow the new changes to IR35 legislation to happen. In fact, it was supposed to be ready by autumn 2016, but is still not live.  Without this, it may be arguable that the government needs to hang fire before introducing the new legislation. 

In conclusion

 

I shall declare an interest. Be-IT has a moderately large percentage of its business in the public sector contracting market.  We stand to lose, and so do our clients and contractors/candidates.

Crucially, if this were to be extended to the private sector – something that the government has said will not happen (but we know that politicians don’t always keep their promises!), we don’t just stand to lose – we stand to close down. Be-IT is not “just about managing” (in fact we’re doing quite nicely thank you), but we – and many of our competitors - might well be “not managing at all” if the worst-case scenario for IR35 comes to pass.

Even a best-case scenario won’t do us a lot of good either. Encouraging small businesses ought to be in the DNA of every serious political party, not creating conditions where they could all too easily go bust. Add in the ramifications of this policy for the public sector and surely there is a case for an eleventh hour rethink?

Is it too late to make changes to this legislation? Possibly not, but we would encourage everyone who is potentially affected to strive to encourage the government to do so.  We do this not to help individuals maximise their opportunities to avoid tax. It is incumbent on all individuals and firms to do so – and for HMRC to collect all the tax that is due.  Rather, we believe it is the right thing to do, right for small firms like ours, right for the public sector and right for the economy as a whole (which is going to need all the good news it can get as we proceed through the Brexit negotiations).  If you agree, please email me at gareth.biggerstaff@be-itresourcing.com and I shall forward all comments to the MPs with whom I’ve been working to try to change the government’s mind. Or, better still, get in touch with your own MP. The more we can bring this to the politicians’ attention the better.  We can – and must – try before we are no longer able to do so.

Gareth Biggerstaff, MD, Be-IT Resourcing

 

Comments

To register your vote to start discussion to scrap the latest changes go to - https://petition.parliament.uk/petitions/170118
Posted on Tuesday, January 24, 2017 12:01 by Chris

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