Contractors may benefit in the short term from changes to IR35 that put end-user clients in the frame for penalties when workers are found by HMRC to be guilty of false self-employment.
However, as Alan Rommel, Managing Director of specialist contractor agency Parity Resources explains, if the cost and complexity of hiring contractors in the UK starts to increase, ultimately it would be negative for all. “If that were to happen,” he says, “then it is likely that many clients will seek the flexible skills they need from outside the UK, potentially damaging the long term viability of the sector.
“If the review of IR35 currently underway by the Office of Tax Simplification (OTS) results in higher costs for clients,” continues Rommel, “those clients are likely to take their business elsewhere, which means outside the UK.”
Could changes to IR35 mean a return to the ‘bad old days’?
According to Rommel, before IR35 was introduced, clients were fair game to the then Inland Revenue (now HMRC). Firms employing contractors and freelancers were the target of PAYE compliance investigations, and as early as 1990 contractors were asked by clients to prove they were self-employed in the eyes of the taxman.
“Clients were investigated by Inland Revenue inspectors for failing to pay income tax and National Insurance Contributions (NICs) under the Pay As You Earn (PAYE) scheme for their contractor workforce,” says Rommel. “Those found guilty could be liable for back taxes, interest and penalties, although many firms put up a spirited defence and won.”
Returning to these ‘bad old days’ that punish contractor clients might generate short-term increases in tax yields, but Rommel believes many clients will simply offshore the work in a lower cost and less regulated jurisdiction, ultimately resulting in a less flexible and competitive workforce.
“It was the agencies that stepped into the role of protecting clients from the risk of transfer of debt obligations for tax and NICs, as well as employment laws,” he says. “That’s a scenario we are very familiar with now, especially since the Managed Services Companies legislation was introduced in 2007.”
The impact of IR35 on clients and agencies
Rommel explains that when IR35 was first introduced in 2000, and contractors started feeling the pain, there was little that agencies and end-user clients could actually do to help contractors: “Following the introduction of IR35, the cost to the sector of accommodating the new law was significant. Parity Resources and others in our field invested substantially into reviewing our contracts so as to make them as IR35-friendly as possible.
“However,” he continues, “as an agency we can’t influence the day-to-day relationship between the contractor and the client, and it is just such relationships on which many HMRC decisions about IR35 and employment status hinge.”
Over time, Rommel has seen the growth of a whole new services sector providing IR35 contract reviews, IR35 investigation insurance and expert advice for dealing with HMRC investigations. In addition, there has also been the growth of trading models as alternatives to contracting through a limited company; these include things such as umbrella companies and offshore solutions.
Changes to IR35 mean changes to risk management
“Ultimately, clients want access to specific skills on an as-needed basis at a good price and with the minimum of administrative overheads and risk,” explains Rommel. “The OTS has a brief to make changes to IR35 that are revenue neutral.
“But placing additional costs and risk on clients and agencies will, in the medium to long term, have the opposite effect. That’s because they will reduce the UK’s direct tax yield as clients offshore their business or potentially relocate. Even more damaging, they will de-skill the UK just at the time when it needs access to a highly skilled flexible workforce the most.”
Ultimately, clients want access to specific skills on an as-needed basis at a good price and with the minimum of administrative overheads and risk
Alan Rommel, Parity Resources
In addition, points out Rommel, key occupations which are already suffering skills shortages will be further hit: “We don’t have enough entrants into the IT and engineering sectors at the moment, and punishing those who want to benefit from their investment in gaining first class IT and engineering skills will deter those at entry level, starving the sectors of vital new blood.”
Avoid ‘one size fits all’
Rommel fears that changes to IR35 could potentially land contractors with a piece of tax legislation that tries to be all things to all taxpayers. “The Agency Workers Regulations (AWR) are a classic example of a piece of legislation designed for a specific purpose, to protect vulnerable workers, but which will almost certainly be applied indiscriminately when it comes into force next year, thereby catching highly skilled, high earning contractors who don’t need or want any protection.”
Rommel says: “If we assume the worst and any changes to IR35 will result in greater risk to clients, agencies will most likely require contractors to go down the umbrella route, or might take them on as agency employees under PAYE. This might in the short term mean more tax for the UK, but it will stifle flexibility at a crucial stage of the UK’s economic recovery.
“That,” he concludes, “is the last thing anyone wants to see as a result of changes to IR35.”