Recent decisions by major employers such as Barclays and Lloyds to bring all contractors onto payroll have ruffled feathers in the contractor community. Six months before IR35 legislation is extended to the private sector, do employers face a talent drain or can they still engage with a flexible, self-employed workforce without facing the wrath of HMRC? Jo Faragher investigates.
Contractors in the banking sector will have been mulling over their career options in the past few weeks. Around six months before the IR35 tax legislation comes into effect for private sector companies, a host of banks including Barclays, HSBC and most recently Lloyds have informed contractors that they will only be engaged if you go on the payroll and pay as you earn (PAYE).
For thousands in the freelance community, these demands could mean significantly less take-home pay and reduced flexibility in how they work. The shift has already happened in the public sector. In April 2017, the government amended existing IR35 legislation so that public sector organisations employing contractors working through limited companies – meaning they pay less tax and national insurance – would now be responsible for deciding whether they were inside or outside of IR35.
IR35 in the private sector
Genuinely self-employed contractors are deemed to be outside, but if you are considered inside IR35, HMRC expects you (and your employer) to pay the same tax and NI contributions as other, permanent employees.
From April 2020, these rules extend to the private sector – and as recent headlines have shown, a number of organisations have opted to avoid the risk altogether by simply demanding everyone goes on the payroll. Don’t like it? Go elsewhere. In the gig economy era when the buzzwords are flexibility and agile, this seems counter-intuitive to say the least.
Shift in responsibility
Is the banks’ reaction over the top? When the changes to the legislation were announced, HMRC claimed that the legislation was not designed to discriminate against genuinely self-employed people, although it is expected to raise £1.1 billion for the Treasury in its first year. Its aim is to clamp down on “disguised employment” – the practice of engaging a worker and treating them as self-employed but to all intents and purposes they’re an employee.
Now that the onus is on the employer, rather than the contractor, to ensure they’re paying the appropriate level of tax, it’s understandable that they want to mitigate any risk. But many believe they’re taking it too far.
“Some [organisations] are refusing to engage with the rules, saying ‘we just won’t take on any contractors’, when there are a lot of genuinely self-employed contractors who won’t even be given the opportunity to demonstrate they work outside IR35,” says Andy Chamberlain, deputy director of policy at the Association of Independent Professionals and the Self Employed (IPSE).
“If you decide that the relationship is one of employer and employee going forward, then there will be consequences from that. Are they then owed holiday pay? Do they acquire the right not to be unfairly dismissed? In theory this could be an issue” – Kevin Charles, Crossland
So what can companies learn from the public sector’s experience? Shortly before the new rules came into effect in 2017, there were widespread predictions that contractors would take their services to the private sector rather than be forced to go on payroll.
One London NHS Trust lost 30 IT contractors on an already-overrunning migration project after it said it would declare them to be inside IR35. HMRC delaying the launch of its Check Employment Status for Tax (CEST) tool until a matter of days before the legislation came in did not help.
“The public sector’s cautious approach to IR35 by deeming entire contractor populations as inside only created further problems, with many contractors quickly leaving their roles to pursue other assignments – and often with competitors – or pay rates increasing considerably in order to retain their services and skillsets,” says Phil Beardwood, compliance and assurance director at the Morson Group. A recent survey by specialist legal firm Brookson Legal found that three in five private-sector contractors will consider working elsewhere if they are found to be inside IR35.
Transparency or talent drain?
Amit Kapoor is a commercial manager in a central government department and also runs his own intermediary company, Mindful Contracts, employing about 40 contractors. He says the rule change has in some ways made things more transparent.
“In some ways it’s become easier and more assured,” he says. “Any declaration happens upfront, rather than the contractors having to self-certify, only to be disproven later on. Now they can pick and choose the jobs they apply for. They also know that any questions will be asked of the client rather than the contractor themselves.” However, with some employers only advertising roles inside IR35, there’s no doubt that the available pool of talent has reduced, he adds.
It’s this that could force private sector companies to loosen any blanket policies on hiring contractors, believes Julia Kermode, chief executive of the Freelancer and Contractor Services Association. “In the public sector a number of employers made similar decisions [to Barclays et al] but reversed the decision for key contractors who said they would only work for them through a limited company. They had increasingly long lists of exemptions – the workers it was OK to engage with in a different way.”
In terms of preparation, it’s a good idea to do an audit of your contractor workforce now, advises Anna Cope, a partner at law firm CMS. “You can still engage with contractors through limited companies, but if their services are provided through an intermediary you may need to take on those additional payroll costs such as employers’ national insurance contributions,” she says.
Ultimately, it will come down to commercial realities – if there’s an IT contractor that would be impossible to replace but who insists on working outside IR35, there may be ways the two parties can work together to come up with a satisfactory arrangement. Other additional factors to consider include demands for rate rises (contractors forced to work inside IR35 could end up taking home around 25% less after tax), and contractors’ expenses (certain expenses will now have to come out their post-tax wages, which could mean a substantial reduction in take-home pay for contractors who travel).
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Kapoor argues that companies should “open their minds rather than giving up before they’ve even tried”, for example considering the rules around substitution, which asks if the contractor send someone else in their place. If not, they are more likely to be deemed inside IR35. “All you have to do is prove that you could substitute, or that you would – it’s a hypothetical scenario,” he says.
Matt Fryer, group compliance director at the accountants Brookson, suggests that companies explore whether treating someone “slightly differently means you can employ them in much the same way”. He adds that the IR35 conundrum should not be solved by HR or compliance departments alone – it’s a business-wide talent decision.
“Some are refusing to engage with the rules, saying ‘we just won’t take on any contractors’, when there are a lot of genuinely self-employed contractors who won’t even be given the opportunity to demonstrate they work outside IR35” – Andy Chamberlain, IPSE
“Get a working party together,” he advises. “And don’t forget about your current contractors – they’ll be starting to ask questions now about how you’ll treat them post-April. Bring them on the journey with you.”
When it comes to determining status, HMRC advises employers use its CEST tool, but it has been slated for its accuracy. While HMRC says the tool has been rigorously tested and unbiased, one anti-IR35 campaigner went as far as saying the taxman’s defence of the tool was akin to “climate change denial”.
From next April, public, private and third sector employers will be obliged to present contractors with a Status Determination Statement, which clearly outlines and explains the reasons behind the decision to deem the individual outside or inside IR35. As long as employers can show they have taken “reasonable care” to come to the decision and file the appropriate tax documents, says HMRC, they should avoid being penalised.
One potentially contentious issue that could come up is how companies should respond if individuals feel that – since they’ve been deemed an employee for tax reasons – they claim employee status in employment law too.
Kevin Charles, consulting barrister at Crossland Employment Solicitors says: “If you decide that the relationship is one of employer and employee going forward, then there will be consequences from that. Are they then owed holiday pay? Do they acquire the right not to be unfairly dismissed? In theory this could be an issue.” Because the tests for determining status are so similar – such as levels of control, ability to substitute, mutuality of obligation – it’s hardly surprising that a status decision on tax could also raise questions on employment status.
HMRC itself is not immune – Susan Winchester, a marketing consultant employed on a contract basis to the tax enforcement body, took it alongside a recruitment agency and three others to the employment tribunal last year. HMRC had run the CEST tool to determine her status, and the tool decided that IR35 applied. She was forced onto an agency’s payroll, leading her to argue that because she had effectively become an agency worker, she was therefore entitled to holiday pay and to the same holiday entitlement as HMRC employees. She won her claim for more than £4,000 in owed holiday pay.
The public sector’s cautious approach to IR35 by deeming entire contractor populations as inside only created further problems, with many contractors quickly leaving their roles to pursue other assignments – and often with competitors – or pay rates increasing considerably in order to retain their services and skillsets” – Phil Beardwood, Morson Group
Dave Chaplin, CEO of ContractorCalculator, compares the reaction to the upcoming changes as being “like everyone doing 110 miles per hour for the past 19 years with no speed cameras” – when the burden of proof of status lay with contractors, employers were generally “lazy” and fell into habits of engaging people who were effectively employees, he says.
Now they will have to look more closely at how they structure their workforce. “If they start again and look at their business they can absolutely reengage with these people,” he adds. “What they can’t do is manipulate things and dress them up.”
Kapoor says this process needs to be more than just cosmetic: “The danger is that some organisations (often at the behest of agencies) could just choose to make cosmetic changes to make the job descriptions or statements of work to give it the appearance of being outside of IR35, while the underlying job remains inside.
“This is an area where HR within the organisation can play a role in applying their expertise on roles and responsibilities – to provide assistance and guidance to operational managers on how jobs can be structured as outside IR35 so as to attract the whole of the contractor talent pool.”
Many predict that – as has happened in the public sector – major private sector employers will relax their stances as they struggle to find the skills to innovate and remain competitive. “Over time, people got more comfortable with employing contractors and began to work within the risk,” says Chamberlain from IPSE. “When the business requires it, and they see their competitors taking a softer approach and getting ahead, they’ll feel like they should do the same.”