The devastating impact of IR35 on business and the UK economy

Source: Julia Kermode, FCSA

Interim Hub - The devastating impact of IR35 on business and the UK economy

April 6th 2017 might have been just another date at the start of another new tax year but for many in the public sector it has become a significant date.  The IR35 reforms in the public sector came into effect on that date and since then employers in the public sector have been required to deduct tax and national insurance contributions from contractors’ pay at source as though they are employees.  The impact on our public services has been devastating but still the Government seems to be standing firm that extending IR35 into the private sector would remove any disparity between the two sectors and level the playing field. It has been the cause of much heated debate which has fallen on HMRC’s deaf ears and the political temperature is bound to hot up as we move into the consultation period.

In the last few years we have seen many changes to tax legislation and I would argue that IR35 reform is one change that has not been properly targeted, not been proportional and not been fair for the vast majority of genuine self-employed workers or the businesses that have engaged them.

Broadly speaking, IR35 reform in the public sector has resulted in a less flexible and less agile workforce that is more expensive and more complex to administer and I am deeply concerned about the potential impact of rolling out the change to the private sector, particularly when it comes to the UK’s position in the global marketplace.  Simply put, if the Government makes it too difficult or too expensive for businesses to access the workforce and talent they need within the UK, then why should they do business here?  Right now, the timing is wrong and will put our economy at unnecessary risk.

Should the Government choose to plough on and roll out the reforms into the private sector I anticipate the following impacts:

The extension of IR35 could undermine Britain’s flexible labour market.

Matthew Taylor, author of the Taylor Review into modern employment practices has stated that the UK’s “flourishing” flexible labour market is one of the country’s biggest strengths, and the ‘envy’ of the world.  If the IR35 reforms are extended to cover the private sector, this workforce flexibility will be irreparably damaged and, together with the cost to businesses, will damage competitiveness.  There are approximately 5.5m private sector businesses in the UK, many of whom engage personal service companies, typically in high-skilled, high value activity for a short period of time.  All businesses that are engaging anyone to undertake work for them – from engaging a management consultant / strategy expert to advise the business on next steps to a web designer, and potentially even handymen & handywomen, decorators, gardeners and window cleaners if they work through their own personal service company (as opposed to being a sole trader) will be affected.

For larger firms, the challenge will be in identifying people providing services through their PSCs.  For example, a marketing department might decide to engage a web designer and it would simply appear as a cost in their purchase ledger.  Previously that would have been the right process but ultimately everyone in all departments who might be engaging an individual directly will need to be aware of the off-payroll rules. Effectively all business purchases may need to be checked, which would be time-consuming and unwieldy.  The impact will be massive.

The extension of IR35 reforms will actually stimulate tax avoidance

An extremely serious consequence of the public sector changes has been the exponential increase in tax avoidance that are deliberately and specifically targeting contractors whose income has been reduced.  These are particularly rife within the health sector where hard-working non-permanent workers can little afford a reduction in take-home pay.  Worryingly, such avoidance schemes often put the individual choosing them at very significant personal financial risk by disguising their remuneration as something else, often an offshore loan.  Such loans are repayable at any time, and these individuals are at risk of receiving an accelerated payment notice from HMRC, meaning that they will have to pay the disputed tax upfront before any investigation or consideration of specific circumstances.  The magnitude of such tax bills is very significant, in short people’s homes will be at risk if they cannot pay.

And it isn’t just loan schemes, there are many different variants of disguised remuneration schemes that seek to reduce workers’ taxable pay.  Often, they are very complex with people simply not understanding what they are signing up to – however not understanding the scheme will not circumvent their personal financial risk, nor will it safeguard them from future tax bills.

The extension of IR35 reforms could reduce tax receipts by significantly delaying major projects and the tax-generating output they produce.

Project delay has been one of the well-documented impacts of IR35 on the public sector.  Transport for London reported that a ‘significant number’ of contractors stopped working on projects as a result of IR35 changes – a move which has led to skills shortages and the significant delay to critical repairs.  We are also aware of important IT projects within the health sector going on hold due to skills shortages.  These are just two examples of delays, which means that the workforce that would have been engaged on these projects won’t have been generating tax receipts for the Treasury.  The private sector does not generally have the luxury of delaying projects as businesses must continue to generate their required outputs and must weigh up the costs of doing so.

The extension of IR35 reforms will significantly increase employment costs.

The experience of public sector bodies suggests this will happen as they have been forced to pay increased rates for contractors.  Respondents to an APSCo survey conducted last year pin-pointed scarcity of resource as the primary cause of this increase in costs.  Such costs have increased at an unsustainable level, with 53% of those reporting a rise highlighting increases in rates of more than 15%.

The extension of IR35 reforms will significantly increase red tape and administrative burden for businesses.

Given that each and every contractor’s specific working practices will need to be individually assessed, the impact of extending off-payroll to the private sector will significantly increase their administrative and red-tape burden.  According to the Office of National Statistics, the non-wage employment costs of having staff increased by 3.9% year on year in the three months to July 2017.  The ONS also said that since 2000 non-wage costs of employment have almost doubled, rising by 99.1%.  Similarly, a report from the British Chambers of Commerce and Middlesex University found 80% of businesses have seen their costs increase this year due to changes to the national living wage, pensions auto-enrolment and the apprenticeship levy.  With further increases to costs likely, 38% said they would raise prices, 25% would reduce pay growth, 21% will reduce staff benefits, and 20% said they would scale back recruitment.  At a time when the UK needs to be competitive in a global marketplace, it would be wrong to unnecessarily target businesses which are the backbone of the economy.

Given that there are over 5.5m private businesses in the UK compared to 50,000 public sector bodies it will require a large scaling up of current policy implementation and I would suggest that HMRC lacks the capacity and capability to enforce IR35 in the private sector. HMRC is already over-stretched and the public sector changes were not implemented effectively or smoothly as a result.

Work patterns are changing and we are seeing a growth in non-traditional employment that is going to continue.  This is a structural change to the UK workforce that requires a structural change to regulations, and a holistic approach to any reforms.  Instead we are seeing knee-jerk changes driven by tax collection for the Treasury’s coffers which have the potential to starve the growth of the UK economy and strangle the flexibility of the labour market.

Our economy needs stability right now and any move for a private sector roll out of IR35 will serve to unsettle the UK economy, UK plc and the many hard-working genuine self-employed freelancers and contractors who are supporting UK businesses and helping them to thrive.  We need to work together over the coming months to ensure that our message about the devastating impact IR35 will have does not fall on deaf ears and the policy makers must listen.

Julia Kermode is chief executive of The Freelancer & Contractor Services Association (FCSA), the UK’s largest independent trade body that is committed to setting standards for umbrella employers and contractor accountancy providers.

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