Delay or not on IR35 reform, the damage will be done

They may be thriving right now, but Britain’s professional contractors are going to come under intense pressure thanks to the chancellor’s Budget 2018 plan to impose the public sector’s IR35 tax reforms on all of them who work on behalf of large and mid-sized businesses, writes Lee Murphy, founder of contractor cloud bookkeeping software Pandle.

Outlining his plan on Monday, Philip Hammond at first appeared to offer a reprieve to the contracting sector, delaying implementation of the new IR35 regime until April 2020 and exempting small firms.

Well, he may have pushed it further down the line but make no mistake, private sector IR35 reform based on the 2017 off-payroll rules will impact the majority of contractors who rely on medium and large businesses for their income.

Under the envisioned private sector rules, which have a foundation in the public sector that the government already admits needs ‘refining,’ large and medium-sized companies will be forced to review all their contractor agreements to ensure that freelance, independent consultant are being taxed in the right bracket. Effectively, if a contractor is deemed suitable for IR35 taxation, the company is liable for deducting income tax and employee national insurance contributions (NICs), as well as paying employer NICs.

What we have here is that instead of helping Britain’s freelancers and contractors to be as strong and flexible as possible, in preparation for Brexit and the years ahead, Mr Hammond has weakened the independent labour market by hitting it in the pocket. Forget ‘giveth and taketh away’ as chancellors usually do at Budgets, this is just plain taketh away. It’s something that, whether there’s a delay or not, has the ability to end up stifling innovation for the entire tech sector -- where contractors are most prevalent.

Just look at what’s happened in the NHS -- another sector reliant on temporary expertise where the inspiration for the 2020 rules has been in force since April last year. Due to organisations trying to game the system and simplify the obligations it imposes on them (roughly the same obligations we can expect in April 2020), NHS bodies have neglected to review every contract and instead insisted that all freelance workers signed up to umbrella companies.

This has happened in a sector extremely fond of thousands of contractors, given that it forked out £2.9bn on contractors and locums in 2016 and 2017. After the IR35 reforms were implemented however, the NHS simply placed all independent workers inside IR35, regardless of their working arrangements.

The locums’ group IHPA and others have calculated that those deemed inside IR35 – so almost all contractors supplying our health service -- have seen their income slashed by as much as 50%. The result? Many contractors can simply no longer afford to work for the health service, leaving it with a skills gap it cannot close.

And the situation is likely to get worse. A massive 98% of independent healthcare professionals said they would look for alternative work, in response to a real-terms pay cut caused by ‘blanket’ implementation of IR35 tax reforms.

Translate this to the IT sector. If tech companies working in the commercial sector opt for the same blanket IR35 approach to all contractors (one leading agency has already ‘guaranteed’ that they will), they could also find top talent hard to come by. So this really is something that could be disastrous for the economy. Oh, and it’s scheduled to happen just after the UK leaves the EU, just when we’ll need all hands to the pump in the engine room of the economy.

I’d like to remind the chancellor that it’s no mean feat to create a successful career as a contractor. These are sought-after, highly skilled individuals, who tend to work for larger and medium-sized companies on a project basis. They are entrepreneurs who make meaningful contributions to UK Plc, effectively managing their own business and paying all the running costs that entails without the luxury of holiday and sick pay. The same entrepreneurs who, on Monday, Mr Hammond paid tribute to. He claimed: “Encouraging entrepreneurs must be at the heart of our strategy.”

So the chancellor has failed to consider the many sacrifices made by contractors, putting them in the same tax bracket as the employed. These currently independent, agile business-owners will likely be forced to join umbrella companies and become employees, paying more tax and national insurance.

To give some insight into just how much contractors can expect to lose, we did a few sums. If you expect to earn £50,000 in the current financial year, your take-home pay -- after tax and national insurance -- should be around £43,670. Fast-forward two years and, having joined an umbrella company where your revenue contributions are now calculated by your latest employer, your income (after tax and NI) will drop by 13.5% from £43,670 to £37,696.

For a contractor earning £90,000, the financial hit is even worse. Their take-home remuneration will fall from £70,037 in the current financial year to £60,949 after April 2020.

To prepare for the changes, all businesses – including the targeted PSCs -- will start taking steps now. For non-contractors, these steps are to assess who is inside, and who’s outside IR35. Contractors should expect this process to begin in the near future, at places they work. 

For these currently self-employed “strivers” -- people who Mr Hammond also claimed his Budget is designed to support, it may be time to do a few sums. You’ll need to assess how the IR35 reforms will impact your own income. The reality is you will likely be expected to move into an umbrella company, so now’s the time to start researching what is available and gauging their relevance to your business, as well as asking other contractors who’s good.

Or can you make the reform work for you? Perhaps consider your own customer base and whether you could move away from larger employers. How feasible is it to work with smaller businesses instead? Could this sustain your business in the long term?

The extension of IR35 reform is an unwelcome change, and the delay for many will be seen as a distraction. After all, it’s still incoming in the next fiscal year. Only by preparing for the changes can you give your business its best chance of success because, unfortunately, there’s currently little sign that the government will rest until it’s implemented.