IR35 has splintered UK contracting, with vast unintended consequences government shouldn’t shirk

Excuse the off-payroll 101, but I need to start off with intentions to really show just how grave today’s unintended consequences of the government’s April 2021 rules on IR35 are, and have become, writes Adrian Smith, senior director of operations at Randstad UK.

The IR35 rules aimed to make sure that a worker, who would have been an employee if they were providing their services directly to the client, pays broadly the same tax and national insurance contributions as an employee. This was laudable. 

Harm

But there’s no question that the changes to off-payroll working introduced by the revised IR35 legislation of this year, have harmed contractors.

In the past, contractors decided whether their working arrangements fell inside or outside IR35. But since April, their status has been determined by the client. If the client decides that IR35 should apply to the engagement, payment to the contractor will be taxed at source.

Impact on the contractor workforce (cont.)

The effect is most obvious when we look at the volume of people in the game. According to the Association of Independent Professionals and the Self-Employed, more than a third (35 per cent) of contractors have left self-employment since the changes to IR35. 

Some contractors have retired. Other contractors have gone to work overseas. The good thing is the country isn’t facing an astonishing skills shortage which policy makers aren’t getting on top of; right?!

Temp pay has plumetted

Why a shrinking talent pool? Well, we’ve got shrinking wage packets. Contractors in scope of IR35 saw about a 20 per cent reduction in their take-home pay. 

But that’s only an average, our database shows. Four out of five contractors (that’s 80 per cent of contractors) working inside IR35 have seen a drop in their quarterly earnings – of 30 per cent. And a quarter of contractors we’ve placed say their income dropped by MORE THAN 40 per cent.

IR35's knock-on effects outside of IT contracting 

This, in turn, has hit pay for permies -- as some IR35-hit contractors moved into permanent employment, unbalancing supply and demand. Our research further found that high-flying cyber security specialists (in Scotland) actually saw their salaries DECREASE over the 12 months to spring 2021. That’s at a time when you can’t actually seem to move for cyber-attacks on organisations!

Off-payroll rules non-compliance (includes ‘SDS; what SDS?’)

Unfortunately it gets odder, and just plain worse. Under the new IR35 rules, clients are now required to give contractors a Status Determination Statement (SDS) to confirm their IR35 status. 

But our database shows nearly two out of five contractors (38 per cent) say their clients have not done this. Other issues include clients who have blanket assessed all engagements as inside IR35 and even blanket bans on contractors altogether, seemingly at odds with the new IR35 legislation’s ‘reasonable care’ requirement.

The fallout continues, affecting expenses, costs, rights

On the ground, contractors are also concerned about business expenses, which most contractors now cannot claim from their umbrella company. Others are worried by the cost of employer’s National Insurance. In particular, 33 per cent of contractors said they were dissatisfied with employer NI -- most likely because many umbrella companies are effectively passing this cost on, through a deduction from their contractors’ day rates.

Of those steadfast individuals who remain contracting, some are still managing to work outside IR35. But we can see about one third are now working through unregulated umbrella companies, while another third work through engagements deemed ‘inside IR35’. As accountants and other advisers have well-established, working inside IR35 not only has significant financial consequences, but it also leaves contractors essentially in ‘no-rights employment.’

From the client side: a true story of a PSC banner -- now reformed

We have had some interesting discussions with clients about the off-payroll reforms. 

One particularly risk-averse client with a large number of IT contractors had never needed to worry so painstakingly about their contractors or their taxes before. Suddenly they needed to take responsibility for it. But they didn’t know how to approach, probe or scrutinise their contractors. Nor did they have the manpower to do so. They just had contractors, who the IR35 rules suddenly said they needed to check out (after telling them for many years to take a hands-off approach to such ‘in business on their own account’ workers). 

As the client summed up – in their own words: “The challenge in terms of knowhow and administrative muscle, as well as risk and compliance, proved too daunting. We didn’t rise to it.”

When the April reforms kicked in, they took the decision to ensure their contractors worked on an inside IR35 basis only. An initial ‘PSC ban’ policy proved to be a mistake as they either lost or ruled out too much talent.

This organisation aspired to raise the level of talent in their organisation -- but in one fell swoop, they both drained their talent pool and shrunk the potential talent pool they were trying to fish in, with their ‘inside IR35 only’ offering.

They were nervous for quite a while but, from our perspective as their agency, we had multiple clients, across multiple industries, going through exactly the same thing. We told them we had seen other clients successfully adjust to the new IR35 situation and fortunately, eventually, we were able to talk them down. In short, once this organisation had had time to reflect, they were persuaded to take a more nuanced approach and they widened their contractor net again.  

What are the latest pay trends for IT contractors?

Fortunately for only very recently reeling contractors, such early teething problems are now clearing up. As a result, growth is now pushing pay for independent professionals in the other direction. Even where IR35 is in play, day rates are up.

For example, a .Net developer on a six-month contract working fully remotely can now command a day rate of £500 -- inside IR35, through an umbrella company. That’s a 25 per cent increase on one year ago. 

Positively for tech as a sector, our agents are seeing signs of progress in the perm sector too. Individuals’ bonus forecasts are 25 per cent higher than they were last year. Almost two in every five tech professionals (39 per cent) now expect to receive a bonus. And as we've touched on before, the UK technology’s industry’s bonus pot is set to top £1billion this year, up from £664m in 2020.

How should IR35’s list of unresolved issues be addressed?

Short of turning IR35 off and on again, and bar the Lords or the NAO actually being listened to by the government, how should we go about fixing IR35 reform’s many unintended consequences and effects, for IT contractors, organisations and others? 

To us, it’s pretty fundamental really. The government must accept the distinction between flexible contractors and employees, and potentially even encourage its enforcer of the rules, HMRC, to actively pass acceptance of this distinction onto all medium and large organisations. It shouldn’t be root and branch stuff because the root and branch stuff has already been achieved; the problem is the bark has splintered with many IR35-caused cracks not getting any government attention. To treat some of those, I strongly suggest the government should move to accept the sensible recommendations of the Taylor Review, a review only part implemented despite being conducted well-approaching four years ago.