From April 2020, private sector contractors in the UK will fall under the remit of IR35. Their client firms will have to ensure that National Insurance contributions and income tax apply to many of their contracted personnel.
It’s a good idea as far as HMRC are concerned, but in practical terms, it means that many of the two million freelancers in the UK (730,000 of whom are in professional occupations, and 480,000 in managerial occupations, according to IPSE) are about to lose a quarter of their income in an effective tax rise. The firms who engage these contractors will become liable for National Insurance (NI) contributions. If evidence from the public sector is anything to go by, a third of organisations may struggle to retain talent as contractors decide that higher taxes and NI represent too high a cost of entry.
Financial services firms are lobbying hard against IR35 being extended, on grounds that range from systemic inefficiency to contractor backlash – and we don’t blame them for being concerned. The financial service industry is held up by contractors. Digital and business transformation, in particular, is often carried out by contracted personnel. What will happen when those contractors have to leave the industry, become full-time employees, or restructure their businesses on the fly to avoid IR35?
Contractors in financial services
In an article for efinancialcareers, Suzie Wang – former investment banking analyst for Credit Suisse – writes that contractors are indispensable to the financial sector. The work they carry out is related to complex regulation, and can’t always be taken on by full-time staff. Their experience in specific and difficult work means they can be brought in to troubleshoot or transform and hit the ground running, while their employment status allows them a clean departure when the work is done.
Bradley Post (MD at Rift Tax Refunds) describes IR35 as “an uncomfortably large and bitter pill to swallow”, for two main reasons.
“Organisations and contractors both benefit from the current state of affairs.”
Firstly: organisations and contractors both benefit from the current state of affairs. Employers can save on NIC contributions and benefits for contractors who might only be in post for half a year. Contractors can take advantage of tax planning opportunities to increase their take-home pay, and have far more control over their expenses and time than Pay As You Earn employees.
Secondly: HMRC’s Check Employment Status for Tax (CEST) tool (the recommended system to use when establishing whether your contractors should, in fact, be your employees) is, according to many, unfit for purpose. For instance, according to Post, CEST “appears to ignore the important concept of Mutuality of Obligation altogether.” Mutuality of Obligation exists when one party is obliged to offer work to another, who is obliged to accept it. It’s a key distinction between employees, for whom mutuality of obligation exists, and contractors, for whom it doesn’t – and it’s outright ignored by the current compliance system.
Now think back to Suzie Wang and her description of project-by-project working in the financial sector where contractors join a business to oversee a policy change or the rollout of new technology and move on in six months. Any investigation and compliance procedure for implementing IR35 in the financial sector has to take this pattern of work into account. And this isn’t the only area in which systems and processes are not up to date.
The legacy problem
Legacy IT systems are a dark horse in financial services – a dormant challenge which has been lurking behind the bright future of fintech for years, if not decades. The original digital transformation of the financial sector in the 1960s brought in the first mainframe systems to support data processing, and some organisations are still using those systems to this day. Traditional banks, in particular, are already struggling against emergent, digital-ready organisations: as Auka founder Daniel Döderlein puts it, “many banks are effectively running a horse and carriage set-up, and they’re competing with folks driving Teslas”.
“A full tax year could be needed to make back-office software IR35 compliant.”
IR35 is set to add a further burden to the IT legacy problem. The Association of Accounting Technicians warned Computer Weekly that a full tax year could be needed to make back-office software IR35 compliant. On the plus side: work for software developers. On the minus: no simple, easy-to-implement way to bring contractors onto the payroll, if they even want to come, and a whole year in which payroll needs to be processed, and further costs could accumulate.
Ironically, the same warning came with a damning legacy accusation about IR35 itself: “IR35 is nearly twenty years old, and has consistently failed to resolve the wholesale non-compliance it was put in place to address.”
How financial services can prepare for IR35
Online accountancy firm Crunch wrote a letter to the government, suggesting that businesses with a turnover of less than £50 million per annum should be exempt from IR35, as should personal services companies working with them. The idea is to prevent IR35 from punishing smaller, newer companies without the resources or capacity to bring all their key personnel onto payroll or field their backdated tax.
For larger businesses which work with contractors, the key is going to be decision-making. When IR35 is extended to the private sector, the onus will be on clients to decide whether their contractors are inside or outside its remit. Financial service businesses will, therefore, have to rethink their existing and future relationships – should a particular role be carried out in-house? Is a given hire truly a business-to-business relationship, or a way to secure a professional’s services in the short term?
From the contractors’ point of view, caution should be the watchword. Contractors may be facing a reduction in income, but they will remain employed – and probably at a very respectable salary. Contractor pensions offer a way to obtain tax relief on PAYE income and may be worth pursuing to manage the immediate impact of being brought into IR35.
And for everyone involved, it’s important to collaborate. Contractors, agencies and clients need to work together, creating a joined-up picture of what work is being done, under what obligations, and under what span of time. It may be the client’s responsibility to determine whether or not a contractor should be a contractor, but the consequences of the decision affect everyone involved.
Many contractors will choose the security of agency work – or even a full-time position. If such is your plan, start your search for a suitable role here.
