Back in 2017, the public sector had their day of reckoning when new tax rules came into force putting the liability with Public sector employers to determine IR35 status.
As of April 2020, it’s time for the Private sector to face the music.
Around 15% of the UK workforce is self-employed. This is an even higher percentage in the construction industry which is estimated to be around 30 to 40%*.
The industry has seen some progress in addressing this over the last few years. Large contractors like Laing O’Rourke have committed to a permanent workforce and mega projects like Hinkley Point C worked with unions to ensure permanent resourcing strategies are followed throughout their supply chain partners.
Despite this, the new measures are undoubtedly going to hit the infrastructure and construction sectors hard. Many medium sized and smaller contractors and consultants will have a significant proportion of their workforce (including in some instances senior management) operating through a Personal Service Company (PSC’s).
Whereas in the past the onus has been on the individual contractor to effectively comply with the HMRC’s guidelines on applying PAYE and National Insurance, from April 2020 it will become the responsibility of the fee payer – this is either the employer or the recruitment agency.
The only exception will be for businesses with a turnover of less than £10m, a balance sheet of under £5m or fewer than 50 employees.
Any company that falls outside of this will have to decide if the freelance contractor is legitimately self-employed or if they are subject to PAYE and National Insurance contributions. If the latter applies, the company will need to employ the contractor directly and tax as income at source.
What will be the likely impact of this?
The obvious risk for freelancers is that many won’t be genuinely self-employed. A significant number won’t pass the test and will face having to become permanently employed, or alter the way they work and/or who they work for.
Choosing to go down the employment route means that they will be taxed a lot more and see a significant reduction in their net income. Likewise, contractors can continue being employed via a PSC, but operating within IR35 – meaning they will pay income tax and NI as if they were a permanent employee.
The financial impact of IR35 is significant. It can reduce the worker’s net income by up to 25%.
The options to avoid losing out for freelancers are essentially;
- Try to renegotiate their current package with employers to increase their rate.
- To contract via an umbrella company or a consulting firm, trying to cut the best deal they can. This is still likely to lead to a reduction in net income.
- To prove they meet the requirements of an ‘IR35 friendly’ contract by only taking on shorter term contracts, restricting exclusivity and always ensuring contracts avoid a ‘right of control’ clause – a contractor should not directly report to a senior member of staff within the organisation.
Private Sector Companies
The big issue for companies is the sheer quantity of freelancers they use. Employing someone on an interim basis has been a cheaper way of recruiting experienced professionals, particularly in niche areas with big skills gaps.
Just consider the admin costs in managing the monumental task of assessing and implementing any changes, without taking in to account the unwanted hassle and time lost.
Then, once individuals have been assessed, if they are not deemed to be legitimately self-employed, there is the question of how to proceed; employ them on a permanent contract, or, if they decline, recruit someone in their place.
On average, the HMRC’s Employment Status Indicator (ESI) will pass around 30% of contractors’, fail around 30% and 40% will be borderline**. Potentially, a lot of contractors will be issued the ultimatum – stay or go.
If, and that’s a big if, they chose to convert to perm, companies will have to take in to consideration the costs that come with full-time employment. Bonuses, car allowances, pension contributions, healthcare, sick leave and maternity/paternity cover will all need to be paid on top of a salary that is mutually agreeable to all parties, in addition to the employer’s National Insurance contribution (13.8% of salary) that will need to be paid.
And, more likely, if there is a mass exodus, there is the challenge of recruitment. Ignoring the price tag attached to filling so many roles, if companies are to stick to current pay scales, they risk having to sacrifice the quality of the candidates in order to stay within their salary budgets.
The legislation will also make freelancers think twice before contributing on many of the big infrastructure projects that would once have been a very attractive career move. Major projects are likely to lose out on valuable freelance contractors for fear they won’t pass HMRC’s rigid guidelines. Particularly because, in as far as we can tell, no clear stipulations have been published relating to duration of contract. So, in theory, someone brought in for a 3 year project or a 3 month project could both be classified as permanent employees.
How do you determine employment status?
The danger with the new regulations is that many companies are considering a blanket approach to assessing a contractor’s status. This is where the assessment is role based rather than looking at individual cases, to save time and money.
Following the Public Sector IR35 rollout, Network Rail disclosed that only 7 of the 817 contractors who were assessed were judged to be outside of IR35***.
But while this approach was agreed following consultation with HMRC, it contradicts IR35 legislation that states the need for engagers to take ‘reasonable care’ when setting a contractor’s status.
The difficulty lies with actually determining what counts as an employee and what doesn’t.
The government’s Check Employment Status for Tax (CEST) tool has faced some serious backlash, with the government itself admitting that it is flawed, needs to be reviewed and that if in doubt you should seek professional advice.
Yet another cost.
In short, the advice is that someone must pass the principal ‘tests of employment’:
- Control: what degree of control does the client have over what, how, when and where the worker completes the work
- Substitution: is personal service by the worker required, or can the worker send a substitute in their place?
- Mutuality of obligation: mutuality of obligation is a concept where the employer is obliged to offer work, and the worker is obligated to accept it.
However companies and individuals chose to adopt the legislation, one thing is for certain come next April we are likely to see some major changes.
If you are looking at ways to reduce your reliance on interim staff at senior level please email me back to discuss how we can help.