How to keep digital transformation alive after IR35

What is IR35?

Inland Revenue legislation 35 (IR35) is a tax law designed to prevent individuals from using intermediaries, such as their own limited company, in order to avoid paying their fair share of tax and national insurance contributions (NICs). Also known as the ‘Intermediaries Legislation,’ IR35 applies to contractors and freelancers who do not meet HMRC’s definition of being self-employed and who are deemed to be working as employees, without paying the same level of tax and NICs.

What’s changed?

While Inland Revenue regulation 35 (IR35) has been around for twenty years, up until now, individuals could decide for themselves whether they were working as freelance contractors.

By setting up a limited company, some people were able to leave their employment on a Friday and return to the same job on a Monday as a contractor, with no change in their role, duties, or place of employment. HMRC wants to put a stop to this.

However, with an estimated 170,000 contractors working through their own service companies, HMRC has not had the resource to address cases individually and so they decided to put the onus on the organisations that hire contractors.

From 6^th April, the responsibility for assessing whether a contractor is genuinely self-employed (outside of IR35) will fall on every medium and large private sector organisation with a turnover of over £10.2 million, a balance sheet of £5.1 million, and more than 50 employees. This means that every contract will have to be reassessed to decide whether an individual’s work falls inside or outside IR35. Contractors must be provided with a Status Determination Statement (SDS) for each contact that they undertake, confirming the organisation’s assessment of their status for IR35 purposes.

Who does IR35 affect?

Clearly, for major enterprises that have engaged hundreds of IT contractors to deliver large scale digital transformation projects, the requirement to scrutinise every contract presents a major drain on resources. As a result, many of the largest organisations have opted either to take a blanket decision that all contractors fall inside IR35, or they have terminated all external suppliers contracts and demand that they work via umbrella organisations, which will shoulder the responsibility of collecting income tax and NICs at source.

There are two major drawbacks for contractors who continue working for the same enterprises inside IR35 after 6^th April. Firstly, if the contractor was previously deemed to be working off-payroll (outside IR35) and suddenly switches to working inside IR35, HMRC may take the decision to investigate their previous work outside IR35 to discover whether any unpaid tax is owed.

Secondly, tax experts have calculated that contractors being paid the same rate but working inside IR35 will see their income reduced by around 25%.

As a result, several reports have emerged that IT contractors are planning to stop working with their enterprise clients before 6^th April. This could have a devastating impact on digital transformation projects that depend on the specialist skills of external contractors.

The impact of IR35 on Digital Transformation

The financial sector, which typically outsources a lot of development work in order to accelerate digital change, is likely to be particularly affected by the new IR35 rules.

The FT reported that Deutsche Bank, risks losing 50 out of 53 IT contractors working in its London-based change management team, in response to its blanket decision to stop working with individuals who bill for their services via a limited company. Work is reported to have been outsourced to India and Romania, in an effort to keep IT projects on track.

Bank of America has also decided that all new contracts will be inside IR35 by default. The bank has imposed a blanket ban on PSC contracts and ruled that there will be no individual status determinations on a per-role basis.

HSBC, Lloyds bank and Barclays bank are also reported to have taken a uniform approach: classifying all contractors as working within IR35.

Brain drain

Enterprises in other sectors are similarly affected, with the National Grid, IBM and BAE Systems, also reported to be taking a blanket approach and terminating PSC contracts, leaving IT contractors with a Hobson’s choice between working inside-IR35, through an umbrella company, or leaving altogether and seeking alternative work with new clients, outside of IR35.

If contractors leave en masse following an enterprise’s blanket inside-IR35 status decision, this severely jeopardises digital transformation programmes, which may depend on the specialist coding skills of IT contractors to ensure that projects are completed on time, to the required standard, and to budget.

A number of contractors have reported that they plan to seek employment overseas after 6^th April 2020 in order to carry on enjoying the flexibility, job satisfaction and remuneration of working off-payroll. This could result in a brain drain for many sectors, such as banking, which relies heavily on the skills of external IT contractors to deliver digital transformation. The recently announced points-based immigration system adds another barrier to plugging the UK’s digital skills gap with IT contractors from overseas.

Fast track to digital delivery:

It is clear that IR35 could pose serious challenges for digital change in the UK after 6th April. However, some CIOs we have spoken to see the contract renewal phase as an opportunity to clear the decks, refocus and keep their best people on the pitch.

Our experience of providing corporates with software engineers who are born problem-solvers, who work in small, capped teams on a 5 in 50 model, has shown that they are often fundamental to getting stalled projects back on track. These developers work alongside enterprise IT teams, bringing fresh coding skills and transforming project thinking into product thinking. They are technology specialists who relish the challenge of working on high profile digital journeys, but who do not wish to work as corporate employees and are therefore hard for enterprises to hire.

IR35 will certainly bring challenges for digital change programmes, however, this is the time for small, agile teams of problem-solvers to shine.