IR35 - Is the game up for contractors?

Unless we get a Lib Dem win at the election (hint: we won’t) the government is pushing ahead with the rollout of its off-payroll rules to the private sector, potentially impacting up to 170,000 individuals and thousands of businesses who rely on contractors. This will probably hit hardest in the I.T space and there isn’t a lot of time left for organisations or contractors to figure out how they are going to operate beyond April next year. 

Here’s a quick summary of IR35. The government really doesn’t like people operating as "shadow employees” so is setting out to catch those who earn money through employment without paying tax and national insurance contributions. Their targets are people operating through Ltd companies purely as a way to pay less tax on employment earnings. Simply, if you take away the engagement vehicle (the Ltd company) and are left with a working relationship day to day that looks like you are employed, the tax man will treat you as an employee. It doesn’t really matter what is written in your contract. Think of it like this - I want an extension built on my house. I get quotes from several companies, dealing with an owner or salesperson. I choose a company, agree a price, sign off on an outcome, agree a completion date, and make one of a number of staged payments based on delivery milestones. Everything after that I probably trust them to get on with as the “expert”, possibly with some notional oversight and lots of cups of tea. When they work, the tools and people they use, how often they are on-site, the methodology or approach they use, none of that matters to me as long as I get my extension. That is outside IR35. If you operate through a Ltd company and your engagements look like this (possibly without the extension bit) you are fine. 

The problem is that most contractors work in big companies and most big companies have forgotten how to buy specialist skills.

Most contractor engagements in big companies are run through mass recruitment providers or RPO’s. A genuine commercial B2B relationship would be run through procurement, setting up the Ltd company as a supplier to provide a service. The recruitment providers don’t understand the nuances of perm vs contract vs “contract” so treat all engagements as essentially the same. Contractors are approached on a job board by a recruiter who has seen their CV. They interview with the end client multiple times and are then sent a contract, provided with kit, told where to be and when, and take direction from the same person every day. If HMRC come and investigate this scenario it would be almost impossible to prove this is not shadow employment, regardless of whether there happens to be a nod towards substitution.

The issue we are seeing now is that by passing the burden of proof down to the end client, HMRC are forcing blanket “inside IR35” decisions and these organisations are going to lose hugely important niche talent. In reality, many of the contractor engagements these companies have in place probably legitimately sit outside IR35, or easily could with some very small changes. The issue is the sheer number of contractors some businesses have, and the perceived challenge of making individual assessments on thousands of engagements.

Significantly, there have been some very public announcements from high profile businesses lately that may signal the beginning of the end for the contracting market as we know it. HSBC, Barclays, Lloyds, RBS, GE and GSK to name a few have announced there will be no further direct engagement of Ltd company contractors, often anywhere in the supply chain. Most of these organisations have already said there will be no rate increases for those who decide to “go inside”. This has big implications for the whole industry. Without the big boys and their deep pockets, contractors lose a lot of leverage. At least in the middle of the market, where people have been able to add ￡50 to their rate every 6 months for no reason other than they can, there has to be a contraction around rates as the big banking money disappears.

On the one hand this is an opportunity for smaller organisations to get a shot at engaging some really skilled people, but on the other it’s unlikely most mid-sized firms are going to be prepared to take the tax risk given these announcements. There are some small firms who get an exemption from IR35 and are a safe haven, but not that many in the scheme of things, and they aren’t going to be in a position to pay the rates the banks could. As a minimum then, the market for contractors is going to contract significantly and those who are going to stick it out are unlikely to be able to command the same high rates they have been used to. 

The other side to all of this is the significant risk of important projects stalling through a lack of skills. Contractors are being given three choices - leave, go perm or go umbrella. A lot will leave, causing significant delivery issues.

If you are an organisation looking for specialist talent, apart from the obvious (make sensible, individual assessments, only use contractors for genuinely specialist skills, and let them work as true independents) there are some basic things you are going to need to do from April.

Talk about outcomes not job descriptions:

Job specs are for individuals you are looking to hire. You should be providing a description of a necessary outcome and some timescales and milestones for how you hope to achieve that. The contractor decides how to get you to your outcome as they are the expert. They should also probably shoulder some delivery risk and insure you for missed milestones

Don’t ask for CV’s:

CV’s describe the achievements of an individual. You have a right to ask for this from someone you are about to hire to carry out a job that you have defined, but I wouldn’t ask my builder to list every achievement and skillset in his career before I engage them. I would expect to see an overview of the capabilities of his company, along with some case studies and testimonials. 

Don’t expect to see the same person every day:

Substitution is spoken about a lot. People believe that by having a substitution clause in a contract, they’re pretty much covered from an IR35 perspective. If in reality the client would either block a substitution, or want to interview the substitute, this isn’t a valid clause. It's also not enough on its own. Companies need to recognise that substitution has limitations in proving employment status, and be prepared that is they are going to deem someone "outside", they have to be happy that any number of different people may turn up to do the work.

Don’t try to manage them in the same way you do your permies: 

This is the whole point. Contractors don’t have managers and don’t take direction. Once you engage them, you leave them to it until a defined checkpoint and assess what has been delivered. You might be the main point of contact and you may agree between you that these milestones are daily or weekly, but remember that you don’t “direct” your contractor as to how to do the work.

Don’t tell a contractor where and when to work:

This will be hard to swallow for many, but unless there are genuine reasons (security etc…) that mean they have to be on-site; the Ltd company chooses where its employees work. You might decide between you in your initial scoping that the work is best carried out on your site 5 days a week, but broadly speaking they choose where and when to work

Provide a statement of deliverables, not just a contract:

Don’t fall into the trap of asking for a specific type of person and providing a vague contract covering the engagement. By defining exactly what sort of person you need you are speaking as if it’s a permanent role. Provide a statement of the work, broken down into meaningful deliverables with timescales attached. 

None of this should be as complicated as some fear. Large corporations have thousands of relationships with suppliers for all kinds of services that look exactly like this, they just struggle to treat the purchasing of skills in the correct way. With some common sense and tweaking of terminology and process, most organisations would be much closer to solving the IR35 problem than they think. No one really needs to make rash blanket decisions when in reality it is completely at their discretion to bundle up demand for niche skills as packages of work, and then to engage genuine Ltd companies to deliver that work.

If you are a contractor, you have a few options come April. Hope enough organisations will be happy to allow you to operate genuinely independently, baring in mind the increased demand there will be for the fewer truly “outside” gigs available; stick your fingers in your ears and ignore it; go “inside” and hope for a big rate increase to pay for the contributions; or go perm. Most will stick their fingers in their ears and hope nothing changes. Some will be able to get big rate hikes and not be out of pocket, but big organisations will struggle to add 20-30% to their rate cards quickly enough so are likely to take the view that contractors either go perm or leave. 

Which leaves the unthinkable - going perm. A lot of contractors are already thinking about making the switch to the safe haven of perm. The average contractor might be surprised if they ran the numbers on their day rate X a realistic number of days worked in a year, factoring in holidays, sick days, time between contracts etc…and worked out a reasonable equivalent salary. Once you factor in paid holidays, pension, bonuses, L&D budgets, private healthcare and a good base salary, going permy might not look like the worst decision in the world. The best solution would seem to be getting a good perm role in a consultancy who provide services into large public and private sector clients. You then get the variety you’d get as a contractor and maintain the ability to work inside multinational organisations, whilst getting paid well and having the security that comes with perm.

One thing is clear; this feels very different to previous attempts at attacking this part of the workforce. It’s hard to argue that it’s the right solution, but the government are pushing ahead and it looks like this time they may be about to herald the unravelling of the contracting industry as we know it. It’s been a good ride, but it looks like the party might be over.