Key IR35 Considerations for Public and Private Sector Companies

In 2000, the UK government put into effect the IR35 tax legislation – officially known as the Intermediaries Legislation – to stop contract workers from running their payments through limited companies or partnerships to avoid paying income tax and National Insurance Contributions (NICs.)

Because the original legislation called for contractors to self-assess whether or not IR35 applies to them, Her Majesty's Revenue and Customs (HMRC) department believes only 10 percent of contractors in the private sector have complied. The cost of this low compliance rate in private sector is projected to reach £1.3 billion in 2023-2024.

contractors walking through London cityTo plug the holes, the UK government in 2017 reformed the legislation in the public sector to place the onus on the client to determine whether IR35 is applicable to its contractors. If it is, the client must put the contractors on its payroll and deduct the applicable income tax and NICS before paying them. The only exception to this reform is small-scale businesses; their contractors, or their intermediaries, will still have to decide whether they fall under IR35.

This legislative change allowed HMRC to recoup an additional tax amount of £410 million in 2017-2018. However, due to fear of penalties for incorrect contractor categorisation and lack of knowledge, certain public sector organisations have adopted a blanket assumption that all contractors fall under IR35. This is creating undue burden on genuinely self-employed contractors in the public sector. This is also driving three distinct changes in the UK’s contingent workforce market.

  • Shift in priorities:

    Contractors are leaving the public sector en masse for work with private sector enterprises, at least until April 2020, when the IR35 reform starts applying to the private sector as well
  • Hike in labour cost:

    Contractors are demanding significant pay increases to keep their take-home amount the same as it was before having to paying additional taxes
  • Shift to a new engagement model:

    Companies are gradually shifting to a more deliverables or outcome-based approach, where the output is defined by a Statement of Work (SoW.) This model appears to be gaining traction in the public sector; there’s been more than a 20 percent increase in contractor demand for SoWs, which means they are willing to take the risk of getting paid on deliverables rather than a reduced take-home pay.

The third change is specifically interesting - It’s important to note that the IR35 rules don’t just apply to contract workers, but also to those engaged under SOWs which may not fall under an organisation’s contingent workforce / MSP programs. Enterprises, therefore, need to evaluate these “other” SOWs (or services engagements) as well to make sure that they are compliant with IR35 regulations. To this effect, organisations must make sure the contractual SOWs are based on a fixed output, rather than time and material, or at least ensure that they understand the employment status or such resources along with the IR35 risk represented by the engagement. Otherwise, organisations risk having resources assigned to them, who the HMRC would consider to be “disguised employees” and would fall under the IR35 rules. And that would, in turn, place both the organisation and its contractors at risk.

IR35 risk audit - close up of business woman looking over a statement of work to look for IR35 risk

What private sector enterprises need to keep top of mind

As noted above, IR35 will start applying to the private sector as of April 2020. Here are several things private sector organisations must do before then to make sure they properly comply.

  • Understand IR35:

    Develop in-house expertise or leverage external expertise to understand the intricacies and complexity of the IR35 legislation
  • Audit the enterprise:

    Carry out a firm-wide audit of where and how contingent workers are employed, and conduct a thorough worker classification exercise in line with the IR35 legislation
  • Assess the workforce:

    Evaluate the constitution of the workforce base to determine how IR35 will affect the supply of contingent workers, and accordingly plan the sourcing strategy, for both temporary and permanent employees, to ensure uninterrupted operations. And keep in mind that the brief influx of contractors from the public sector will stop in April 2020
  • Leverage other sources of contingent workers:

    In order to keep on engaging with contingent workforce, enterprise will have to leverage alternative sourcing channels
  • Build SoW expertise:

    Because the SoW model can be valuable to both enterprises and contingent workers, build internal SoW procurement capabilities and category expertise, or outsource the work to an external party such as a Managed Service Provider (MSP.)


Final thoughts

With implementation of IR35 in the private sector fast approaching, enterprises are running short on time to properly prepare. Those that proactively redesign their talent sourcing strategy and ready themselves for alternate modes of engagement, such as SoW, will be well positioned to avoid increased labour costs and attract the talent they need.

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    Vishal Gupta (Everest Group)
    Vishal Gupta is a Practice Director at Everest Group driving research and advisory for Recruitment Process Outsourcing (RPO), and Managed Service Provider (MSP), and Data & Analytics (D&A) offerings.