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Our perspective on IR35

The chances are if you’re reading this, it’s not your first blog post you’re reading about IR35. It feels like everyone has an opinion about the regulation and is open to sharing it.

The zoom-out is pretty straightforward, HMRC is ensuring that anyone who ‘looks’ more like an employee than an independent contractor, pays the taxes as an employee would. The big change as of the 5th of April, is that the liability shifts from being solely with the contractor to one that’s shared with the employer. This means HMRC will move from selecting, reviewing and penalising contractors one-by-one to starting with the company and working through their contractors. It will be a lot more efficient for them as they’re moving from a 1:1 investigation ratio to 1:x where X in some cases could run into the thousands.

The response from a significant number of large organisations has been swift and decisive; they will stop using contractors. RBS, Barclays and BP are amongst the organisations we know of who have made this decision. Conservatively the number of contractors impacted runs into the thousands just from those companies that have announced their intent.

What are the four core options on the table for organisations?

1. Reduce capacity by stopping working with contractors

The regulatory change brings about the perfect opportunity to reduce your capacity, leading to more effective prioritisation of what needs to be done. In our experience, that’s no bad thing. As with a number of options listed below, this could be an effective short-term strategy which can buy you some time until you are ready to make decisions about an appropriate medium and long-term approach.

Reasons for reducing capacity:

  • It removes all IR35 risk
  • If digital is not a core part of your business and is more of a supplementary exercise
  • It reduces organisational disruption if you employ a small number of contractors.

2. Hire contractors directly putting them onto your payroll

While this option is harder in practice, there are three critical aspects of your business to align to make this route work:

  1. Your ability to add head-count to your teams
  2. The budget required to make the offers
  3. Having contractors open to swapping a low-tax day-rate for a fully-taxed salary.

Of the three, headcount should be the easiest. There’s a strong case to be made for developing your own in-house capabilities and we will be exploring this in more detail in the second part of this blog series. Points B and C are where conversations are most likely to fail. For example a contractor earning £500 per day (fairly typical for a well-skilled individual) will be paying around 20% tax which equates to an income of £110,000 or £88,000 after tax assuming the individual works 220 days in a year. However, to earn £88k post-tax as an employee, the annual salary would need to be close to £150k. Taking national insurance and income tax into account brings the total ‘cost’ to your business to around £175k.

The alternative is that your budget for the role remains static. This requires the contractor to drop their income from £88k to c.£65k, essentially a 25% pay cut.

The reality is that most companies won’t be willing to spend £175k recruiting a contractor and most contractors won’t take a 25% pay cut so the end result will be somewhere between these numbers. Getting to that outcome will not be quick and it’s likely neither party will be too happy with the outcome.

Reasons for hiring contractors directly:

  • You retain the knowledge within your business
  • No transition is required so this is the least disruptive route
  • Using fixed-term contracts can deliver long-term flexibility
Colleagues working around a desk

3. Hire permanent employees to replace contractors

While options 1 and 2 above are very reactive, the proactive approach to tackling IR35 is using this as an opportunity to grow in-house capability. Over the years as digital has become a core component of most businesses, the ability to deliver in-house has become a core competency.

The commitment to creating an environment that’s appealing to prospective employees cannot be overlooked. It has been a large stumbling block for organisations , and the reason why many have resorted to using contractors. Using IR35 as a motivation to direct the right resources to the challenge is where a significant opportunity exists.

Reasons for hiring permanent employees to replace contractors

  • Digital is core to your business
  • It is aligned to your long-term ambitions
  • Direct employees will have a lower cost than the equivalent contractors

4. Using third-parties to ramp-up quickly

This option provides good flexibility as a long-term strategy or a short/medium-term approach whilst you plan your next steps.

We work with a number of clients who, in parallel to working with us, are recruiting their own team. This means when we deliver specific products, we do so with an understanding that part of our time and effort needs to be spent on building in-house capabilities and working with client teams to help inform hiring decisions that align with their long-term strategic goals.

How we helped build in-house capabilities at NatWest

Read more

Undoubtedly this is the most expensive option listed but you typically get more than what you pay for. By using third-parties, you're bringing in cross-functional teams who are accustomed to delivering in complex environments. Additionally, utilising an external team allows you to benchmark your existing teams. Our experience is that you often find changes in behaviour and practices continue long after the third-party teams have completed their projects.

Reasons for using third-parties

  • You want the greatest flexibility short and long-term
  • You can’t afford to let output drop in the short-term
  • There are specific projects which lend themselves to a focused effort from an independent team

We hope this blog post has helped to provide some new information about the options available to you.

To explore option 4 in more detail, get in touch

Get in touch