#151: Mini-budget implications on contractor and permanent markets

On the 23rd September, the UK Chancellor announces a series of change during a "mini-budget".

The mini-budget, and its contents, have been the subject of much debate ever since.

What might have been missed by many people where the changes to the IR35 off-payroll rules - which, as I discuss in this episode, could have material impact on both the contractor AND permanent recruitment markets

Note: Since the original recording and release of this episode, the proposed reversal of the "Off-Payroll" rules has been dropped. This episode does still however provide some value with a description of IR35 and the Off-Payroll rules.

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Published: Wed, 12 Oct 2022 12:22:46 GMT



Hi, I wasn't planning to release an episode this week, but recent changes proposed by the UK Government have prompted me to create this while taking a little break.

This episode is very focussed on the UK contract market - thus, feel free to skip if this isn't a relevant subject for you. If, however you're using contractors or permanent staff within the UK, then this announcement is important to you.

While the changes discussed in this episode should impact all aspects of the "gig economy", I will predominantly be focussed on the impact and experiences I've had within software development.

On the 23rd of September, the new Chancellor delivered a controversial mini-budget.

There has been considerable noise in the press from the mini-budget, which many attribute to a massive drop in the value of the pound, as well as being seen as a series of poor fiscal choices.

What might have been missed by many people were the changes to how contractors were taxed.

Within the mini-budget, the Chancellor spoke about the need for "tax simplification". Going on to say that "we can also simplify the IR35 rules - and we will". "In practice, reforms of any off-payroll working have added unnecessary complexity and cost for many businesses", he continued. "So ... we will repeal the 2017 and 2021 reforms. Of course, we will continue to keep compliance closely under review", he added.

To provide background to this, and why it matters, I need to explain both the IR35 rules and then the subsequent off-payroll rules introduced to enforce them.

IR35 is HMRC's attempt to ensure that contractors are paying a "fair" level of tax. I use the word "fair" specifically as it's subjective - which is the majority of the problem with the IR35 rules - but I'm jumping ahead of myself a bit.

The HMRC uses IR35 to enforce the fair payment of taxes for those contractors that it feels are deemed employees - those that are seen as, to all intents and purposes, employees - but are using a contractor status to reduce their taxable income.

So let's take a little aside; how does being a contractor reduce an individual's taxable income?

As an employee, you will be paying income tax based on tax bandings that are in place at the time. There will be:

  • Personal Allowance which attracts 0% tax
  • Basic Rate which attracts 20% tax
  • Higher Rate which attracts 40%.
  • And Additional Rate that attracts 45%.

These rates come in bindings. So once your income goes over £50,270, then you hit that Higher Rate and any amount you earn over that £50,270 will be charged at 40% tax rate. The Additional Tax rate then kicks in at 45% for anything over £150,000 worth of income.

Whereas as a contractor, you would generally pay yourself out via dividends, which attract less taxation compared to the higher rate values. In comparison, a dividend would attract corporation tax at 19% and a dividend tax at 8.75%.

As a very simplified example;

If you're a higher rate taxpayer, then £100 as an employee would be around £60 take home.

Compare that to a contractor, it would be closer to £74 - a take home a difference of £14.

While this example is very simplified and certainly doesn't take into account all of the calculations necessary for an employee or a contractor, it's fair to say that the additional take home can be considerable if operating as a contractor, especially if you would otherwise be a higher rate income taxpayer.

Thus IR35 is an attempt to resolve the issue of an employee simply changing employment status to a contractor to explicitly avoid tax - it is their [HMRC] attempt to enforce that fairness.

And we are back to that word "fair" again.

HMRC believes it is "fair" that a contractor that is, to all intents and purposes an employee, should pay similar tax to their permanent colleagues.

The permanent colleague believes that it is "fair" that the contractor takes home a comparable amount for comparable work.

The contractor believes it is "fair" to receive relevant take home in line with financial risk and to fund benefits that they don't receive as an employee.

This last part, the funding of benefit, can often confuse the issue of how lucrative being a contractor can be. An employer is responsible for many payments above and beyond an employee's wages. They pay for holidays. They pay for insurances. They pay for sectors. They pay towards pensions. They will often pay for training, jury service, cover equipment, events and a raft of potential additional outlays - which they simply do not provide to a contractor.

The contractor is expected to fund themselves out of their invoiced day rate.

So often the day rate can be considerably higher for a contractor than that of a permanent employee, as all of the additional costs are factored in. Thus we are generally not comparing apples for apples.

And I personally do not see this difference in benefits as being a reason for a contractor to justify a different in taxation. The day rate is there to handle that. If your day rate isn't enough to fund your holiday sickness, training, insurance equipment, etc. all of those things necessary to operate as your own business, then I suggest you need to rethink if you're ready to be a contractor.

In contrast, however, I do consider financial risk to be a justification for a difference in taxation.

A contractor will take on considerably more financial risk than a permanent employee. Whereas an employee receives protection for the government, such as if the employer goes into bankruptcy or refuses to pay salaries, a contractor has significantly less protection.

Take, for example, a normal contractor will likely be through an agency to the employer. This gives a contractor two organisations that can have a material impact on invoices being paid either through choice or circumstance.

If one or either of those organisations goes into bankruptcy, it is unlikely the contractor will be paid for work done - and if they do is likely to be pence in the pound, they will simply be too small a creditor to gain access to any residual funds.

If one or either of the organisation chooses not to pay, then the contractor will likely need to engage in legal action to retrieve the money. In that case, the costs are likely to outweigh the return.

This risk is well understood and known by every organisation out there. The risk of simply not being paid for the product or service provided.

And for me, this is a very real reason why a contract can justify a different employment status than an employee.

Okay, back to IR5; IR35 are the HMRC's rules to apply that fairness. Unfortunately, much like fairness being subjective, the IR35 rules seem to be that way as well - often with individual HMRC enforcement cases having to go to court for a ruling with the HMRC losing cases simply because the court did not agree with their assessment.

And this is why many in the industry say the IR35 rules as a mess. If the HMRC are getting it wrong, then how is it reasonable to expect a lone software developer with no legal training to correctly make a judgement call if their work is inside or outside IR35?

You're asking an individual to interpret rules and then make the business decision between higher take home pay and the risk of a HMRC penalty should they be investigated and be found to have been inside IR35.

Now, personally, I'm generally risk averse in these situations.

For a number of contracts, I've defined myself inside IR35 (thus paying more tax) whereas most contractors would have, given the same circumstances, defined themselves outside (thus paying less tax). Now, is that fair to anyone if the decision may come down to an individual contract as appetite for risk?

The off-payroll rules are an attempt to resolve some of this by taking the decision out of the hands of the individual and moving it to the employing organisation.

It moves the responsibility for the determination - if a role was inside or outside of IR35 - as well as a responsibility to ensure that appropriate taxes were collected if the role was indeed inside IR35.

Now, personally, I actually like the intent of this change. I always felt that it wasn't appropriate to put all of the responsibility onto the contractor. So much of how the contractor would operate would be influenced by the employer, often with the employer not knowing or caring how to interact with a contractor correctly and just treating them as another employee - another bum on seat.

So I actually welcome the change as it encouraged employers to actually think about the work and how the contractor would be engaged to provide the service - rather than previously really not having any "skin in the game" and often forcing poor practice as the dominant party in the relationship.

Unfortunately, our organisations found it just as difficult, if not more so, to get this determination right.

The change was originally introduced to the public sector in 2017, and there has been plenty of evidence to suggest that there has been struggles. A telling sign is how much the HMRC has fined other government departments for incorrect determinations:

  • In July 2021, the Department of Works and Pensions were fined £88 million for incorrect determinations
  • In February 22, the National Audit Office reported a total tax bill for the government departments to that point of off payroll non-compliance was £263 million
  • Later that year, in August, HS2 revealed a further £9.5 million IR35 problem.

These are government organisations. And if since 2017 they're still not getting it right, what hope does the private sector have?

I'll link to an article that discusses this more in depth.

The private sector implementation in 2021 has seen similar struggles with employers being uncertain about the rules and thus generally being very risk averse to avoid the threat of any fines.

In some cases, organisations have simply determined a role as inside IR35 and told the contractor that they would continue to pay the same amount without any investigation or consultation. I feel decisions like this were largely motivated by it being easier to have an argument with an individual contractor than it was with the HMRC.

In other cases, organisations simply chose to no longer use contractors. Rather than run the risk of HMRC fines, they decided to forgo the flexible workforce benefits that contractors had previously provided.

And this had a considerable impact on the contracting market. A good many contractors moved to permanent employment. They simply felt they had no choice if they wanted to retain income.

So back to the Chancellor; his announcement appears to roll back the off-payroll changes introduced to the public sector in 2017 and the private sector in 2021. I say "appears" as details have yet to be released. But most commentators seem to agree that the core IR35 rules are likely to remain unchanged. Rather, the responsibility for the determination will revert back to the contractor.

And in general, this has been welcomed by the IT contractor community as a good move. The unintended consequences of the employer making the decision had a negative effect on the market.

So rolling that back does seem sensible.

Though most commentators do agree this is only a first step in resolving the whole IR35 complexity, but that it's unlikely to be resolved any time soon. Until we can have a clear determination of what is inside and what is outside IR35, there will always be an inherent unfairness in the system.

So why should you be interested in the change?

Well, obviously, if you engage contractors, then you will need to revisit that in light of the change, something that has been made overly complex by the off-payroll changes.

However, I'd also suggest you need to pay attention if you have permanent staff.

I recently ran a poll on LinkedIn posting the question:.

"With the reversal of the IR35 Off-Payroll rules, do we foresee an impact to the market?

Will those that left contracting return?

Will the contracting roles (and rates) increase as the liability is removed from the employer?

Is this likely to lure new contractors away from the perm roles?" 

I'll include a link to the poll in the show notes. However, 57% felt that it was likely that we see a perm to contract a migration, 36% felt it was going to drive up contractor roles.

While I'd never suggest that a LinkedIn poll was the most scientifically rigorous method of surveying, I found it interesting that the vast majority of respondents felt that there would be some change.

Those organisations that stopped or reduced their contractor headcount are unlikely to return to take advantage of that flexible workforce that contractors provide.

Those contractors that went permanent are likely return to the contractor market.

And many permanent staff will be tempted to see if the grass really is greener.

All in all, leading to a smaller pot of permanent staff - in what can only be considered a candidate driven market as it is.

So what, if anything, should you be doing about it now?

Probably not a lot.

The reverse has yet to be ratified. And part of the mini budget has already been dropped due to the controversy it has caused. Thus, there is a good chance that the entire thing may be rethought in the coming weeks and months.

Plus the government has form for making last minute changes around IR35. The introduction of the private sector off-payroll rules was delayed at the 11th hour from its intended launch in 2020 to 2021, which I personally felt rewarded those organisations that hadn't prepared, while penalising those that had.

So should you ignore it?

Definitely not.

I suspect the final ratification will come very late in the day, maybe February, with changes taking place in April. So waiting for ratification would be risky depending on how affected you as an organisation would be.

Certainly start thinking about what changes you would implement - potentially a switch to using more of a contractor mix or maybe returning to a previously working mix - this may need signposting throughout your organisation depending on how your budgeting and employment processes work.

Also take a look at your permanent staff. Are they happy? Are you doing enough to keep them from looking at the contractors with jealous eyes?

But this is something you should be doing anyway, regardless of any IR35 changes.

In this episode, I wanted to raise awareness of the potential impacts to both the contract and permanent recruitment market in response to the potential change of rolling back the off-payroll rules.

The impacts could be trivial, but if it's anything like the original implementation of the off-payroll rules, then it can be expected to present a number of opportunities and risks - something definitely to keep an eye on.

Thank you for taking the time to listen to this podcast. I should be speaking to you again in a couple of weeks time.