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IR35 and the future

Its happening. The IR35 changes announced in the Budget statement in March have come to pass and will be implemented from April 2017. Responsibility for determining IR35 status will shift from the candidate to the intermediary or the client. In one sense no one can complain, its simply the closing of a loop hole which has been exploited on a widespread basis since IR35 legislation was passed in 1999. The governance around determination was all wrong from the off – if you leave it to the candidate to self certify their IR35 status, and effectively leave them to make a choice between option a: declare yourself in scope and pay full income tax and NI, or B: declare yourself out of scope and have a much more tax efficient low salary, high dividend income, its unsurprising that most chose the latter, particularly when the risk of investigation by HMRC has proved so low. Just 12 people were investigated in 2010 and 23 in 2011, if the number of personal service companies is estimated at around 100,000, that puts the risk of investigation at less than 0.001 %. Indeed, in my 6.5 year working in interim management Ive only come across two candidates who have been investigated and even then no charges were brought against either.

And its been quite the party for the last 16 years, the vast majority of interims have enjoyed a lucrative, tax efficient income as they have with impunity declared themselves out of scope of IR35. The public sector interim market has grown all the faster because of the lack of regulation, but it was also kick-started by heavy investment in the public sector by a Labour administration, and a growing cultural acceptance of using external expertise. Who knows how much smaller the market might have become had the new rules on IR35 determination been in place from 1999, certainly fewer candidates would have moved into interim management because the low salary, high dividend earning potential would not have been practically guaranteed irrespective of their activities.

We now all eagerly await publication of the HMRC online tool, which will be used by intermediaries and clients to assess the IR35 status of the candidate they wish to engage, but the criteria to assess IR35 probably wont change. It’s the responsibility for determination which changes, and whilst HMRC would never have the resource to adequately assess and regulate the IR35 self certification activities of an estimated 56000 public sector interims, they will have a much better chance of properly regulating a few hundred interim management agencies and c. 2000 public sector organisations of a size big enough to be using interims. And the economics of this model work far better too, HMRC investigation resources spread over 56000 targets would yield a poor return for each individual they find flouting the rules, but with the value of lost tax pooled across a smaller group of perhaps 2500 agents and public sector organisations, each offender should potentially have a much higher value in lost taxes.

Having said that there is every chance the government will recover nowhere near the estimated 400M in extra tax revenue from these measures. When IR35 was introduced in 2000, HMRC estimated it would generate 300M in National insurance contributions and income tax, and yet a 2009 FOI request revealed that in the 5 year period between 2002-2007, IR35 raised a paltry 9M in income tax and NI, around 1% of what was expected. I would put this principally down to the self certification problem, and the miniscule risk of investigation meaning that the vast majority of interims have declared themselves out of scope and not paid the appropriate income tax and NICs that the government hoped for.

Perhaps the government have based the extra 400M on modelling the new tax receipts if every public sector PSC was suddenly in scope and paying full NIC and income tax. The reality of course is somewhat different, an unknown proportion are wrongly declaring themselves out of scope, but crucially, many are legitimately declaring themselves out of scope and for those genuine change and transformation agents, nothing really changes.

As for the rest who will find themselves in scope: • Some will convert into fixed term contract and permanent employment, they will be paying income tax and NI, but on lower gross pay.

• Where their experience allows, those doing high risk, in scope activities, will start to move towards low risk, out of scope activities.

• Many will form small scale consulting businesses, fully evading the attack on one man band PSCs, and continuing to draw their incomes in the same low salary / high dividend way.

• Many will head to the large consultancies, either permanently, or as associates, where the IR35 changes will not apply to them as they contracting with a private business.

• Many will retire, move abroad or move to the private sector.

Take away all of those who leave by any of the exit routes above, and we’ll be left with a market of interims who continue with their usual activities, accepting they are in scope, and paying the appropriate tax and NI, and Im doubtful that smaller contingent would be contributing anything like the 400M in extra taxes that is predicted. Additionally, we’re likely to see price rises for that group as the interims charge higher day rates to cover the larger tax contribution and to make sure they have the same take home pay. And they will have a market forces following wind to do so if lots of their competition leave the market by one of the various exits above. Which of course just creates a public funding merry go round, as public sector organisations pay more to interims, just to cover the greater taxes that those interims pay onto HMRC…

The party has been great, and some of you may wish to stay, but the booze is running low and some taxis are starting to arrive.

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