IR35 reform will reshape the market

6th August, 2019

IR35 reform will reshape the market

The agency

The shift of the decision maker for determining IR35 status, post April 2020 is going to have deep and permanent repercussions.

Until that date, the decision as to status lies with the contractor. If that decision is ultimately incorrect and more tax is due, the contractor is liable.

Post April 2020, the end client will determine IR35 status. The obligation to pay any tax arising from the decision being correct – or incorrect – lies with the fee payer. Usually this is an agency closest to the contractor.

I suspect that the word “agency” conjures in most minds an organisation which talks to an end client, helps define a position to be filled. They seek suitable candidates, arranges interviews etc., arranges contracts, arranges invoicing, perhaps undertakes a range of other services for both parties to the contract. In return the agency has a fee usually each time an invoice is paid.

This arrangement works well in that there is a balance of economic motives. The contractor wants the work and recognises that the agency brings a number of positive elements to the table. The end client wants work done and recognises that the agency has expertise and skills and experience that they do not have. The agency has an incentive to provide services to both because this generates income that is regular and ongoing.

Is this the case post reform?

Post reform incentives

It remains to be seen how end clients will react to the reform. Already some have said that all their contractors will be let go and no new ones will be engaged. Others have said that they will be undertaking reviews and will adopt whatever policy is best for them. Many have announced that the inevitable period of adjustment and equally inevitable HMRC enquiry will incline them towards “inside IR35” decisions. Most of these plans are based on real or assumed risk. The end client, assuming they have complied with the rules, should be insulated from the cost of an incorrect decision. There is a risk that they are not. This colours their judgement as their first obligation is almost always their shareholders.

Individual contractors have a difficult choice. Should the end client decide that they are inside IR35, they have recourse to a dispute resolution process, but absent a change of mind, the likely result for the contractor is take the role or leave it.

There are commentators who think that this may drive up rates (perhaps but with end clients facing a 14%+ employers NIC bill, my bet is not). There are those who think we will see a lot of contractors leaving one role and taking another with a different end client, even where this is also inside IR35. HMRC’s declared intention is that 90% of those presently claiming to be outside IR35 will be deemed (or actually) inside from April 2020. Contractors are facing a reduction in disposable income with little redress available.

Agencies face perhaps the worst of all worlds.

End clients who make contractors permanent employees will not be willing to pay fees to the agency each month. A recruitment fee? Yes. But that is a one off.

Contractors who are placed via an agency into an inside IR35 role should not be bearing the cost of agencies directly or indirectly. They should do the sums. The day rate is always impacted by this element. If contractors are inside (or permanent) then this element of agency income disappears.

The incentive for the agency to have contractors outside IR35 and the risk averse end client who wants no surprises will inevitably clash. We are sure to see long standing relationships between these parties tested.  

Reinventing the wheel

We are already seeing agencies (and others) try to maintain an outside IR35 status for contractors, whilst protecting themselves should that status be challenged and found wanting. This is via clauses in contracts under which contractors are essentially offering open-ended indemnities to agencies and end clients, for tax. Avoid these and have your contract checked.

Many agencies are seeking to become service providers. Unfortunately, whilst some will achieve this, for many the process will prove too difficult and will leave gaps that HMRC is guaranteed to poke levers into.

In theory the transition from providing people to providing services is simple. The agency needs to educate the end client that what they have is a need for a service to deliver project Y. They then identify a group of contractors who can deliver project Y. A commercial contract is signed for a service to be required and delivered and work starts.

So do the problems.

If the service is from the same people all the time and if they are unavailable, no work is actually done, is the service arrangement real? Is it not in reality a means of extending the supply of a particular person(s) which would otherwise be susceptible to IR35 determination?

What features within the arrangement have converted an agency supplying workers into a service provider? Does the former agency have the skills and commercial nous to determine the services required by client and the management skills and tools required to deliver them? Do they have them?

Is it the case that the VAT treatment has changed to reflect the new arrangements?

Is a person employed by the agency to identify an end client role, identify a candidate and match them, equipped with the skills to measure service contracts?

We fear that many agencies will attempt to make this transition but will fall short.

The economic imperative is however to do exactly this as such a transformation solves the problems of end clients and contractors and maintains monthly income.

(Incidentally I have ignored the rules around managed service companies here as I have assumed that ALL contractors will be part of the service company. The practical arrangements around that alone are difficult.)

An arbiter

The pre-IR35 reform system placed responsibility and financial obligation in the same place. The post reform system does not. It places cost with the agency at a time when the risks increase – often risks beyond their control. We will see those risks being attempted to be passed on to contractors.

Once again however, our fear is the contractor is the victim here. As we saw with loan schemes, many contractors are not wise to the ways of those adept at concealing the tax nature of their products. We can ascribe this to a trusting nature, an inability to grasp 20,000 pages of tax law or a fear of all things legal. This attitude will result in new enquiries and where the agency fails to transition sufficiently to “service provider”, no prizes for guessing where the buck will stop.

HMRC enquiries are routinely taking place several years post the event. They do however always ask for papers that relate to the time the events happened. An agency that moves seamlessly into service provider but is unable to provide sufficient documentary evidence or testimony validated by a third party is one that is to be avoided.

Control is key

Ultimately however this is about contractors taking control.

Understand what you are being asked to do. Understand what incentives are driving the parties here and how they can be leveraged. Do not accept, without due diligence, anything that seems too good to be true (sign here and nothing will change, aside from some admin).

Especially be aware of the actions of intermediaries.

I have no doubt that most are genuine and are seeking to do the best for their end clients and contractors. Some may not be able to manage the transition, but it may be a while before you know. Some will try harder than others. Some will be content with a few more years of income before folding.

How do you tell the difference?

Do your research and get impartial advice.