By SKS Business Services
SKS Business Services has analysed the data from 89 AIM-listed oil and gas companies. The analysis highlights the continued problems in 2014 of excessive general and administrative spending, a persistent issue that emerged from the 2013 analysis of 134 AIM-listed companies also undertaken by SKS Business Services.
The research also serves to highlight the benefits of outsourcing (or right sourcing) the finance function of AIM-listed companies, to reduce G&A costs,to generate independent and more detailed and accurate management accounts and to improve the transparency reports to investors, who are often kept in the dark about where their money has been spent.
|“Even if you’re making pots of money, you should be looking hard at what you can do to reduce costs. This is to cushion the business against market volatility, be it commodity prices changes in demand and supply or changes in customer behaviour. Companies involved in developing natural resources or undertaking research and development have long gestation periods and are thus funded by investors until they produce revenue.“Keeping G&A as low as possible makes for a sound business case as one would think that investors would back thrifty management given a choice.”
“All too often the analysis of G&A takes a back seat. Investors don’t have benchmarks to compare and challenge the costs and are therefore losing out on potential returns. This report aims to shed light on how improvements can be made.”
As competition becomes fiercer in a global economy, the traditional and widespread approach tomanaging finance for medium and small sized companies, is likely to change. Evidence continues to emergeof the difference that professionally prepared management accountsand ongoing reviews of G&A costs can make to profitability, cashflow and attracting good investments.
Currently, business growth is being stifled in too many medium-sized firms by a lack of financial insight into their own business and by a lack of focus on reducing non-core spend.Several AIM-listed companies in this research fail to look at an efficient operational model for their business and most of them appear to omit potentially useful detail about certain cost areas in their annual reports.
This analysis follows on closely from the research undertaken by SKS in 2013, which looked at 134 AIM-listed companies’ level of spending on their general and administrative (G&A) costs since 2008. Key findings from the research found:
- Overhead costs had increased 21% since 2008 (compared to inflation of 12%, a real increase of 9%), while profits had fallen from an average of £9.6 million to an average loss of £1.52 million
- In 2012 AIM-listed companies spent 5% more on non-core operations than in the previous year
- Despite the rise in G&A expenses, only three of the 134 AIM companies analysed provided any explanation to investors as to why this rise took place or what they were doing about it
The findings highlighted the problems AIM-listed companies were facing due to a rise in G&A costs. As a result, SKS conducted deeper research this year into sector-specific AIM-listed companies, in this case the oil and gas industry. This new report analyses the annual reports from 2012 and 2013 of 89 AIM-listed oil and gas companies and identifies a significant continuing over-spend in G&A costs in both revenue-producing firms and those still in exploration stages.
SKS also suggests in this report that a change in a company’s finance function through outsourcing can not only reduce the cost of the finance function by 50%, but it will allow greater efficiency when regular monthly accounts highlight any excess levels of spending. Our findings indicate that by adopting further right sourcing methods, companies can save up to 20% of their overall G&A costs, which, for some of the organisations, could see the difference between making a profit or a loss.
This research looks closely at how AIM-listed companies are falling somewhat short of reporting closely on G&A costs in their reports and asks, how can investors be expected to make sound judgments about potential returns if such important information is lacking?
Section 1 – Investors are still being kept in the dark
General and administrative costs are the sets of expenses needed to administer a business. These costs are not related to the construction or sales of business goods/services. Examples include:
- accounting staff wages and benefits
- building rent
- corporate management wages and benefits
- depreciation of office equipment
- office supplies
- legal team’s wages and benefits.
These costs are a prime example of expenditure any business will have to endure before trading has started.
They are thenon-core costs which businesses are always under pressure to reduce. Yet in firms with a strong centralised command and control management system i.e. a head office, these costs will be larger than those that outsource different departments, like the finance function and legal team.
The AIM-listed firms examined in this researchfall into four different categories when portraying their G&A costs:
28% of these firmsreported total G&A spend for the year, with a minor explanation where costs have increased or decreased. For example, Madagascar Oil Limited, a revenue-producing firm, provided its explanation of G&A in 2013 as follows:
“Total general and administrative and VAT penalty expenses increased to US$10.0m (2012:US$9.6m). This is primarily due to VAT penalties recognised as a result of the tax dispute settlement and increased legal and professional fees relating to the Board restructuring and Houston office closure during 2013.”
Another 28% reported G&A spend without explaining why it has changed. One revenue producing example does suggest further explanation on their G&A spend in the additional notes of the financial statement, yet no justificationis eventually provided.
There are a small numberof firms (11%) whose reporting on G&A costs lacks clarity as only partialknowledge about the total amount being spent. For example one 2013 annual report states, “the group’s ongoing G&A expenditure is generally estimated to continue at between $1.5 million to $1.7 million gross per month.” This report not only fails to give accurate figures for the overall spending on G&A, it lacks the precision around what this spending constitutes.
33% of firmsprovide a detailed picture of their spending, up from what was discovered last year. One non-revenue firm, Antrim Energy plc,is a good example, stating in 2013 that“general and administrative (“G&A”) costs decreased to $4.8 million in 2013 compared to $5.8 million in 2012. The decrease in G&A is primarily due to reduced employee compensation.” Further details are provided in their notes too.
In the 2013 research of general (as opposed to sector-specific) AIM-listed firms, only three had management discussion and analysis reports where the description around G&A costs alluded to an increase in spend, but not around how it was going to be reduced. Even though the number is larger within the oil and gas sector,this type of analysis did not increase our understanding of why the G&A has risen or fallen when two-thirds of these firms are not reporting enough information.
A greater level of detail should exist amongst those revenue-producing oil and gas firms in general, but even moreso forthose businessesthat are not making revenues and are only in the exploratory stages. It is here that reducing G&A costs is more important than ever, at least until revenues and profits are generated. If investors can clearly see where their money is being funnelled, it might increase the level of trust to invest more money, an obvious benefit for those early-stage companies.
Section 2 – Why AIM companies are losing money when revenues are up
After analysing the 89 oil and gas firms closely from their 2012 and 2013 information, it can be determined that for many of them there was a dramatic increase in revenues produced.Some have all dramatically hit oil with their revenue streams. This was mirrored in the overall rise in revenues for all 89 companies, with total revenues having risen by 28%.
However, this positive revenue stream does not correlate with the level of profit made in 2013. The number of companies making a profit dropped from 16 in 2012 to 9 in 2013. Only Bankers Petroleum made a profit in both years and in 2012, 15 of the firms went from a profit to a loss in one year. Overall, losses in revenue streams increased by 45% in one year.
Last year’s research revealed a consistent rise inG&A costs since 2008. This year’sresearch found a drop in overall G&Aspend and although between 2012 and 2013 there was a reduction of 12% inG&A spend in these 89 firms, their losses increased by 83%. Clearly, more work needs to be done.
Last year’s research found a link between a reduction of profits and the large costs of G&A. This link is still apparent in the latest research: in 2012 there were 27 companies whose total spend on G&A was either more than or equal to their total loss in revenues. So if these firms were able to reduce all of their G&A spend (and in some cases like Max Petroleum and Infrastrata they would only need to reduce a percentage of their G&A) a loss making company would be profit making.
When looking at those oil and gas companies who moved from a profit to a total loss in revenues, seven of them had increased their G&A spend.
While there is anencouraging overall reduction in G&A spend, non-revenue producing firms actually saw a rise of 5.5% in G&A spend between 2012 and 2013. For firms not generating an income, keeping those costs down should be imperative. As we saw from Section 1, the companies provide no reason for where this rise is coming from and what can be done to make cuts.
For a select few, the G&A spend is an identifiable contributing factor to explaining a loss. However, for the rest, the average level of G&A spend has decreased, suggesting there are other contributing factors affecting these losses. One explanationmay be a rise in variable operational costs.
Regardless, the level of variable operational costs does not reduce the scale of the effect G&A costs have on overall spending. As seen in Section 1, a detailed analysis of G&A costs can help to highlight areas where non-operational savings could be made, thus potentially reducing the loss in revenues.
Section 3 – Is there an answer?
While a central office is able to integrate the businesses, various departmental functions do not necessarily need to be carried out on site. The finance function is a prime example. Too many businesses will have accounting teams on staff, yet they only carry out simple book-keeping tasks and produce report content for the CFO to review.
Outsourcing the finance function will of course create more freedom and opportunity to create more regular management accounts, and independent business advice, which will clearly identify where the over-spending on G&A costs is coming from. Without this analysis it is clear that a level of puppy fat is surrounding these businesses, where easy savings could otherwise be made.
Revenue-producing firms would normally build up higher levels of G&A costs as these businesses will have extra staff and offices to support the production of oil and gas. It is easy to see that certain aspects of these businesses would not be essential for non-revenue producing firms. For those firms, keeping non-essential costs down is crucial, especially when informing investors of their research progress.
Having accounting staff in-house means paying for services which require spending furniture, office supplies and utilities. Through outsourcing, these costs will vanish overnight without diminishing the quality of the work. This can be taken to a higher level where the finance, legal and HR functions are all right-sourced. An example of this operational modelcan be found at an SKS client. The mining firm is listed on the Toronto Stock Exchange andmaintains flexibility by operating without a head office. The CEO and CFO are based in London, the COO works from the U.S and the Auditor from Canada.
Several aspects of its business benefit from this model, from management to finance function to operations– all being outsourced to different countries. It is estimated this company has saved over $300 K on G&A costs by moving the finance function and at least three times this amount on overall G&A costs.
A simple way of finding cost savings is through regular management accounting and external business advice. Regular independent management accounts can address spending on all aspects of the business, from planning for future investment to achieving cost savings. The benefits of having monthly accounts allow for decisions to be made in advance instead of making a rather late assessment of the budget when compiling year-end accounts. These savings would then be explicit in the annual statements, highlighting cost reduction and improved profit forecasting.
Too many companies are failing to grow because they are unable or unwilling to invest in structuring/managing their finance function better. All too often the cause is simply a lack of understanding of what skilled financial analysis and forward-looking management accounts can deliver. The oil and gas companies analysed here could clearly benefit from closer analysis to discover why their revenues have increased, but they continue to incur a loss.
The purpose of this research was to highlight how a group of AIM-listed oil and gas companies are missing a fairly straightforward opportunity to maximise precious resourcesand, in some cases,avoid losses in revenues.They do not seem to be reviewing their non-core G&A costs or adopting tested and emerging shared services or outsourcing models to reduce these non-essential costs.Their financial statements typically reveal a significant lack of information about where investments are being spent. Investors are losing out as a result, unable to analyse whether their financial contribution will be a solid return on investment. And without regular, more detailed analysis of how the business operates, it is easy for these oil and gas firms to miss potential profits.
It is becoming easier to cut costs through the better use of technology and to negotiate better terms with suppliers. Technology can make it easier to outsource areas of the business like the accounting and legal teams to other locations, firms or countries, which in turn will reduce G&A costs. Indeed some companies stand to reduce their finance function spend by 50% by addressing this more closely.On top of this, with the right application of further right-sourcing methods, companies can reduce their overall G&A spend by 20%. Many of the 89 oil and gas companies would benefit from this approach. It would appear that their focus on developing an industry reputation for innovation takes necessary attention away from controlling general running costs more keenly.
The oil and gas sector is unpredictable; businesseshave a limited lifespan before natural resources run out. Without effective business and financial analysis, these firms will fail to keep control of lossesin revenue. Addressing this is surely imperative for non-revenue-producing firms, who seek further investors to aid their exploration.
If these companies can demonstrate a solid business plan with keen monetary projections it will help toconvince investors to spend more on a worthy project. Only once these firms start addressing this fact and outsourcing more sensibly, they will not only reduce their G&A spend, but keep those valuable investors happy at the same time.
Is cash now redundant in western society?
By Daumantas Dvilinskas, CEO and Co-Founder of TransferGo
Research from UK Finance has shown that cash consisted of less than a quarter of all payments in 2019, suggesting that as a method of payment, it was already on the decline before the pandemic struck. Evidently, this means that current negative attitudes towards cash have been compounded by COVID-19 and no doubt suggest that fears are growing over how the use of physical currency could be a possible vehicle for virus transmission. In turn, this has caused a shift in consumer behaviour with those stuck at home turning to digital as the only way to spend, send and save money.
But if the usage and popularity of cash was already on the decline – what factors were driving this? Primarily, it’s been a shift in consumer behaviour towards online shopping, and the increasing speed and convenience offered to end users by contactless payments and new services in the fintech market. An example of the latter is in digital money transfer services, which facilitate the flow of money across borders but without the added fees and hidden exchange rates traditional cash-based businesses have.
But what impact will this behavioural shift have on our society, and what does this mean for the finance industry?
The finance industry’s response
With the pandemic bringing country-wide lockdowns, consumers were forced to turn to digital as trips to banks and post offices to make deposits or collect banknotes became inaccessible. Fintechs, who are digital by default, were particularly well placed to support customers by allowing them to send and spend funds by facilitating online transactions through digital payment services.
Additionally, digital lending firms, who were able to move fast in response to the surge in loan applications as a result of redundancies and businesses shutting down, were much more nimble than physical branches and traditional financial institutions. And the demographic of users has widened too, with digital lending platforms seeing not just tech savvy users, but older users in their 40s and 50s turning to their services.
Prior to the pandemic many people, for reasons such as lack of trust, being technophobes or just being creatures of habit, were hesitant to use digital finance services over cash. We expect to see a continued reversal of that as consumers get used to the ease and accessibility that fintechs have bought to the sector.
Remittance sector has already proved that cash wouldn’t reign supreme
This issue of cash vs digital is especially prevalent amongst the migrant worker community. Migrants are often relied upon by their families for income support, and in some cases are the sole source of income. For example, in 2019 remittances amounted to $554bn according to the World Bank, beating all other forms of cross-border financial flows to poor countries.
Alongside the lockdown, we also had to deal with the issue of closed borders, which prevented migrants arriving home with actual cash. Combine that with the closure of most retail finance operations, options for sending physical cash were basically eliminated. Workers therefore needed to find other ways of ensuring their hard earned money could get to those that needed it at home. Digital finance bridged the gap.
Through the benefits of digital, providers can offer guaranteed and fair exchange rates, ensuring that migrants, who may be undergoing financial difficulties, are not stung by hidden remittance fees. They can also provide consistent and accessible support, for example by offering in-country agents who understand local discourse and issues and can help find appropriate solutions. What’s more, these services can offer a seamless customer experience, increased service reliability and perhaps most importantly security. For example, TransferGo recently announced a partnership with end-to-end ID verification companies SumSub and Veriff, which ultimately means that migrants are able to have their identity verified, quickly and reliably, preventing fraudulent activity, without causing a delay to registering for and using the service.
Was this a result of the pandemic or is cash truly on its last legs?
COVID has undoubtedly caused a huge shift in consumer propensity to use cash. Findings suggest over half of consumers had used digital transfers to give money to friends and family at least once during the first month of lockdown, with 20% doing so more than twice. When you consider that cross border payments are expected to hit $240 billion by 2024 due to an increasingly global and interconnected economy and TransferGo experienced a 63% growth in transactions in April compared to the same time last year, the future is seemingly evident.
The convenience, speed, improved customer experience and security offered to consumers through digital payments will be difficult to surrender – especially as people become accustomed to new ways of working and living.
At the current pace of technological innovation, I can’t help but feel that this is the irreversible direction of travel. It is incumbent on those of us at the sharp edge of innovation in the industry to ensure it remains secure and fit for purpose as the world continues to change around us.
FRC’s audit enforcement – more remedial action for auditors?
With recent accounting scandals such as Wirecard, we’re seeing a continuing focus on the role of auditors in detecting fraud and, the importance of confidence in the audit process for corporate reporting.
The Financial Reporting Council (FRC), principal regulator of the profession (and accountants in business), recently published its Annual Enforcement Review 2020. It analyses its enforcement actions and outcomes across the past 12 months, identifying key themes and issues, and sets itself performance objectives for the year ahead.
One of the notable themes coming out of the Review is the FRC’s greater focus on the use of remedial action and non-financial sanctions as a means of driving audit quality within audit firms. It seems to us a sensible development.
Despite being criticised for not being tough enough on audit firms (total fines have come down this year, although the trend of fines in individual cases is on the rise), the FRC has focused on measures aimed at achieving lasting improvements in audit quality. Heavy fines, while inevitable in the more serious cases, mark public censure but do not in themselves change practices, and ultimately can reduce a firm’s resources to invest in audit quality. Audit cases dealt with by the FRC are rarely about intentional conduct by auditors. Far more often, they relate to errors of judgement, points missed in audit work, or inadequate processes. Non-financial sanctions can be a much more direct mechanism to promote investment of time and resource into audit improvement across a firm.
FRC’s enforcement powers
The FRC became the “competent authority” for audit in the UK under the Statutory Auditors and Third Country Auditors Regulations 2016 (SATCAR), which came into force following the EU Audit Regulation and Directive. SATCAR requires that the UK has effective systems of investigations and sanctions to “detect, correct and prevent inadequate execution of statutory audit” – which led to the implementation of the Audit Enforcement Procedure (AEP).
Under the AEP, a statutory auditor and/or statutory audit firm may be liable to enforcement action where there has been a breach of the Relevant Requirements of SATCAR 2016, the EU Audit Regulation or the Companies Act 2006. This creates a very low hurdle for regulatory sanction. Any breach of any auditing standard can be sanctioned, however trivial, although the FRC has increasingly been willing to handle the more minor cases through constructive engagement.
The FRC has a wide remit of sanctions at its disposal, which can be imposed singly or in combination. Possible sanctions include permanent or temporary prohibitions on the auditor performing statutory audits or signing audit opinions; exclusion of the auditor as a member of a recognised supervisory body; financial sanctions; declarations that the statutory audit report did not satisfy the relevant requirements; requiring the auditor or firm to cease or abstain from certain conduct and ordering a waiver or repayment of client fees.
While the FRC may have a greater remit for enforcement action under the AEP than the former Accountancy Scheme, its purpose in imposing sanctions is not to punish, but to protect the public and the whole public interest. The public is after all better served by higher quality audits which lead to higher investor confidence in the company’s financial statements.
Financial sanctions will continue to have an important role in the FRC’s enforcement strategy, particularly with regard the deterrence of future breaches; however, the use of non-financial sanctions continues to increase significantly. Non-financial sanctions are used at all stages of the enforcement process, whether that is as part of its early resolution of cases via the Constructive Engagement process, settlement, or following conclusion of a Tribunal hearing.
Constructive Engagement and remedial action
Constructive Engagement is a process introduced by the AEP for resolving cases where the audit quality concerns can be addressed without full enforcement action. The FRC’s guidance provides that it will be suitable for cases where there has been a minor, technical breach, and there is no real concern about harm to the public or a loss of confidence in the audit process.
Constructive Engagement is a more flexible process, aimed at ensuring that the breach is rectified quickly, and not repeated. It may take any form including written advice, warning letters, discussions or correspondence with the auditor and/or audit firm. Unless the FRC is satisfied that the conduct leading to the breach has already been sufficiently addressed to prevent the risk of recurrence, the outcome of constructive engagement will usually be for the firm to carry out remedial actions (if a breach is identified).
The remedial actions imposed in each case are bespoke to the particular circumstances of the breach, and will often involve amendments to a firm’s audit procedures and/or training and guidance across the firm. Remedial actions are often firm wide rather than limited to the particular audit process, or team, in order to reduce the risk of reoccurrence of the conduct that lead to the breach.
The FRC dealt with 33 cases in Constructive Engagement over the past year, an increase of 73% compared to 2019.
Remedial actions were imposed in 27 of those cases, and were predominantly focused on ways audit firms could improve audit procedure and technical knowledge in problematic areas. For example, firms were required to implement measures requiring audit teams to consult with a firm’s technical team on particular issues such as:
- require enhanced work to be carried out by specialists such as tax and actuarial specialists;
- implement better procedures for communication between audit teams and specialists;
- implement additional audit procedures and training on complex areas;
- implement guidance for improving the level of documentation on the rationale for conclusions reached.
A recurring problem with FRC investigations is that they take too long. Constructive Engagement provides the FRC with the flexibility to resolve cases more quickly: the average time taken to conclude a matter through Constructive Engagements is eight months, compared to an average of 48 months for the FRC to conclude a case through to a hearing before the Tribunal. The firm can then implement the remedial actions imposed more swiftly, while the FRC can direct its resources to cases involving more serious breaches which warrant full investigation. We expect the trend towards Constructive Engagement to continue in the coming year.
Investigations resulting in sanctions
Over the past year, the FRC imposed sanctions in nine cases in relation to audit matters, 11 of which were financial, as compared to 27 non-financial sanctions. All but one of the cases resulting in sanctions in the past year was a result of settlements.
The total amount of financial sanctions on audit firms alone (pre-discount) was £15.9 million. Financial sanctions were also imposed against six audit partners, totalling £0.7 million (pre-discount). Where financial sanctions were imposed, 30-35% reductions were applied for early admissions and settlement.
The use of non-financial sanctions is clearly a key part of the FRC’s enforcement strategy. Measures imposed over the last year included increased use of reprimands and severe reprimands, requirements for firms to undertake firm wide training, requirements for firms to produce written reports to the FRC on quality performance reviews, requiring firms to implement an ethics board, and increasing the monitoring and support of regional offices.
If firms carry out enough remedial work prior to the conclusion of the matter, further non-financial sanctions may not be required.
The FRC reminds firms in this Review that a further way that they reduce any financial sanction imposed is by providing an “exceptional” level of cooperation with the FRC’s investigation, for example, by self-reporting.
The year ahead
The FRC remains in a state of flux. Following Sir John Kingman’s review in December 2018 and the Brydon and CMA Reviews in 2019, a number of recommendations have been made to the government for the overhaul of audit profession which, if adopted, will have a significant impact on the regulation of audit in the UK. The FRC itself is due to be renamed as the Audit, Reporting and Governance Authority (ARGA). There has been little progress on the legislative front however, with no shortage of recent other distractions on parliamentary time.
The FRC has been recruiting heavily, notably to increase its ability to monitor audit work, which will then feed into more cases for Enforcement. It has also conducted a review of the AEP, and a consultation on proposed amendments to the procedure is expected later this year. It will be interesting to see what changes are proposed to its enforcement strategy. Beyond that, we may see significant upheaval in audit regulation once we return to normal business.
How to prepare for the Off-Payroll legislation
By Dave Chaplin is CEO of IR35 compliance solution IR35 Shield
We now know for certain that the Off-Payroll legislation will take effect from April 2021. Whether you’re a client, an agency or a contractor, it is vital that you take steps now to mitigate against the damaging impact and costs of the new rules so that all parties can continue to enjoy the mutual benefits of flexible working. Dave Chaplin is CEO of IR35 compliance solution IR35 Shield and author of IR35 & Off-Payroll Explained and here he explains how best to prepare.
Preparing for the reform – hiring firms
The Off-Payroll legislation requires hiring firms to determine whether thousands of contractors can continue to operate as they have for decades. The new rules require hirers to conduct an IR35 status assessment of contractors and inherit a degree of tax risk depending on whether they have taken reasonable care in reaching their conclusion. However, the impact of the Off-Payroll legislation for hiring firms stretches far beyond this.
Hirers will, under these new tax rules, be required to pay the employment taxes due on the earnings of ‘inside IR35’ contractors because agencies simply won’t have the financial resources to cover these extra taxes. When you consider that roughly 80% of the additional tax now due from an ‘inside IR35’ engagement under the Off-Payroll legislation is composed of employment taxes, this is a significant cost to bear.
Inability or failure to offer contracts on an outside IR35 basis also threatens:
- Contractors increasing their rates to counter their own tax loss
- Employment rights claims from contractors deemed ‘employed for tax purposes’
- Struggles to attract talent as contractors look elsewhere for outside IR35 contracts
Firms are also required by the legislation to demonstrate ‘reasonable care’ in reaching the conclusions in their status assessments, which is actually the easiest of the challenges to overcome.
Establish your firm’s IR35 risk
The first step is to acknowledge that Off-Payroll compliance will create an ongoing administrative overhead which your firm will have to plan for, whether status assessments are outsourced or conducted in-house.
The second step is to establish your firm’s IR35 risk by assessing your contingent workers.
The significant compliance challenge posed by the Off-Payroll legislation has necessitated innovation by way of automation. Firms tasked with assessing status and maintaining compliance for vast numbers of engagements need solutions that provide immediate assessments and assistance with the more trivial tasks.
When considering online solutions, bear in mind:
- Are the Status Determination Statements (SDS) detailed and comprehensive?
- Does the solution continue to monitor ‘outside IR35’ engagements throughout the contract for added protection?
- Is the service insurance-backed?
- Does the provider have demonstrable expertise in IR35 and employment status case law?
- Are the solution’s assessments demonstrably consistent with historical IR35 tribunal outcomes?
- Can assessments be instantly turned around?
- Can the solution provide real-time tax calculations to enable hirers and agencies to understand their impact?
- Does the solution make evidence gathering easier?
It is important to establish the credentials of any provider. Almost overnight, a new market for IR35 expertise has sprung up, populated by many unqualified providers without the essential pedigree of legal expertise required.
The importance of enlisting a quality compliance solution or service provider can’t be underestimated. Remember, to gain access to the best contracting talent, you will need to engage contractors on an outside IR35 basis. It’s imperative that any chosen provider doesn’t present a risk to your organisation.
Create contracts and working arrangements that mitigate IR35 risk
Once you have established the greatest risk factors threatening the outside IR35 status of your contractors, these need to be addressed in the contracts and working arrangements. Mitigating these risks reduces the chances of contractors withdrawing from a proposed contract over IR35 status while further minimising your risk of tax liability.
The working arrangements must reflect the written contract and reality. Past tribunal cases have exposed sham contracts, the unrealistic clauses in which are often referred to as ‘window dressing’. If an engagement is firmly caught by IR35 and the proposed contractual amendments aren’t realistic in practice, you will have to accept that the position can’t be rectified.
At this stage, you will have addressed the assessment status, helping to fulfil the ‘reasonable care’ requirement while mitigating your tax liability risk if HMRC investigates. However, for stronger protection, make sure the provider you work with can offer access to insurance policies for ‘outside IR35’ determinations.
Watertight IR35 compliance practices won’t necessarily deter HMRC from fishing via an investigation, so taking out appropriate insurance will ensure that any investigation costs and liabilities required to defend an investigation by HMRC are covered.
Ongoing monitoring and evidence gathering throughout the engagement are other crucial compliance processes. With the Off-Payroll legislation effectively dictating that IR35 status assessments be conducted prior to the beginning of the contract; parties must take measures to ensure that the working arrangement continues to reflect the original status determination.
Preparing for the reform – agencies
The preparation required by recruitment agencies is two-tiered. On one hand, as the intermediary, agencies will be expected to contribute to the IR35 compliance process and help negotiate compliant outside IR35 assignments. On the other, agencies will need to identify and implement processes to calculate, pay and report taxes for contractors deemed caught by the legislation.
Though hiring firms are ultimately tasked with assessing the IR35 status of their contractors, they will rely on recruitment agencies to help develop a solution. The input of agencies into this process is especially important, given most engagements consist of two contracts, both of which the agency is involved in – the upper-level contract between the hirer and agency and the lower-level contract between the agency and contractor.
Assist in addressing IR35 risk
Though it is ultimately the hiring firm that decides the IR35 compliance processes to be applied, they may be open to recommendations. The hirer will generally have no prior experience of IR35 and will be relying heavily on the agency to help complete any negotiations. Though they wouldn’t be considered IR35 experts by any means, most recruiters will have handled requests from contractors to make IR35-friendly alterations to arrangements in the past, and so will have some degree of understanding.
All parties stand the best chance of securing a legitimately ‘outside IR35’ arrangement where there is cooperation and clarity throughout the supply chain, and where hirer, agency and contractor are all involved.
Protect yourself with insurance
Though the hirer is responsible for determining the contractor’s IR35 status, agencies face the primary tax liability risk in the event that HMRC challenges an assessment – that is unless the hiring firm has failed to take ‘reasonable care’ when conducting the status assessment. In the public sector, fears over tax liability risk left many agencies reluctant to engage contractors outside of IR35.
However, this is an unhelpful approach which benefits no one. In any case, agencies needn’t be concerned provided they have assisted in ensuring that the necessary measures have been taken to accurately assess IR35. Agencies can gain another layer of protection by securing tax investigation insurance, which provides the expertise and costs necessary to mount a strong defence in the event of an HMRC investigation.
Agencies suffer disproportionately from the Off-Payroll legislation and the issue of administrative costs is probably the most difficult to tackle fairly, which makes it all the more important that agencies play their part in negotiating legitimate outside IR35 arrangements.
Renegotiate margins to accommodate employment taxes
Finally, agencies will also have to consider the cost of employment taxes on fees paid to ‘inside IR35’ contractors and work out with the hiring firm how these are going to be accommodated. This is another liability which really shouldn’t rest with the agency. Being the party that deemed the contractor ‘employed for tax purposes’, the hirer is for all intents and purposes the ‘deemed employer’.
Nonetheless, the legislation dictates that the agency is ultimately liable. As a reminder, employment taxes consist of employer’s NICs (13.8%) and the Apprenticeship Levy (0.5%). This sum is due on top of the contract fee. This is a rather unreasonable cost for a recruitment agency to pay and will therefore need to be sourced elsewhere.
With the rate the agency charges being fixed, one option is to reduce the pay rate being quoted to the contractor. Hirers will need to understand that paying by offering a lower pay rate than before, they are unlikely to be able to attract the same calibre of worker.
The alternative is to increase the rate charged to the hirer so that they at least contribute towards this cost. This could prove awkward, and you will no doubt encounter hiring firms that are reluctant to pay more for what they see as the same resource.
Ultimately, hirers that wish to hire contractors and treat them like employees will need to accept the accompanying additional cost burden.
Preparing for the reform – contractors
Although contractors have few statutory responsibilities when it comes to the Off-Payroll legislation, choosing to take preparatory steps will impact on whether you can continue operating on an outside IR35 basis beyond April 2021. There is no tax risk for the contractor under the new rules, provided they haven’t committed fraudulent activity, but to secure an outside IR35 engagement you must play an active role in the compliance process.
The immediate threat that the Off-Payroll legislation imposes on hirers and agencies is the chance of being investigated by HMRC, and possible tax liability risk. As the public sector reforms have shown, this can prove very effective in seeing parties taking non-compliant, evasive action by conducting and facilitating blanket status assessments, so all contractors are deemed ‘inside IR35’ by default.
As a contractor, it’s your job to help prevent this, and there are plenty of reasons for the hirer and agency to fulfil their compliance requirements. The first of which is the faact that taking ‘reasonable care’ is the necessary requirement for hiring firms to rid themselves of any tax risk. In an Off-Payroll context, this essentially means taking care to ensure that you have arrived at a correct status determination. Contractors need to make everyone realise that. The message is clear – start talking to hirers now.
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