Phil White, Managing Director at Leeds and London based software developer Audacia, discusses the impact private sector reforms will have on businesses.
By the time you read this, private sector IR35 reforms will have come into force, causing the potential for significant risk and disruption for any financial business reliant on IT contractors to accelerate digital transformation initiatives.
What is the impact of the change?
From April 6th 2021, every medium or large private sector business is expected to review their use of contractors and how their roles are classified under the IR35 legislation. Essentially, your organisation must decide whether each role falls 'inside' or 'outside' IR35 – a task that was previously left to the contractor themselves.
If the role is determined to fall inside IR35, your business is expected to deduct income tax and National Insurance contributions (NIC) from the contractor's payments.
Learning from IR35 in the public sector
Using 'personal service companies' (PSC), businesses have been able to reduce their wage bills – no Class 1 employer contributions was a useful way for an organisation to control their costs. And it wasn't just the private sector benefiting from this arrangement.
In 2017, public sector bodies began the process of classifying contractor roles as being inside or outside IR35. Some jobs were made permanent with staff being taken onto the payroll. Other contractors were forced to join umbrella organisations who assumed responsibility for deducting PAYE and NICs.
The process was long and arduous and the tax loophole was eventually closed – but there were some unintended consequences too. Some 76% of public sector departments lost highly skilled contractors – and 38% could not be replaced. In addition, 24% of projects lost at least half of their contractor workforce as individuals left for the private sector – or even moved abroad.
The public sector experience shows what private companies should expect this April and beyond.
Why has IR35 become such a headache?
IR35 will create problems for any organisation reliant on long-term contractors for headcount.
Obviously, there's an increase in cost because you need to pay Class 1 NICs. And as contractors find more of their salary disappearing under PAYE, you are likely to face demands for rate/salary increases to cover the shortfall.
With Harvey Nash reporting 17% of 1,100 IT contractors are raising their rates to over the tax increase, some by 13% – 38% to cover the difference – this is a stark rise on the already large invoice.
The reclassification of roles is likely to be highly contentious. Public sector organisations like the NHS faced a lot of time-consuming, costly disputes and push-back from contractors who felt that their roles had been classified incorrectly.
Eager to remain compliant with HMRC regulations, many businesses have taken a hard-line – no contractor policy. All big three banks in the UK – HSBC, Royal Bank of Scotland (RBS) and Lloyds – revealed that they will no longer engage with contractors who work through personal services companies, and instead will employ individuals on a pay-as-you-earn (PAYE) terms or via an umbrella company.
The impact on digital transformation
More and more businesses are continuing to promote and invest in digital-first strategies, especially with recent events making it abundantly clear how dependent we are on digital services for business continuity, enabling businesses to rapidly adapt and respond to customer needs throughout times of change. More than a third of 2021 tech budget increases will be influenced by Covid-19.
As the finance sector typically uses contractors for development work to accelerate digital change, IR35 changes now present a high risk of digital transformation programs stalling, with a potentially devastating effect on projects.
As seen in the public sector, 79% of IT projects were delayed after IR35 came into force due to contractors leaving, putting a quarter of big government IT projects at risk, including the Home Office's £341m Digital Services and Border Programme, and HMRC's £220m tax digitisation for business plans.
As IR35 changes come into the private sector, it is extremely likely that at least some of your most valued contractors will leave. In fact, 52.5% of contractors plan to leave immediately – and another 4% plan to emigrate. Another 19% plan to stay on short term while they evaluate their options.
CIOs in the finance sector are now faced with a potential resource shortage, as IR35 is leading to contractors leaving, at the same time the UK is 'heading towards digital skills shortage disaster'. This makes the option of hiring permanent employees to replace contractors a challenging one.
What are financial companies doing now?
A number of CIOs are now seeing the contract renewal phase as an opportunity to revaluate delivery teams.
Given the complexity of reclassifying every role, alongside contractors upping sticks, more and more organisations in the financial sector are shifting from the use of traditional contracting methods to using external partners to accelerate digital transformation initiatives.
As opposed to scaling or augmenting internal engineering teams with disparate contractors, technology leaders are considering digital transformation partners to provide flexible teams to meet current needs, with the ability to scale and adapt as priorities change. Enabling their organisation to deliver projects faster, without the need to increase headcount.
This can also provide benefit in mitigating risk and concern around IR35 by engaging with a service delivery company with full time employees under a genuine management structure. Whilst also tapping into a 'technology hub', with experienced specialists across different business areas and industries to suit staffing needs and keep pushing technology forwards.
Audacia works with businesses in a range of sectors to provide digital transformation services, from advisory and strategy development, to providing teams to deliver digital projects. Teams operate as an extension to client businesses, either based onsite, providing the benefits of contractors or internal hires, or offsite, an approach that has only strengthened as businesses continue to work remotely and online collaboration continues to excel.
This reduces the reliance on external contractors and ensures agility and efficiency for businesses; in current periods of continuous change, adaptability has become key to success. Small, agile teams, enabling organisations to rapidly deliver digital projects and focus on continuous improvement and innovation will be essential for finance businesses to respond to employee and customer needs, improve service offerings and scale.