Some government departments lost up to 40% of IT contractors after IR35 changes

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Some government departments lost up to 40% of their IT contractors as a result of changes to IR35 tax rules  introduced in April.

The reforms to IR35 were introduced by HM Revenue & Customs (HMRC) to clamp down on an estimated 20,000 contractors who essentially work as permanent employees, but use their off-payroll status to avoid making PAYE and national insurance contributions.

Different departments took different approaches to introducing the changes. Some decided to take a blanket decision to place all contractors into IR35 – or sometimes only those above an equivalent civil service pay grade – while others did not.

Some departments were heavily affected, but others have seen much less impact – one large ministry lost only two IT contractors, according to a source.

One example, confirmed by multiple sources, demonstrated the problems caused by such an apparently haphazard approach.

Four contractors working as part of a team rolling out a new network in one Whitehall department were informed they would be classified as inside IR35, and therefore taxed as if they were permanent employees.  As a result, those four individuals subsequently switched to work on a similar networking project in another department, where they were classified as outside IR35 and taxed as such.

An executive at one supplier said several digital projects in government had been put on hold or even scrapped because of IT contractors leaving after being told they were inside IR35. Some departments have offered contractors up to 20% more money to offset the extra tax they have to pay, in order to retain their services.

The reforms were intended to prevent contract workers paying less tax for doing a job that would otherwise be done by a permanent employee. Previously, it was up to contractors to self-declare if their public sector engagements meant they should be taxed in the same way as salaried workers (inside IR35) or as off-payroll staff (outside IR35).

The reforms meant that public sector bodies became responsible for declaring contractors’ IR35 status instead.  HMRC estimated that the activities of non-compliant contractors cost the Exchequer £440m during the 2016/17 tax year. The treasury expected the changes to generate about £185m in additional tax during the 2017/18 tax year.

“Public sector organisations and contractors are free to work with each other in a manner that suits their circumstances,” HMRC said in a statement when the reforms were introduced in April. “However, it is fair that two people doing the same job should pay the same taxes. These reforms will ensure that happens.”

In May, health service body NHS Improvement, which oversees the work of various NHS trusts and care providers, admitted it had made mistakes in how it interpreted the new rules, and as a result reversed its original decision to take a blanket approach to all contractors, instead assessing each case individually.

Departments are meant to publish monthly updates on workforce numbers, although some do so more frequently than others.  Figures for the Home Office showed it used 2,316 contractors during March 2017, but this fell to 1,355 in April, after the reforms. HMRC used 215 contractors in March, and 181 in April.

However, these numbers refer to all off-payroll staff, including everything from cleaners to interim managers, so it is difficult to relate them directly to IT workers.

Significant impact

Former Home Office chief data, digital and technology officer Sarah Wilkinson has said that IR35 reforms could have a significant impact on digital projects at the department.

“There is no doubt in my mind that, if we are realistic, we are going to have a year of significant pain because you will see a degradation of the contractor population,” she said at the time.

“It will take some time to embed new pay structures, even if they were approved tomorrow.  So 2017 is going to be extraordinarily difficult. I don’t know if there is a way of imagining the IR35 problem isn’t going to have a delivery impact – but once it’s done, it’s done.”

In March 2017, research by tax adviser Qdos Contractor suggested that 85% of respondents would cease working in the public sector if the organisation they worked for concluded that they should be considered inside IR35.

Recruitment firms providing contract staff to government warned before the April reforms that the IR35 changes could harm public sector projectsThe loss of IT contractors in some departments comes as Whitehall takes on a growing digital workload, with the government transformation strategy announced in February and preparations for Brexit both likely to require significant resources in the two or three years.

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