Matt Fryer, Head of Legal Services at Brookson Legal
The Government’s recently announced £650bn programme of infrastructure works is a welcome boost as we emerge from the pandemic and organisations look to grow. However, talent shortages combined with a recent change to the tax laws governing contractors, commonly known as IR35, have the potential to cause major challenges to project delivery.
The competition for talent
To strengthen the recovery of the infrastructure sector, the Government also recently announced a Plan for Jobs which will support young people entering the construction and engineering industry. This initiative, however, will not address the current shortage of skilled and experienced technical contractors that will be required to deliver these vital projects.
As job vacancies top an all-time high, we are already seeing that contractors are able to pick and choose the programmes that they work on. In fact, data from the Recruitment and Employment Federation’s (REC) Report on Jobs found in September that hiring activity rose sharply amid unprecedented demand for candidates, but a shortage of experienced talent is being felt across almost every industry. As a result, fierce competition is driving up starting pay for both permanent and temporary workers. With data continuing to highlight increased hiring activity, it’s clear that the competitive hiring environment will not be a short-term challenge.
Contractors are vital to the sector
Infrastructure businesses rely on expert contractors to help deliver their projects on time and, crucially, on budget, so these talent shortages pose a major commercial risk. A similar situation can clearly be seen in the haulage sector where competition for HGV drivers has combined with poor management of the IR35 tax changes to result in significant delays to deliveries across the country. Thankfully there are steps that can be taken now to ensure that they are maximising their ability to attract and retain a reliable flexible workforce.
The changes introduced earlier this year to IR35 off-payroll legislation transferred compliance for tax and national insurance (NI) contributions for contractors from the individual contractor to the end hirer. The means that the hiring business is now responsible for producing the Status Determination Statements (SDSs) of its contractors and clarifying whether they should be paying employment taxes (NI and income tax) to HMRC. The legislation aims to ensure that contractors, who would be employees if there was no intermediary, pay the same tax and NI as employees.
Genuine contractors working through intermediary companies are classed as working outside of IR35 and are paid gross for work completed. However, if the contractor is classed as inside IR35 the hiring business is responsible for the employment deductions, effectively leaving the worker with a 20% reduction in take-home pay. Given the choice between working inside and outside or IR35, experienced contractors are voting with their feet.
The risks of a poor IR35 solution
If we look to the public sector, where similar IR35 rules were introduced in 2017, we can see the impact this had on key projects, such as HS2 which experienced well-publicised delays.
This was due to one of the most common knee-jerk reactions to the IR35 changes – implementing a blanket “inside IR35” determination on all of their contractors. Such an approach effectively puts them on payroll in order to avoid exposure to any tax risk. This comes with a number of significant challenges, the first being recruitment of talent to complete projects as skilled contractors, who could find outside IR35 roles elsewhere, will either seek alternative roles with higher pay rates or demand an increase in pay to compensate them for the loss.
While the risk posed by HMRC tax liabilities is easily quantifiable, this needs to be weighed against the commercial risk of project delays. If talent cannot be recruited to deliver projects on time and within budget, this presents a major reputational risk to private sector companies delivering public infrastructure projects, not to mention costs incurred through fines and increased resource costs.
Compliance
Another learning we can take from the public sector is that inadequate approaches to IR35 compliance can create hidden tax liabilities. Included in the financial reports of Government body organisations which receive bills earlier this year, the sums owed by The Department for Work and Pensions (£87.9m), Home Office (£33.5m) and HM Courts & Tribunal Service (£12.5m) are a clear warning that a robust solution is required.
Theses public sector fines demonstrate the complexity of IR35, and the need for specialist support. HMRC sought to help public sector organisations and private sector businesses manage their new responsibilities with an online tool ‘Check Employment Status for Tax’ (CEST). However, as their government colleagues have discovered, the legalities are too nuanced and intricate for organisations to rely upon to produce accurate status determinations.
The tool is only as useful as the information entered into it and if a question is misunderstood, or inaccurate data is used, the outcome will not be correct or compliant. The HM Courts & Tribunal Service annual report clearly states that a £12.5m deduction was for ‘incorrect assessments of the employment status of workers’. In addition, the CEST tool returns an undetermined result in 20% of cases, meaning that a professional-led approach is needed to evaluate the contractors IR35 status.
Getting IR35 right
However, it does not have to be like this and it’s never too late to adhere to best practice. Network Rail implemented a blanket ban when IR35 was introduced in the public sector, but four years later it has taken the positive step to reconsider its approach.
In fact, Network Rail’s contractor status determinations found 74% of contractors outside of IR35 compared to its previous approach of 100% inside determinations. This clearly demonstrates the risks of a blanket ban – by implementing a blanket ban for four years, Network Rail had lost access to three quarters of its skilled contractor workforce, risking project delays and fines as well as loss of reputation.
Ultimately, IR35 management is a governance issue. Getting it right now will give organisations in the infrastructure sector a competitive advantage in securing and retaining talent during this vital period of opportunity. Investors should challenge the businesses they work with to ensure that a robust IR35 solution is in place, which meets HMRC’s reasonable care threshold, reduces the risk of unexpected tax bills and maximises the organisation’s ability to recruit and retain a flexible workforce to support business growth.
