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HM Revenue & Customs (HMRC) has underestimated the widescale disruption the IR35 tax avoidance reforms will have on the delivery of public sector IT projects, as stakeholders warn that the number of contractors affected will dwarf department estimates. 

The reforms, which come into force today (6 April), will see limited company contractors cede control for determining whether they should be taxed in the same way as salaried employees (inside IR35) or off-payroll staff (outside IR35), to the public sector bodies (PSBs) they engage with.

HMRC says the reforms are designed 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.  

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

But contracting stakeholders fear that the “blanket approach” many PSBs are understood to have adopted in the rush to comply with the reforms means many contractors risk having their outside IR35 engagements incorrectly reclassified as inside IR35.

This is a scenario the Association of Independent Professionals and the Self-Employed (IPSE) has previously warned about, as PSBs get to grips with assessing the often nuanced engagements that contractors have with the organisations they work for.

“What we feared would happen is happening,” said Jordan Marshall, policy development manager at IPSE. “PSBs are taking a blanket approach because they have not really been given enough time to assess engagements properly and they are saying all contractors are inside IR35 after 6 April.

“People are saying ‘we are not going to work in the public sector any more, we don’t want to be taxed in the same way as an employee, especially if we are not getting employee benefits’, and they are leaving.”

While contractors have the option to challenge the classifications they receive by going to an industrial tribunal, anecdotal evidence suggests most are opting out of the public sector altogether, for fear of becoming the subject of a retrospective tax investigation by HMRC.

“If they are currently working on an assignment and the PSB has decided they are inside IR35, there is real concern among contractors that HMRC might look back over what they have done before and decide perhaps that they should have been considered inside IR35 over the past year,” said Julia Kermode, CEO of the Freelancer and Contractor Services Association (FCSA).

“PSBs haven’t got time to assess every contractor engagement individually, so the fact that someone is caught now doesn’t necessarily mean they should always have been inside IR35.

“I don’t know how HMRC would have the resources to check back over everyone’s prior work, but it is making people lose sleep over the threat of a potential unpaid tax bill.”

Contractor exodus

There is already mounting evidence of contractors leavng the public sector, with Computer Weekly previously reporting on the IT contractor departures that have blighted the UK Hydrographic Office and HMRC in the run-up to 6 April.

Computer Weekly has received numerous complaints from IT contractors who claim that the PSBs they work for have taken a “blanket approach” to these decisions, prompting mass walkouts and leaving the delivery of various digital projects hanging in the balance.

One ex-public sector IT contractor, who spoke to Computer Weekly on condition of anonymity, claimed that entire teams, tasked with delivering digital projects across several large government departments, had walked out.

“People came in on Monday and were greeted by swathes of empty desks, vacated by people who had elected not to turn up – and the same is happening elsewhere,” the contractor said.

“It is difficult to quantify the impact this is having on IT delivery at the moment, but in the months and years to come, I can see IR35 being cited as a cause in various National Audit Office investigations into future IT project failures and delays.”

Jumping ship

Seb Maley, CEO of IR35 contract review service provider Qdos Contractor, said the “vast majority” of white-collar IT workers should have their engagements rightly classified as outside IR35, but that is not happening. As a result, they are voting with their feet and fleeing to the private sector.  

“Our experience overall is that, in all public sector departments and on a wider basis, the vast majority of IT contractors are outside IR35,” said Maley. “There is a very high level of compliance.

“In pretty much every public sector body, there has been a big loss of contractors, regardless of whether they have done a blanket determination or tried to do things properly. A lot of contractors just thought they would get out while they could because of the sheer uncertainty around it.”

Counting the cost

IPSE’s Marshall said public sector IT managers were likely to be counting the cost of these departures for many months to come.

“Government is very reliant on contractors to deliver their IT projects because that kind of expertise is not available in the permanent workforce, and lots of people in IT are being affected and it will have a knock-on effect on projects,” he said.

“We will just have to wait and see exactly what impact this has on the delivery of public services and projects over the next few weeks.”

When Computer Weekly put this view to HMRC, a spokesperson said the organisation was keeping a close eye on the situation and was ready to intervene if needed. “Like all tax changes, we are monitoring their effect to make sure they work effectively and fairly and we have yet to see any cause for concern,” the spokesman said.

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