SBA

UK follows Manx example …

… and shoots itself in the feet with both barrels.

More of that later, but let’s start with a little characterisation of IT workers. They generally fall into four categories - employees, contractors, freelancers and consultants.

Employees are the permanent “on payroll” workers who provide continuity of service and knowledge, handling most of the business as usual (“BAU”) workload of providing and maintaining IT. Most employers aim to keep these folks long term.

Contractors come and go. They are off-payroll temporary resources, typically employed by either their own “personal service company” (“PSC”) or an Umbrella company (a company which provides employment and payroll services to multiple independent contractors). A contractor is usually engaged for a specific purpose for a number of months - to resource a project, develop a specific bit of software, or fill a temporary resource shortfall.  Freelancers come, go, and come again. Freelancers typically perform an intermittent function for which a full-time resource is not merited, for example the periodic maintenance of a website. Consultants are a bit of a hybrid, they do shorter pieces of work like freelancers, but they usually only do it once like the more project-oriented contractors. Freelancers and consultants almost always operate through a PSC. 

Contractors, Freelancers and Consultants all take frequent risk of unemployment until finding their next work; the customer has no obligation to them beyond whatever is in the contract, they are not employees and have no employment protection or rights, no employee benefits, pensions, health insurance, paid holidays, employer-provided training, redundancy payments, whatever. They must cover all these things for themselves out of their fees. They are also usually not eligible for unemployment benefits / jobseekers allowance, so most keep a reserve of cash in their PSCs to cover the income gaps between assignments.

All this means that these off-payroll workers have daily or hourly rates much higher than the direct cost of employees, or so it appears to the taxman. Many off-payroll workers cover the value of their employee benefits themselves by accumulating reserve cash in their PSCs - this is one of the primary benefits of running a PSC, the other being the limited liability protection which is as essential for freelancers and consultants as for other small businesses. 

Contractors in particular, as they tend to have assignments where they work solely for one client for several months, can appear to the taxman to be substitute employees who are being unfairly permitted to accumulate wealth outside of PAYE and NI by retaining contingency funds in their PSCs instead of paying to themselves and incurring their employer and employee taxation liabilities.

In reality the vast majority of IT contractors are project based workers on short fixed-term contracts. A few are fortunate in that no sooner have they finished one project than their customer gives them another, creating an illusion of longer term employment which reinforces the taxman’s perception that they are really substitute employees who are successfully avoiding tax.

In the UK the taxman devised a mechanism to deal with this perceived avoidance; known as IR35 it places an obligation upon the contractor to pay themselves the majority (95%+) of their billings unless their contract meets certain tests showing that they are not substitute employees. This means that affected contractors have to pay the employer’s and employee’s NI and PAYE on almost all their income and cannot accumulate rainy day reserves in the PSC or fund employee benefits or marketing and operating expenses from untaxed income like any normal business. It also has the effect that contractors pay higher rates of tax than employees but get far fewer employment benefits and protections. Unsurprisingly IR35 is, by contractors, regarded as being a very unfair taxation regime.

IR35 was introduced by Gordon Brown in 1999 and despite being over 15 years old remains controversial because of its perceived inequity. It caused a substantial exodus of contractors from the UK to other places including Spain, Switzerland, South America and the USA, and has been attributed direct responsibility for the UK losing some of its best IT specialists. The effectiveness of IR35 has been repeatedly questioned in the UK Parliament and in 2009, ten years after its first implementation, HMRC was eventually forced to disclose that IR35 had raised £9.5 million over its lifetime against a projected revenue of £220 million per annum. HMRC blames contractors and “employers” for finding contractual devices to avoid IR35 eligibility. Independent tax experts have calculated that HMRC has lost many millions of pounds because the cost of administering IR35 is much higher than the revenues collected.

The Isle of Man tried to learn from the UK’s mistakes with IR35, and in 2014 introduced the “Income Tax (Amendment) Act 2014” which deals with any PSC tax avoidance problem by placing the tax liability for the contractor onto the client (employer) as a “Deemed Employee”. This approach, known as GN50, solves the avoidance problem because most employers are not willing to risk the liability of being required to pay back taxes if someone is retrospectively determined to be a Deemed Employee, so they insist on PAYE type arrangements for contractors.

Which is where we shot ourselves in the foot. The island harmed itself with GN50 because it discouraged IT contractors from coming to the island, and encouraged those who used to work on the island to work elsewhere instead. Numerous businesses, particularly our larger employers, have suffered increased difficulty in obtaining the contractors they need to execute IT projects. Further, because some of those contractors who remain have been pushed into temporary employment on PAYE instead of invoicing via their PSCs, we traded a marginal gain per contractor in PAYE and NI collections for a total loss of the VAT they used to charge at 20%. The economics of both fewer contractors and less VAT are bad for Treasury. The difficulty in obtaining contractors is bad for business. The island’s PSC tax avoidance approach has proven to be a lose-lose strategy.

Hard evidence of the damaging effects of GN50 is hard to come by in-island beyond the bleatings of employers and contractors, however rock-solid proof that GN50-style mechanisms are harmful is now emerging from an unlikely direction. HMRC cannot change its failed IR35 scheme without the risk that Parliament will throw it out altogether because it has been such an expensive waste, but it can however insist that UK government departments treat all their contractors as if they are “on-payroll”, either by converting them to payroll or insisting that all their billings are paid to the contractor as salary and thus liable for the maximum PAYE and NI burden in exactly the way that the Isle of Man’s GN50 scheme works - and this is what they have recently proposed. 

UK Central Government has around 30,000 IT workers, of which 12,000 are payroll employees and the other 18,000 are contractors. Shortly after HMRC announced its intentions a poll of contractors working for government showed that around 90% said they would either cease working for the public sector or raise their rates to compensate for the added cost of paying for their employment benefits and protections out of their taxed income.

Despite this feedback HMRC ploughed ahead, fired both barrels, and circulated its new guidance to central government employers. The first UK government department to roll out the new IR35 guidance was the UK Hydrographic Office - the part of the Ministry of Defence responsible for mapping the seas in order to keep Royal Navy and Merchant Marine sailors safe. It issued new rules for its IT contractors on 1st September. On 11th October the UK’s primary IT newspaper, Computer Weekly, reported that 30 of the Hydrographic Office’s 32 contractors had voted with their feet and quit, leaving a raft of IT projects in mothballs and the remaining permanent employees struggling to cope with the day to day business as usual workload.

The UK Autumn Statement is tomorrow (November 23rd) and was widely expected to formalise the imposition of IR35 PAYE requirements on all off-payroll UK Public Sector employees. It will be interesting to see if the new Chancellor goes through with it. If the polls and the Hydrographic Office example are any indicator the UK Government could lose over half its IT workforce in short order.

Either way I hope the Isle of Man Treasury is watching closely. We have made the island a very unattractive place for some of the most highly skilled IT workers, those itinerant experts who waft from client to client, doing the specialist work or providing the temporary extra resource that most major projects need. Because we are a small island our own data on the effects of GN50 is small scale and hard to rely upon, but the large-scale data emerging from the UK is hard to ignore. Around 90% of contractors said they would leave if faced with the UK equivalent of GN50, and in the first test case last month over 90% actually walked out. It’s perhaps not surprising that many Isle of Man businesses are struggling to get the specialist IT skills they need.