HMRC's efforts to make sure contractors are paying the right amount of tax has prompted a 'mass exodus' - Photo credit: Fotolia

The government is facing a "mass exodus" of digital contractors and an influx of invoices as stricter tax rules drive workers to the private sector.

HMRC is tightening up a piece of legislation known as IR35, which dictates how much tax contractors pay, in a bid to recover millions in unpaid taxes from contractors working in the public sector.

The legislation requires that personal service companies - which are often single people offering their personal services and are common in the IT sector - apply PAYE and national insurance taxes on the payments they receive. 

The reforms, which come into force on 6 April, will see this responsibility shift to the bodies or agencies that hire the contractors, and the government hopes this will help identify those contractors who aren't paying the right rate of tax. Contractors who should be paying IR35, but aren't, could end up paying around 20% more tax each year.

However, the move is expected to have an adverse effect on the public sector, as some workers have decided to stop working for government rather than risk being deemed "inside" IR35.

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Although the rules apply across the public sector - with an estimated 20,000 contractors on the government's books - it is expected to hit the technology professions hardest because there is already more competition from the private sector in digital than in some of the other areas where contract workers are prevalent, such as healthcare.

"The big problem is the IT guys, because they can just jump ship." said Dave Chaplin, chief executive of the contractor portal ContractorCalculator. "There will be some people that have been there for years and will clearly be caught by IR35...those people will probably leave the public sector."

Sources with experience of government digital contracting contacted by PublicTechnology agreed that it was unlikely contractors would remain working for government if they were going to be classed as falling within IR35, describing a "mass exodus" among IT workers.

Some estimated that as many as 90% of contractors in some central government departments were thinking of leaving, while the trade title ContractorUK reported last month that thirty personal service company contractors were planning to abandon an overrun £16.5million health service IT project after the London NHS Trust they work for said they would all be inside IR35.

"The big problem is the IT guys, because they can just jump ship."

And, because the rules will apply to invoices paid after 6 April, the reforms could also put an extra administrative burden on departments, with today (6 March) being a crunch point as many contractors planned to invoice departments today in the hope of getting paid before the cut-off date.

"People will want to get their invoices issued and payments made before 6 April if they can," said Julia Kermode, the chief executive of trade body the Freelancer and Contractor Services Association, "It's a massive amount of work [for government agencies and departments] to do."

However, HMRC disputed the reported effects of the changes, with a spokesman saying that the authority was "monitoring the impact of changes to public sector hiring and has not seen evidence of any movement to the private sector".

For local government IT, the effects could be less severe: David Bryant, commercial director of the local government IT professionals association Socitm, said that digital contractors are a small proportion of councils' workforces.

“It’s extremely difficult to portray the impact of IR35 changes at a universal level," he said. "While it’s been well documented already it will likely have significant, negative repercussions for local authorities and contractors, we understand that ICT and digital contractors – those who work most closely with Socitm members – only account for small section of the market: approximately 11% of the total contractor workforce.

"Of greater significance will be the impact on those contractors working in the delivery of social care services which have been reported to consist of 40% of the contractor workforce."

Employment status tool 'not fit for purpose'

The UK's tax authority has also come under fire for failing to properly brief public sector workers on what is expected of them, with one source who works with government contractors, but who wanted to remain anonymous, saying the guidance had been "nothing short of appalling".

HMRC has now launched an online tool - the Employment Status Service - in a public beta. This aims to help agencies and contractors identify whether they fall inside IR35, which HMRC said had been developed using relevant case law. Although it isn't mandatory for agencies to use it, a spokesman said it would "provide HMRC's view for the overwhelming majority of cases".

But critics have said that the tool, which only went live on 2 March, had been released too late for many contractors to take action, and voiced concerns about its accuracy.

ContractorCalculator said that it had tested the tool against 21 historic IR35 court cases and found that 27% returned a verdict of "unknown", while 10% of cases that failed in court were passed by the HMRC system.

Chaplin said: “With only a few weeks to go before the IR35 reforms come into force, HMRC’s tool is nowhere near fit-for-purpose and HMRC could be handing out employment status decisions to contractors, agencies and public sector hirers that are wrong – or simply leaving them in Limbo Land. For an organisation to assess its tax risk on such a shaky implementation presents a huge risk to projects and ultimately the bottom line."

Government 'failed to plant' the carrot to counter the stick 

Although the focus of much of the debate has been on the reforms to IR35, one contractor working for the government who spoke to PublicTechnology on condition of anonymity said that this ignored the drive for wider reforms within public sector staff.

"This isn't about tax, it's about something completely different: it's about trying to change the way that contractors are used in the public sector," he said. "The government is trying to shift so work is procured against an achievable outcome."

"This isn't about tax. It's about changing the way contractors are used in the public sector."

For instance, the government's Digital Outcomes and Specialists platform asks departments to set out a clear outcome and hire a specialist to carry out the necessary work.

"Most public bodies can't afford to hire a full-time cyber security specialist, so you need to bring one in," the contractor said. "Now, instead of asking for a contractor to come in as deputy head of cyber for two years and pay them a day rate, you have to ask for a report, or a strategy, get a specialist in to do that and pay them a set amount for a set period of time."

The problem the government is facing, the contractor continued, is that it it "needed a carrot and a stick" to make the reforms work.

"HMRC is the stick - they're the Rottweilers of the establishment and their job is to recover every penny of tax they think they can get hold of - but the problem is, nobody remembered to plant the carrot. Nobody briefing the public sector bodies on how they should take this on and change the way they procure services, and nobody briefed the contractors."

He said that the best thing for contractors to do was to take some time off and start up talks with government departments once the dust had settled, adding that he would no longer be a contractor after 24 March, and would be "approaching things differently".

He also urged the government to relax the DOS2 procurement rules so existing contractors could be fast-tracked onto the system so departments are "not left totally high and dry".

The Cabinet Office had not responded to a request for comment on the situation by the time of going to press.

Update: HMRC issues further response

A spokesman from HMRC contacted PublicTechnology after publication to issue a further comment on the impact of the reforms - in addition to that supplied by the authority before publication. It is published in full here.

A government spokesman said: “None of these claims are correct. The tool is working correctly and has been extensively tested. We welcome feedback from users.

“Public sector organisations and contractors are free to work with each other in a manner that suits their circumstances, however it’s fair that two people doing the same job should pay the same taxes. These reforms will help ensure that happens.

“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.”