Changes to IR35 – how will it Impact the supply chain?

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The intended changes to IR35 in the private sector have been a big topic of conversation over the past few months, which we have covered extensively at Armstrong Watson.  Whilst HMRC’s main aim is to combat tax avoidance, the impact on sectors using contractors is expected to be wide-ranging, from the top of the supply chain, down to the bottom, and we will attempt to cover the main aspects here.

Increased Burden on Principal Employers

One of the fundamental differences from April 2020 will be in respect of where the obligation will lie to determine whether a contractor falls under the IR35 rules or not.  Historically, the contractor was able to decide whether they could apply IR35 or not, but the principal employer will now have to make that decision from next April.  As a consequence, for any contractor who is deemed to be ‘working in a manner akin to employment’, the principal employer will be expected to deduct the appropriate tax and National Insurance, paying it over to HMRC as they would with normal employees.

In theory, this shouldn’t be of major consequence, as the contractor would receive the net amount of their usual monthly payment rather than the gross amount; the only difference would be that the principal employer would have to split the payment to the contractor so that the taxes element is paid over to HMRC and the net goes to the contractor.  However, there are likely to be increased costs internally as the contractors now deemed to be employees will need to be added to the relevant submissions to HMRC, so the burden will be on the principal employer from that perspective.

It should also be noted that the principal employer, as the one making the decision about whether their contractors fall under the IR35 rules or not, will be responsible for any incorrect reporting too.  This obligation also extends to any reprimands for incorrect reporting - including fines that may arise!

Contractors vs Employees

Contractors have been popular in sectors where there is a fluctuating labour demand.  Employees have to be paid every week/month, whereas contractors can be brought in when the demand is required.  There may be an argument to employ contractors on a permanent or temporary basis but contracting employers should consider this fully before taking the plunge: not only would there be an additional cost in respect of the wage bill, but there will also be additional costs in respect of benefits.  Don’t forget that employees will need to be included in auto-enrolment, there will also likely be additional benefits to factor in, as well as holiday pay requirements.  Certain benefits will also have the additional National Insurance implications, which would again be an increased cost.

Potential for increased cost is not the only factor to consider when deciding whether to swap contractors over to employees.  Employees also have entitlement to notice, time off, etc. and this may impact on the employer’s ability to be agile and adaptable to change.  Consideration should be given to the lengths of time for which the contractors are likely to be required on a particular project, for example, is this over a set period (say 12 months) for which a fixed term contract can be agreed and, if so, is the remuneration going to be acceptable for the level of expertise required?

There are also concerns that an employer’s staff base will not be particularly happy if a contractor is employed by an employer to do effectively the same work as the permanent staff.  Consideration will need to be given to how such a programme is implemented, although in theory the position on a day to day basis would not be too different to how it is at the moment.  We can of course assist with this, if it is a concern.

Labour Shortages May Lead to Project Slippage

There have also been concerns that there will be potential for labour shortages as a consequence of the changes, which will then impact on the different employers within the supply chain being able to complete their respective contracts, and the financial penalties which then may arise.  Businesses in this position will need to review project milestones to identify whether there will be any risk of slippage due to the labour shortages - and factor in any potential delays.

By keeping on top of the project, the chances are that you will identify the risks of slippage sooner, thereby being in a more favourable position to mitigate them.

Overtrading

Managing growth can be quite challenging at the best of times.  At a minimum, a business needs to be able to generate sufficient cash flow to keep trading but it also needs to grow in order to be able to earn an economic return.  Overtrading occurs when a company takes on new orders without having the resources to fulfil them, for example if staff numbers are short, or there has been insufficient investment in equipment to complete an order.  Cash flow is often stretched beyond breaking point at these times and the company begins a decline before they are paid by their customer.  Where the business has an overdraft facility with their bank, there might be evidence that the overdraft limit is near to being breached, and this is a key indicator for overtrading, as is struggling to pay suppliers or HMRC on time.

With the changes to off-payroll working there is going to be a risk of overtrading, especially for those companies in the middle of the supply chain.  This is likely to be particularly prevalent as the changes bed in, as these companies will want to ensure that they retain the contract with the principal employer (who will be in charge of the purse strings for the project), but it will be difficult to evaluate the longer term effects when factoring in the potential for labour shortages and project slippage.

It should be noted that overtrading does not necessarily mean that a business is financially distressed, but, if not managed correctly, overtrading can prove terminal in some cases.  Luckily our Restructuring, Recovery and Insolvency team are well placed to deal with this type of challenge that businesses can face.

Managing Cash Flow and the Working Capital Cycle

If there are delays to the project due to labour shortages, not only is there a real risk of overtrading, but there will also be additional stress placed upon your cash flow as invoicing, and subsequently cash collections, are pushed back.  The working capital cycle will be extended as it takes longer to collect in the monies owed to you, and it will then take longer to pay suppliers.  Managing cash can become difficult in these scenarios, especially when it comes to managing the expectations of the various stakeholders.

We are able to work with you and your bank or funder to ascertain whether there is action that can be taken to free up cash, and we can also assist with cash management and critical payments, helping you bridge the gap without taking out additional finance.

Closing down your Personal Service Company (PSC)

Whilst the majority of this article has concentrated on the effects to the employers within the supply chain, for those contractors who will no longer need their personal service company we have written a handy guide about the options available to you, which can be found here.

What should I do now?

The changes to the IR35 regime will undoubtedly have an impact on those sectors that have been heavily reliant on contractors over the past 20 years.  If you are an employer, you need to watch out for project slippage, monitor your cash requirements and, if you feel that your business might start to struggle, please get in touch sooner rather than later.  Inevitably there will be challenges ahead but our Restructuring and Insolvency team can help you find a way through the uncertainty.