IR35 History | 30 March 1999 | Hammer to crack a Nut

IR35; countering tax avoidance or helping big business?

IR35; countering tax avoidance or helping big business?

Just as the Web is about to revolutionise the way our knowledge based service industries work, the Government, with this "tax avoidance" legislation, is about to cause major damage to this fast growing business sector. This would be a view shared by many who have visited the site engineerjob.com which since launch has attracted over 200,000 hits and a subscriber base for a free email newsletter which is some 2000 and growing at over 250 each day

Having had experience of managing a multi-million pound "technology" project it might be worthwhile to outline the commercial fundamentals driving the growth in this market and the way we are now doing business. A client has a project in an area requiring large amounts of intellectual "capital" i.e. the design of a ship/plane/car/IT system. What are the human resource options?:-

1. Taking on permanent staff when there is no certainty of continued employment would be wrong
   
2. Specifying the work to enable a fixed price bid to be invited may involve several problems
   
   • The client may not have the time or resources to carry this out
     
   • The technical issues and risk may make this route commercially unacceptable as any price will have to take account of this risk.
     
   • The client may require close integration with his own core team of staff and a fixed price relationship will often be detrimental to this
   
   
3. Increasingly in the knowledge based industries a client turns to a cost plus route, that is payment for time worked, other features of this commercial relationship are often:-
   
   • The client will require the Consultants to work on site and integrate closely with his own team, as such they will be expected to keep similar hours to his own staff.
     
   • Normally the added value that a client will bring to the relationship is in managing the technical risk in the project. They will normally retain design approval (Control) and often limit the liability of the consultant working on the projects. They may not even be required to correct their mistakes, as the liability downside on some of these projects will be enormous.
     
   • Work will be carried out on the Client's own Computer equipment and software as problems with virus/network interconnectivity and compatibility make it impractical for the Consultant to bring his/her own "tools"
     
   • Although budgets will have been set, safety or technical issues may prevent a bonus being paid for early completion.

To carry out this work the client can subcontract this to a large number of small Companies, often with one employee who may sub contract the marketing of their skills and the collection of their fees to an Agent. Alternatively they can utilise the services of a design/software house to effectively manage the problem, however this will incur a premium, maybe double that of the small Company, to support the larger overhead structure. Increasingly the Client is selecting to employ the smaller Company and to add insult to injury the problem for the larger Company is exacerbated by the loss of staff to set up in competition.

Perhaps you can now understand where the Inland Revenue is coming from:-

"The Government is committed to encouraging modern businesses which develop and build on the strengths and commitment of their workforce". They go on

"Businesses employing their workers directly say that they are unable to compete with those encouraging the avoidance at which the new legislation is aimed." You can now start to see why these larger Companies have a larger overhead, part of it goes on political lobbying.

Evidence would point to the Revenue utilising the existing tests for employment Vs self employment to determine whether someone is "employed". Developed in an era of manual labour they no longer take account of the commercial reality of the knowledge based industries that I have outlined. However they are a convenient "hammer to crack this nut" and thus the one man Company in the situation above will have his fees paid with tax and NI taken off at source, the larger Company carrying out work in similar circumstances would appear to operate under no such disadvantage. The argument that the small Company is avoiding paying tax, while the larger company is engaged in "genuine entrepreneurial activity" is clearly flawed as the only difference is the small Company has not yet had the opportunity to fully develop. If these proposals go through that will become a lot less likely.

Andy White 30/3/99

This article also appeared in the Computer Contractor