Stephen Fitzgerald: IR35, senior officers’ pay and the real cost of public services

HMRC’s approach to IR35 and interim managers may be aimed at resolving a tax disparity but Stephen Fitzgerald argues it ignores market economics.

IR35, the strangely named tax rule now affecting interim managers, would once have been considered esoteric but has, in fact, become a major topic in management circles across the public sector.

Room151 has given the issue due attention, especially in the article Petition demands government abandon tax rule targeting interims, but IR35 has also received extensive coverage across the internet.

Always eager to follow current trends I will not attempt to advise on the technical aspects.  People, more comfortable with the UK tax system and its subtleties are better qualified to advise clients, interims and recruitment firms how best to navigate the changed system.  But there are wider issues that arise from HM Revenue & Customs’ approach.

Motivation & understanding

It appears that the government’s motivation in tightening the rules effecting public sector interims is to achieve a greater tax yield than is currently the case.  I have heard it suggested that the loss to the exchequer through the current interpretation of IR35 is over £400m.

This need to address a shortfall probably results from the outcry over tax evasion caused by publicity brought to the issue by the Public Accounts Committee when Margaret Hodge was the chair.  And I can see that it could be viewed as wrong that two office holders in similar circumstances, undertaking the same job, would have different tax treatments. This, of course, is what the new guidance endeavours to resolve.

However, this argument shows a lack of understanding.  Where interim managers have established private limited companies, it was not with the objective of avoiding tax. It is because clients did not want to take on managers as employees.  Limited companies gave clients the flexibility they needed to manage their engagement with interim staff.

In this “flexible” business model, interim managers have no employment rights such as sick pay and holiday entitlement, and can be disengaged at short notice.  Effectively, those managers are working on “zero hours” contracts with all the uncertainty and risk that brings.  In some cases, clients are paying a premium for that method of working and for the additional expertise, skills and versatility that the interim provides.

As for me, I generally advise clients to use interims sparingly and populate with permanent staff as soon as is reasonably possible.  But there are, on occasions, instances where the longer-term engagement of an interim manager is necessary and justifiable.

Trends

One trend that has led to a growth in interim contracts has been difficulty in recruiting people to senior positions.  A driver for this has been a downward pressure on salaries for permanent roles. This has meant that senior roles have become hard to fill as local government pay packages do not compete with the market.  Sub-prime pay rates are a false saving and organisations are finding that where they cannot recruit they must call upon the interim market to plug gaps, sometimes at a significantly greater cost.

In response to this IR35 attempts to redress a perceived tax imbalance. But this, curiously, seems to ignore the effect of market economics.  If the tax take on the interim market increases it is likely to be reflected in the fee rate.  It may be that interim managers take a hit in the short term, but I believe the market will adjust to reflect the increased tax burden and clients will pay more or have to do without (which can be an untenable position). So, the money will circulate around the system resulting with a gain to the exchequer at the expense of the wider public sector.

Ultimately, this touches on the fundamental issue of the real cost of public services.   Currently, the UK has significantly lower levels of taxation than European countries of a similar size, while the aspiration is that there will be similar levels of public service provision.

To close the circle public sector salaries have been constrained causing recruitment gaps that are being met through the use of interims.  But changes to the tax regime will impede that model of delivery. There is a simpler solution: organisations need to be empowered to recruit well and remunerate well, then the interim cost will fall.

As it stands, I understand that the online tool that is designed to help the interim community determine how the rules will apply, may not be available until after the April 2017 start date, which appears to present something of a difficulty. I am also advised that the new arrangements do not apply to interims working for private sector clients. So, it appears that there is one permissive treatment for private sector interim managers while those who support the public sector are subject to a different, more restrictive regime.

No doubt those of the us in the public sector will make the new regime work although, it will nevertheless create a further level of complexity in the challenging world of providing interim management in the public sector.

Stephen Fitzgerald is a management and financial consultant. 

@SHJFitzgerald