ROI of Contractor Status

This article is part of my Better Return On Investment from Software Development series.
These articles are aimed at senior management funding Software Developer or IT Professionals attempting to show the ROI benefits of what can sometimes seem counterintuitive.
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In this article, part of my series explaining better ROI from software development, I’d like to look at Contractor employment status.


The HMRC are changing the rules regarding Contractors. These rules may affect not just the rate you pay for Contract resource … but may produce a financial liability.

Declaring an interest

Ok, I’m operating as a Contractor …. So I care about this.

Note that I also care as an employer. Contractor employment status makes a difference to how much they “should” cost me (see note below).

Introducing IR35

“IR35 is the United Kingdom tax legislation designed to tax "disguised employment" at a rate similar to employment. In this context, "disguised employees" means workers who receive payments from a client via an intermediary and whose relationship with their client is such that had they been paid directly they would be employees of the client.” Wikipedia

If you are using Contractors, each one will be looking at the contract & working practices to decide if they do or do not fall with IR35. If inside, then (roughly) any amount they invoice for the work will be used to calculate PAYE & NI contributions. If outside, then the invoice is like any other business invoice – allowing the Contractor to take the money as dividends.

The latter of these two options provides more take home pay to the contractor – thus can financially have a huge impact on the individual.

What change is occurring?

In the Autumn 2016 statement it was confirmed that for the public sector, the responsibility of deciding if a contract is within IR35 moved from the Contractor to the Agency.

The Agency will be responsible (from April 2017) for making the decision (which isn’t clear cut – see below), calculating the PAYE/ NI on an invoice and paying that amount to the HMRC. Underpinning this, they will be liable for any lost PAYE/ NI if they get it wrong.

The expectation is that the same rules will be rolled out to the public section in 2018 (although not confirmed).

Making the decision

The decision on if a contract is within IR35 or not isn’t simple.

At the most basic level, HMRC look to define under two broad categories:

Unfortunately there isn’t generally a clear cut decision which any individual contract is. HRMC would, in a review, look at working practices and make a judgement. This is very much open to interpretation so can easily go to court for legal interpretation.

This decision isn’t helped by the lack of knowledge on this subject with Agencies and Customers. It should be more than possible for any engagement (up front) to define (and advertise) as being inside/ outside of IR35. The silver lining of this change, due to the shift of liability, may well improve this situation.

So the decision currently is down to the Contractor.

Personally I treat the IR35 decision based on the available information and take a risk adverse strategy on it. I treat most of my engagements as being within IR35. Another contractor in the same position may make a different judgement - and be correct. Without going to court to get a ruling on it, neither of us would know which had the correct interpretation.

Deviation from topic … the missing definition

While I don’t want this article to turn into a rant about HMRC or a moan about the unfairness of the situation, I did want to talk about what I feel is a missing definition.

There feels like there should be a separate category between Disguised Employee and Supplier.

Ok, I can accept that employee benefits such as holiday pay, sickness pay, training, etc are rolled into my invoice rate – I don’t see that as a problem.

The main problem for me is legal rights – especially if the customer goes bump.

As an employee I would have rights to any remaining capital (admittedly after the HRMC … and I’m unlikely to get the full of my back pay). There are also schemes to help with that.

As a supplier (even if within IR35), I’ve only got the same rights as any other supplier. Largely this means that I’d be lucky if any of the cake is left by the time it reaches me … let alone the amount of time to get those crumbs.

And if you think that I’m reliant on both the Customer and the Agency, I’ve two potential failure points. This for me represents a much greater financial risk than a real employee … thus for me suggests a third category.

There are no plans from the HMRC to go down this road, so little point dwelling on it in this article.

So back to the main topic …

Why this matters

It matters due to that shift of liability.

Previously if the Contractor got it wrong, they had to handle the liability.

Almost certainly the liability will shift (via Contract or HRMC rules) from the Agency to the Customer. So it matters that you understand what type of activity you are contracting out.

Do I just treat everything as IR35?

This is undoubtedly how some Agencies will handle when the new rules come into place.

If they simply sheep-dip then they are clear on the liabilities.

It will however have an effect on the contract market – almost certainly pushing day rates higher to compensate. This will be through a combination of contractors trying to retain a level of take home pay and a percentage of contractors moving to permanent employment.

(I’ve already seen activity on Contractor boards where public sector contracts are being passed up)

Largely this doesn’t affect the Agency … they are just passing the cost on. It is the Customer and/ or Contractor that will feel that pain.

Another way … Understanding the engagement

This is a topic that I’ve meant to write about for a while – understand the engagement correctly allows the Contractor to use the most appropriate treatment – which if outside of IR35, it should be cheaper to you than inside of IR35.

I had originally planned to about this as part of the value of supplier relationships.

I’ve always been of the view that you gain much more value for a supplier if you build a sustainable, mutually beneficial relationship than screwing them down on cost. I believe this to be true for pretty much every supplier relationship. For a Contractor that is going to be in your office & systems on a regular basis – this is a must.

Understanding how IR35 affects a Contractor allows you to understand that take home for the individual – and thus why contract and working practices can be so important.

I’m certainly not suggesting any collusion or skulduggery to obscure Disguised Employment. If, however, you are both in agreement that this is a true supplier relationship, then make sure that all activities are in line with that.

Simply put, if it’s effectively employment, then let’s all agree and treat it as such. If not, then let’s make sure that the lines are not blurred. You almost need to operate at extremes.


The decision is unlikely to get easier anytime soon.

The HRMC are to release an online tool for assessing IR35 – but the result won’t be binding.

Agencies will ultimately need to provide the expertise and knowledge to assist Customers in defining the engagement correctly. Interesting most Agency contracts I see are broadly IR35 compliant – but most Agency staff are under trained on the working practices. I can see this becoming a clear differentiator for Agencies over the coming years.

I would recommend that any Managers that regularly use Contractors review and understand the rules. This should go a long way to correctly defining an engagement that is correctly outside IR35 in both contract and working practice. Thus making the day rate more tax efficient and thus (hopefully) making the day rate to yourself cheaper.

Over a considerable number of Contractors, this can be a considerable saving.

The elephant in the room

I’ve alluded in this article to saving being passed on. I can almost see the eye rolls at this.

We Contractors do have a reputation of taking as much money as we can – so I’d understand a level scepticism that any benefits may not be passed.

I certain can’t talk for other contractors; but I know that I go into any conversation about a role with an open mind – I look for all the factors that influence my rate – location, activities, technologies, IR35 position, etc. I am then looking to build that relationship with the Customer – and part of that is providing a fair rate.

I’d like to believe the all professional contractors are of the same mind-set.

Further reading

There is a wealth of IR35 advice and guidance online. Some of it can be heavily biased towards tax avoidance – but the below should give you an idea of how it works.

About the author:

Mark Taylor is an experience IT Consultant passionate about helping his clients get better ROI from their Software Development.

He has over 20 years Software Development experience - over 15 of those leading teams. He has experience in a wide variety of technologies and holds certification in Microsoft Development and Scrum.

He operates through Red Folder Consultancy Ltd.