Impending changes to IR35 regulations mean businesses that rely heavily on contractor resources are facing significant disruption. Many of the default solutions are largely reactionary, do not address core delivery requirements and will likely lead to tactical procurement exercises that may wreak havoc with procurement strategies. In our view, procurement functions need to play a pivotal role in leading the business to a strategic response to this issue. A strategic procurement approach can resolve the immediate IR35 disruption, while improving value traceability and delivery.
What is IR35 and how is it changing?
IR35 regulation was introduced in the year 2000. Its aim is to restrict the eligibility criteria for tax exemptions so that contractors working as ‘disguised employees’ cannot take advantage of personal service company (PSC) arrangements. The new rules, which come into effect in April 2020, reinforce the regulation by transferring the determination of this exemption from the contractors themselves to the companies procuring their services.
While not always the ideal solution when it comes to delivering business outcomes, contractors have filled resource requirements relatively effectively. However, few companies are likely to risk HMRC audits and fines in the wake of the new legislation. The alternative of moving contractors within IR35 raises its own challenges, not least the risk of an exodus by contractors due to reduced earnings.
Likely tactical business responses
There are three principal approaches businesses are likely to take to mitigate the risk of losing contractor resources. None are likely to be sufficient.
1. Move all contractors within IR35
While this is the simplest solution and ensures broad regulatory compliance, there will be a noticeable increase in costs due to NI contributions as a result of moving contractors within payroll or on a PAYE basis. Additionally, the reduction in earnings from income tax and NI deductions could lead to a possible exodus of contractors depending on the IR35 solution chosen by competitors. Most importantly, this option does not address the inadequate service delivery in the current contractor model, where most resources are compensated on a time and materials basis, with little accountability in achieving business outcomes. In effect, this IR35 solution is not only expensive but propagates a less-than-satisfactory model.
2. Shift all contractors to IR35 compliant SoW-based consultant models
This solution requires significant administrative effort to assess and re-contract many resources to deliverable-based terms, if possible. At a minimum, each contractor’s statement of work must demonstrate independent activity and reporting lines, substitutable resources, as well as delivery and financial accountability for clearly defined deliverables. In addition to the scale of the ask given the number of contractors involved, this approach exposes organisations to errors and possible audits and fines. Moreover, it would depend on a large internal procurement ecosystem to track deliverables and outcomes to assure IR35 exemptions.
3. Move all contractors to a managed service model
Another solution may be to contract deliverables through managed service providers. This solution addresses the issues of contractual accountability and reduced regulatory exposure due to IR35, but it increases business risk by aligning transformation delivery with a limited number of providers who are focused on minimising costs rather than optimising outcomes. As a result, it’s likely the business will end up with an inconsistent and sometimes unreliable resource pool, suffering from a service provider with ‘amber’ syndrome, where it is more concerned about falling into ‘red’ RAG status in terms of meeting contracted delivery than exceeding expectations.
In all these cases the needs of the business are unlikely to be fully met. To avoid failure in delivering business change, it is likely that business leaders will trigger short-notice appointments of a disjointed set of consultants to mitigate urgent resource gaps, creating havoc for the procurement function.
An alternative approach
An alternative, strategic approach requires procurement to take the lead and find a set of strategic delivery partners that will work side by side with the business to deliver change. As well as avoiding challenges associated with IR35, it provides a great opportunity for the business to maintain its current interests, while also shaping a more fruitful direction.
From an accountability point of view, transformation partners ensure the work is delivered and value is extracted by working towards deliverable-based financial milestones. They provide highly traceable impact, not least because both parties rely on it. From a procurement point of view, not only are strategic transformation partnerships IR35 exempt, alleviating the risk of disruption, they implement a step-change in the effectiveness of the delivery of the business transformation agenda. By delivering right the first time, they also present better value than networks of contractors or disjointed sets of consultants.
Focusing on where strategic suppliers can add value
In order to ensure strategic transformation partners deliver optimal value, we suggest the following framework when mapping your transformation requirements:
- Scope your most significant transformation challenges to strategic transformation partnerships. This gives you a clear line of sight over who is (and isn’t) working with you to achieve your most pressing business outcomes.
- Where important delivery efforts do not align to transformation partnerships, either because they are isolated in scope or one-off exercises, work with highly competent and specialised change contractors to shift their contracts to IR35-compliant agreements. These measures should be selective and therefore not require an ecosystem to govern. If IR35 exemptions cannot be met, then it is inevitable that these contractors will have to move within the scope of the regulation.
- Where contractors are delivering business as usual as a service or conducting an activity that is not core to your value chain, find a managed service provider and build in as many incentives as possible for them to deliver optimal outcomes.
Making it happen
For the partnership model to be a success, the suggestions below offer practical means of embedding and governing your strategic transformation partners.
1. Be selective in your partner ecosystem
Engage with transformation partners that truly understand your business, your ways of working and quality of delivery to achieve your transformation agenda. Too many partners will inevitably lead to complexity and reduce your capacity to manage delivery accountability.
2. Ensure an ecosytem of partners aligned to your demand profile
Being selective does not mean that a single provider can deliver your entire transformation agenda. Having said this, define and demarcate scope and accountability across your transformation remit to ensure a clear line of sight and drive the right behaviours between partners.
3. Communicate clear measures for scope, size, capability and pricing
Your partners need to be aligned to your goals if they are to proactively offer support and solutions. Be open about the underlying needs of your business and your transformation challenges. This will enable your partner ecosystem to do the work for you in offering custom and competitive solutions.
4. Track and measure results
A transformation partner will need to ensure quality of output with consistent and measurable outcomes. The right internal assurance capability is required to work with your partner ecosystem to track results. In agile environments, this becomes even more important, as you will need to reflect developments in measures on a more frequent basis.
5. Drive the model where your partners are working with you and not for you
In order to have shared accountability and an environment of transparency, partners should be working alongside your teams to deliver results. This ensures clear progress while upskilling your internal capability so that they can deliver transformation programmes more independently in the future.
Our principles as a strategic transformation partner
At Gate One, we pride ourselves in our ability to work alongside our clients as their strategic transformation partners. This has been part of our ethos from the day we launched our award-winning management consultancy and since then we have had the opportunity to work with many leading FTSE 250 companies across a range of sectors.