Is the public sector freezing SMEs over IR35 compliance fears?

After a number of multimillion-pound tax bills and penalties incurred by some public sector organisations recently due to IR35 compliance failings, it is claimed that some government departments are cutting SME consultancies out of their supply chain altogether in an effort to avoid such penalties in the future.

Brightman was recently interviewed by Computer Weekly for our views on this issue. You can read the full article here.

The background

According to a Public Accounts Committee (PAC) report published in May, mistakes that were made during the implementation of IR35 since 2017 has so far left government departments owing £263m in unpaid tax to HMRC. So the numbers aren’t trivial.

At Brightman, we have seen first-hand how some departments have opted to avoid carrying out a status determination by simply cutting SMEs altogether. With such sizeable fines for non-compliance, and clear evidence of HMRC taking non-compliance very seriously, the calculation appears to be that it’s better to impose a blanket ban than to risk getting the determination wrong.

Romy Hughes, director at Brightman was quoted in the article, “It is because HMRC actively went after bits of the public sector and levied fines against them [for IR35 errors] that the fear across the public sector of getting things wrong is huge. It’s the fear of an unexpected fine or tax bill that has really driven this behaviour more than anything.”

“Any SMEs like ours, where my business partner and I work in the delivery of the service, are being deemed too risky to use by some of our [public sector] customers, and therefore they do not want to include us in their procurement pipelines,” she said.

“What we’ve got is a situation where public sector is cutting out huge amounts of SME expertise, and they’re not even getting as far as doing an assessment to say that you’re inside or outside IR35. They’re simply saying, ‘If you work as a director of an SME on delivery, we simply won’t have you in our supply chain’.”

Serious implications for SMEs and the public sector’s digital transformation ambitions

The net result of this change in policy is that it is now increasingly difficult for SMEs to do business with the public sector, and this will have significant ramifications for the public sector’s ability to deliver on its myriad of digital transformation plans.

There are a few other aspects to this story:

  • Forcing SMEs out of the public sector is in direct conflict with the Department for Trade & Industry’s SME strategy to make procurement easier for SMEs. While the government continually says it wants to work with more SMEs, IR35 fears are forcing some departments in the opposite direction.

  • At a time when inflation is hitting double digits, the public sector is willingly increasing its own costs as it chooses to engage with more expensive consultancies in place of the SMEs it has removed

  • SMEs play a huge part in digital transformation. This policy will potentially slow down or even kill these projects altogether and put the UK behind in this critical area

  • This affect could spill over to the private sector too: HMRC’s pledge to take a “light touch” approach to enforcement has now ended, risking many private companies to be just as cautious and ban SMEs from their supply chain too

For more on this story, I encourage you to read the full article on Computer Weekly.

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