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The Burden of IR35 on Small Businesses Trying to Hire Software Contractors

Updated: Jun 29, 2023

Introduction The implementation of IR35, a tax legislation introduced by the UK government to combat tax avoidance, has had a profound impact on the hiring landscape, particularly for small businesses looking to hire software contractors. IR35, also known as the "off-payroll working rules," has placed additional burdens and complexities on small businesses, making it increasingly challenging for them to find and engage the right software contractors for their projects. In this blog post, we'll delve into the specific challenges faced by small businesses and shed light on the burden of IR35 in the context of hiring software contractors.

Understanding IR35

IR35 aims to determine the employment status of individuals who provide their services through an intermediary, such as a limited company or a personal service company (PSC). It seeks to identify cases where workers are essentially employees in all but name, allowing them to benefit from certain tax advantages. If a contractor is deemed to fall within IR35, they are considered an employee for tax purposes, and the hiring company becomes responsible for deducting income tax and National Insurance Contributions (NICs) at source.

Challenges Faced by Small Businesses

  1. Compliance Complexity: Small businesses typically lack the resources and expertise to navigate the complexities of IR35. Understanding the legislation, conducting status assessments, and managing tax obligations can be overwhelming for businesses that don't have dedicated HR or legal departments. This puts them at a disadvantage, making it harder to attract and engage software contractors.

  2. Increased Administrative Burden: IR35 places additional administrative burdens on small businesses. They must now undertake rigorous assessments to determine the employment status of contractors and ensure compliance with tax regulations. The administrative workload required to comply with IR35 diverts valuable time and resources from core business activities, hindering growth and productivity.

  3. Reduced Contractor Pool: IR35 has led many software contractors to reconsider their engagements with small businesses. The legislation has diminished the tax advantages and flexibility that once made contracting an attractive option for many professionals. As a result, small businesses face a diminished pool of qualified software contractors willing to work with them, limiting their options and potentially affecting project timelines.

  4. Cost Implications: The financial implications of IR35 cannot be ignored. Small businesses are now responsible for additional tax liabilities, including employer NICs, which can significantly increase the overall cost of engaging contractors. These increased costs may force small businesses to either reduce their contractor budget or compromise on the quality of talent they can attract, ultimately impacting project outcomes.

  5. Lack of Clarity: Despite efforts to clarify the IR35 rules, there remains a degree of ambiguity surrounding the legislation. Determining employment status is subjective, and the potential risk of misclassification can deter small businesses from engaging software contractors altogether. The lack of clarity leads to uncertainty and reluctance among businesses, further exacerbating the burden imposed by IR35.

Solutions and Mitigation Strategies

  1. Seek Expert Advice: Small businesses should consider consulting with HR or legal professionals well-versed in IR35 to ensure compliance and gain a deeper understanding of the legislation. Expert guidance can help alleviate confusion, minimize risks, and provide insights into effective contractor engagement strategies.

  2. Outsource Compliance: Engaging with a reputable umbrella company or a professional employment organization (PEO) can help small businesses offload the administrative burden of IR35 compliance. These entities specialize in managing payroll, taxes, and employment status assessments, enabling businesses to focus on their core operations.

  3. Budget Appropriately: Small businesses must carefully assess and factor in the additional costs associated with engaging contractors within the IR35 framework. Adequate budgeting can help mitigate financial strain and ensure that the business can attract and retain skilled software contractors.

  4. Invest in Internal Resources: Building in-house capabilities to navigate IR35 compliance can be a wise long-term investment for small businesses. Hiring or training dedicated professionals who can handle the complexities of contractor engagement and taxation can help streamline processes and reduce dependence on external expertise.

  5. Agencies and SDaaS: Consider productized development services, or SDaaS - Software Development as a Service providers as well as engaging software development consultancies.

Conclusion IR35 has undoubtedly placed a heavy burden on small businesses seeking to hire software contractors. The legislation's complexities, administrative requirements, reduced contractor pool, increased costs, and lack of clarity have created significant challenges. However, by seeking expert advice, outsourcing compliance, budgeting appropriately, and investing in internal resources, small businesses can mitigate the burden imposed by IR35. It is crucial for policymakers to continually review and refine the legislation, considering the specific needs and challenges faced by small businesses, to foster an environment that supports their growth and innovation while ensuring fair tax practices.

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