Select Committee on Treasury Written Evidence


Memorandum submitted by the Professional Contractors Group

EXECUTIVE SUMMARY

  1.  The Professional Contractors Group is the cross-sector representative body for freelance contractors and consultants in the UK. Its members provide their services to a range of clients using their own one or two-person companies. They work in IT, engineering, project management, oil and gas extraction, marketing and many other sectors.

  2.  As the smallest of small businesses, and also a significant part of the growing of people number—currently about one in seven workers—choosing to work for themselves, freelancers are a group that sit outside the traditional divide of employer and employee.

  3.  The UK's freelance contractors and consultants are a highly skilled, highly flexible and highly mobile workforce. The UK's model of freelancing is uniquely sophisticated and, by affording companies the ability to acquire specialist skills on a flexible basis, offers the UK a meaningful competitive advantage, particularly in the knowledge-based industries on which its future growth depends.

  4.  This dynamic body of workers leaves the UK well-placed to capitalise on the opportunities offered by globalisation. The slowness of the government to come to a full understanding and acceptance of freelancing as a valid business model has, however, led to a legislative and regulatory framework which disadvantages freelancers and hinders the UK in taking full advantage of globalisation.

  5.  Specifically, the structure of the UK's tax regime hinders small businesses, whose cash flow is often tight. The burden of complying with all regulation can hinder small businesses disproportionately in competitive global markets. The government's understanding of business risk is often lacking and its schemes and regulations flawed accordingly.

  6.  Globalisation has led to much work being moved from the UK to overseas locations. The effects of this offshoring do not seem to have been as beneficial as economic theory predicted. The result may be a long-term erosion of the UK's skills base. The government has not allocated resources to study the impact of this phenomenon and continues to base its policy on economic theory.

  7.  This submission comprises two case studies, in which the owners of two different freelance small businesses set out both how globalisation provides them with new opportunities and the difficulties involved in making the best of them. Further observations on the impact of globalisation on the structure of the economy are then set out.

CASE STUDY 1

  8.  Derek Pattenson is the founder of, and principal consultant for, Small Office Solutions Ltd. He founded the company in 1995, to provide quality independent software development, training and consultancy services to small businesses in Hertfordshire. Initially also providing ad-hoc troubleshooting and support on a range of platforms, the company subsequently specialised in desktop- and web-based software development for the Windows platform.

  9.  Derek has over 25 years' commercial IT experience, gained working for major domestic and international blue-chip companies. His roles have included development, maintenance, systems analysis, database administration, pre- and post-sales support, help-desk management, consultancy and training. His clients range from specialist SMEs to large companies including J Sainsbury, Mothercare (UK), Red Star Parcels Ltd and British Home Stores PLC.

  10.  "Over the past 3-5 years my own business has changed from servicing purely UK-based clients to getting around 50% of business from overseas, yet without ever meeting these distant customers. From their perspective, in terms of the services I provide, it makes no practical difference whether I am in the next town, the next state or the next continent. Providing I can be flexible about working hours there is no practical impact on clients in the USA, Canada, Australia or any other English-speaking country. Language is potentially a barrier to some markets, but a much smaller one to UK-based suppliers than to suppliers in many other locations. It is arguable that the need for flexible working hours favours home-based micro-businesses over larger outfits; I do not mind checking email from home just before bedtime but I would not want to drive into an office in the next town just on the off-chance that a customer needs some urgent input.

  11.  "There are implications, however, for the supplier. I find that contract terms and wording, payment methods and timings etc tend to vary with client location, and as a business I need to be much more flexible in the contracts and agreements I enter into. Of course should a client fail to pay there may be little I can do to recover debts, so I need to be careful about choosing clients and billing; but conversely should a client not like what I deliver, there is a reduced risk that litigation would be contemplated or successful. From an administrative point of view, however, there are complexities arising over contract management, accounting (especially taking account of currency conversions), VAT handling and more. These should not be underestimated by small businesses entering a global marketplace. On the plus side, I find that many of my US and Australian clients pay their bills by return of email, often within 24 hours of raising an invoice. Given the 45 day average payment time for my UK-based customers this is a big bonus.

  12.  "In the market in which I operate, which is typically very low value, short duration tasks (often my first job for an overseas client will be in the region of $100) clients often put their tasks out to global tender, using online `auction' sites. One such site, Rent-a-Coder (http://www.rentacoder.com) currently has well over 100,000 small companies and individuals worldwide bidding on work placed there (I am currently the top-ranked UK supplier). But whereas a UK or US-based supplier may be used to charging, say, £50 an hour for their services, globalisation of the marketplace means that suppliers in Romania, Russia, Argentina or India will often offer a whole day's work for less than that. In order to gain a foothold in the marketplace, therefore, it is essential to either offer outstanding service (which is hard to do until you have won the contract) or start off by making very low bids on work, and accepting that for potentially quite a while, you will be making a loss on every job. There comes a time when, if you are good, your reputation builds up and you can start to place higher bids for new work, and charge higher fees to existing customers, as they begin to realise that it is virtually impossible to identify the good suppliers from the tens of thousands on the Indian subcontinent, for instance, all offering rock-bottom prices. There even comes a time when those developing world suppliers seek assistance, and can be prepared to pay `Western' rates. But even with established clients, there is always the spectre of dirt-cheap competition and therefore one must continually demonstrate outstanding value-for-money. In the old-style market when everyone charged pretty much the same, because they were in the same environment, there was far less price pressure.

  13.  "Certainly the Internet has opened up enormous new markets and opportunities, but inevitably that brings enormous competition as well. In my own experience the key competitors are in India and Romania, with Russia, South America and other eastern European countries not far behind. It seems the far-eastern economies are not yet supplying into this micro-business end of the market, probably due to language barriers."

CASE STUDY 2

  14.  This case study is from a PCG member who prefers to remain anonymous.

  15.  "During the last 10 years or so I have been contracting as an executive programme director with, for example, IBM, AT&T. The responsibilities are to represent these companies in the countries I worked in—mainly the CIS and CER states—at the highest level in negotiations with ministries and government owned enterprises in order to have access to the state infrastructures (telecoms, satellites etc) that are necessary to implement and enable large projects for, say, IBM's large global customers—such as Sony, Johnson and Johnson, Coca-Cola etc.

  16.  "Obtaining overseas business in this field is a protracted process; small firms are disadvantaged in this by government policy. The issue here is that jobs tend to be of high value and long duration, and absolutely require personal meetings to `test the chemistry'. In addition there are long lead times (typically upwards of nine months) of protracted and deep negotiation before anything is agreed, consequently pre-sales costs are relatively very high—typically £15k to 30k per prospect—and the conversion rate is relatively low—that is, one expends `sales cost' against maybe 10 potential clients to get one actual contract. It is particularly awkward, accounting-wise, if this expenditure straddles a tax-year end. The net total level of work needed is very high, as you have to maintain the standard of service to the current client in parallel with seeking out the next contract.

  17.  "Because of the long lead times, the taxation regime for small companies is proportionately extremely onerous. Corporation tax is levied annually on perceived surplus. HMRC is usually unwilling to allow a small company to justify carry-forward accruals against the cost of sales expenditure expectations. While it is true that in future years one can obtain rebates, this is of no help in a tight `current cash-flow' situation in terms of day to day payments. Attention also needs to be paid to the tax regime in the client country, involving, for example, withholding taxes of different types. While handling these is not, of itself, difficult, the rolled up effort for a small company is extremely significant, firstly in elucidating the requirements and then conforming.

  18.  "In one year I can operate in over 15 countries, and trying to work out the optimal money handling strategy, and what will fit in with the client's needs, can be taxing (sic). A large company, on the other hand, can easily assimilate these costs out of pre-sales budgets.

  19.  "Payment can be a problematic issue and UK policy is unhelpful. Because of the nature of my work it is often not always possible to know when it is finished—although strategies to sign-off work by stages are common. Nevertheless, it is not uncommon for large sums to be withheld on various pretexts and for considerable periods in spite of full sign-off having been obtained—I think of an associate owed more than £500k by a Gulf state for over now three years.

  20.  "This is not seen as commercial risk by the UK authorities, who seem to presume that, as far as a small company is concerned, all commercial regimes are as relatively honest as the UK. In practice therefore HMRC are unwilling to differentiate between paper profit and `cash paid'. The practice of presuming future incomes on the basis of prior incomes and therefore demanding advance payment is particularly offensive. If one seeks to mitigate this and makes an error then one is obliged to pay interest and penalties on top of the structural on-costs arising from the cash-flow disruption.

  21.  "In the case mentioned above, my colleague argued that as he had not been paid any of the money his advance taxes should be nil. If and when that money is paid then he will likely be fined for `misleading' the tax authorities about his advance expectations—but the matter is entirely out of his hands. No sensible advice on such things is available from HMRC, over their help lines—they are not geared to provide a specialist response and I would not have confidence in such a response as definitive even if I could obtain it.

  22.  "R&D grants do not assist small firms in the global marketplace. It has been suggested that the research necessary in generating international Governance processes should be attributable to Research and Development, thereby making the expenditures eligible for various R&D relaxations and grants. But the costs of going through the hoops involved—often requiring the fulfilling of various criteria, which are time-bound in that you cannot do certain things until some government department has issued approval, and completing ill-thought-out forms with extraneous information—are far too burdensome for small company even to consider attempting it. In my own case, it is not even considered valid by government agencies for you to be researching such legal matters as an R&D project if you are not legally qualified: this often automatically invalidates the claim, on the apparent reasoning in that you are not serious about it being R&D—if you were, you would employ a lawyer!

  23.  "The net effect is that very many potential relaxations and grants might as well not exist. The companies that are most likely to benefit from them are the large companies who need them least.

  24.  "UK policy disadvantages small companies providing services globally more than policy in other countries. It used to be the case that `exporters' had advantages taxation-wise and in the treatment of expenses etc, but this is definitely no longer so—in fact small companies often seem to be positively discouraged from operating at this end of the market. Even the most recent of UK government initiatives to attract smaller firms as suppliers require financial guarantees and histories of the type that only a large company can provide, or ask for qualifications irrespective of experience. Small businesses seeking to trade overseas are, in my experience, constantly looking over their shoulders to watch for new penalties or barriers imposed by the government.

  25.  "This is definitely not the case in most other countries, which have policies designed to maximise net inflow of funds. CER countries specifically allow all advance expense expenditures that give rise to net importation of `dollar' funds, and only take the taxes (though they may be levied at any point), after the income is secured.

  26.  "Transferring funds earned by a small company out of certain countries can be made difficult by withholding taxes, which can render a job non-viable if you are not careful. Sometimes it is necessary to structure payment so as to allow the value to be transferred to a country with a less punitive tax structure—and even then it is extremely arduous to ensure compliance with all legislation.

  27.  "Methods for transferring funds between countries, especially with non-convertible currencies, are also an onerous cost, because you are a prisoner of the financial systems. This is especially foggy in the services sector where most countries with `added value' style taxation require that invoices for services delivered in a country, and originating in that country, must have both parties VAT registered. This becomes almost insurmountable in countries with non-convertible currencies, such as Kirkitzstan. The widespread assumption in practice by all Western regimes that all movements of money are laundering, unless proven not to be, adds yet more cost: time must be spent in repeatedly proving income transaction audit trails, involving an additional fee, at each movement. In the UK this is so bad that, even having been with my bankers for over 50 years, and having a family connection with them for over 120 years, I now need on every occasion to show a passport to draw £100.

  28.  "It is fortunate that the UK's market value is not derived from being a low wage/cost area: we could not be ahead in the Regulatory Regime game if it were. Nevertheless, my overall feeling is that 25% of my effort is spent fighting the system with all the cards stacked against small companies."

OFFSHORING, GLOBALISATION AND GOVERNMENT POLICY

  29.  Beyond offering new opportunities to UK businesses, globalisation also has implications for the structure of the UK economy and labour force, which the government is not fully monitoring.

  30.  It has become increasingly common for work in many sectors to be outsourced to companies outside the UK—so-called "offshoring". This affects several sectors in which PCG members operate, including IT and the design processes associated with engineering. The government has placed much faith in the economic theory that suggests this is beneficial: it allows companies to make cost savings which off-set the short-term economic upheaval caused by the loss of work in the UK. Very little research has been done, however, to assess whether this beneficial effect is being seen in practice.

  31.  If this beneficial effect is not occurring, offshoring has obvious dangers: it could result in the UK's skills base being eroded and therefore a long-term decline in competitiveness. A study by PCG, utilising publicly available accounts and financial statements of large companies in various sectors, showed that there is no clear competitive advantage for companies who offshore over companies who do not. It also suggested that the hoped-for cost savings usually fail to materialise in practice. There can be many reasons for this, for instance outsourcing contracts are often insufficiently detailed, creating problems in the delivery of services. The government has not allocated resources for a full study of the effects of offshoring in practice to be carried out.

  32.  Nonetheless, the government continues to promote offshoring and associated policies. It is common for companies about to offshore their operations will bring overseas staff to the UK for a period of up to two years, to familiarise themselves with the business, usually utilising work permits known as Intra-Company Transfers (ICTs). In its new immigration strategy, details of which were announced in March 2006, it proposed that workers on ICTs would be granted automatic access to the UK, irrespective of the checks and balances on other workers, such as skill levels. This is in order to continue easy facilitation of offshoring; but the economic rationale behind this is still open to doubt.

May 2006





 
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