A squeeze too far for construction companies?

Author: Tom Crane – Glenigan Economist (@TC_Glenigan)

Last week saw the start of the latest clampdown on construction tax avoidance with the introduction of the new ‘false self-employment’ legislation on 6 April. Directly in the line of fire are payroll and umbrella companies which operate across the industry, most notably in the mechanical and electrical (M&E) sector.

The legislation has come under criticism from voices across the industry, with calls for its introduction to be delayed. But it has also been welcomed by some who say it will level the playing field for companies who already employ all their staff through PAYE. The rules require workers who carry out work in the manner of a direct employee to be paid as such, even if they remain registered as self-employed. This means employers will have to pay National Insurance contributions, holiday and sick pay, while employees are also likely to face additional tax on their income. HMRC have pencilled in £400 million a year of additional tax revenue from the changes.

With HMRC delaying the introduction of reporting requirements and associated penalties until August 2015, some firms may choose to bury their heads in the sand and hope to avoid enforcement or try to keep workers employed under umbrella company arrangements and lay the burden of extra tax and holiday pay on workers’ pay packets – however this is a risky tactic.

Last week M&E workers downed tools on jobs including the Tottenham Court Road tube station upgrade (Glenigan Project ID: 92433441), demanding to be taken into direct employment under PAYE. Workers unions are actively supporting the cause, with UCATT protesting on Friday, 11 April, outside the offices of Hudson Contract Services, one of the UK’s largest payroll firms.

Alternatively firms can take the hit and bring workers back under PAYE arrangements, thereby increasing labour costs by up to 25% but protecting themselves from the risks of site disruptions, reputational damage and enforcement fines.

Critical time for changes

As the situation plays out over the coming months, and indeed from August 2015 when penalties are introduced, it appears likely that the new rules will be an added pressure on labour costs and overall margins. The changes come at a time when, as the volume of work rebounds quickly from the downturn, cost and cash flow issues come to the fore. Construction companies face just as significant risks coming out of a recession as going in to one, as firms who have under-priced tenders in order to keep afloat during the downturn struggle to fulfil work profitably as input costs rise and their operating capacity become strained.

Construction price and cost indices from the Department for Business Innovation and Skills estimate that tender prices have failed to keep pace with input costs since the beginning of 2008. Tender prices have begun to converge with input costs and are likely to gradually accelerate over the next year, but contractors and their supply chains will remain vulnerable to fixed price contracts committed to over the last two years.

Currently input price pressures are being driven by rising material costs. In the short term material cost inflation may pick up further, amid lengthening lead times for bricks and blocks. However further ahead, this may begin to ease as suppliers reopen production at plants mothballed during the downturn. In addition, part of the current rise in demand may be a one-off due to contractors stockpiling materials ahead of an anticipated crunch.

Wage pressures

Wage inflation is likely to gather steam, as the industry struggles to re-attract workers lost during the downturn. Labour shortages are emerging, although currently concentrated in house building-related trades such as bricklayers. These shortages are expected to spread to a wider range of trades as the recovery gathers pace across the commercial sectors. 

According to the Office for National Statistics, construction workers who remained in employment during the recession suffered a 13.4% fall in real hourly wages between the first quarter of 2008 and the final quarter of 2013, faring significantly worse than the manufacturing and services sectors of the economy. Workers will want their earnings to reflect the market recovery, and they may well want them through PAYE too.

Ultimately, with contractors’ margins already tight, all of these higher costs will either have to feed through as higher tender prices or be absorbed by efficiency gains. Higher costs may act as an additional spur to the industry, encouraging changes to procurement and work practices alongside innovative building techniques and products. Nevertheless, clients will have to adapt their expectations as prices recover from their recessionary lows. 

The extra £400 million per annum that HMRC expects to gather will add to this trend. With central and local government accounting for around 40% of construction output, the tax change could exert a £160 million squeeze on public sector budgets at a time when a solid financial footing has never been more critical.

What do you think of the new tax rules? Do they add extra pressure to already strained construction margins or provide a much needed boost to the public purse? Get in touch with your views on Glenigan’s social media channels via the icons at the top of the screen.