Since the introduction of Chapter 10 of the Off-Payroll Working rules into the public sector in April 2017, and its subsequent expansion to medium and large private sector engagers from April 2021, HMRC’s guidance has covered the issue of “contracted-out services” and how such arrangements are affected by the rules.

The published guidance currently states that “A person who receives a fully contracted out service does not need to apply the off-payroll working legislation, as they will be above the client in the contractual chain and will have no obligations under Chapter 10, Part 2 ITEPA 2003 in relation to that contract. The service provider providing the fully contracted out service must consider if it is a public authority or medium or large-sized entity to see if it is within scope of the off-payroll working rules.”

In simple terms, if a public sector or medium or large private sector client is engaging “services” as opposed to “labour”, then there is no obligation on that engager to determine the IR35 status of any PSC contractors involved.  Instead, the service provider itself becomes the contractor’s “client” for IR35 purposes, shifting the responsibility down the chain, how far now dependent upon the service provider’s size.

This exception to the rules has often been perceived as a loophole of sorts, resulting in the emergence of lots of new “consultancies” who are engaging in “Statement of Work”, “Managed Service” or similarly structured contracts, as a route for placing PSC contractors with engagers who would otherwise fall within scope of the rules.

Is a managed service written contract sufficient on its own?

It is really important to stress that a services-based written contract alone is not a golden ticket. HMRC place emphasis on contrived arrangements in their guidance, stating that “Whether a contract is for a fully contracted out service is a question of fact, based upon the commercial reality of the arrangements. Care should be taken to ensure that a labour supply contract has not simply been re-labelled as a managed service.”

It is essential therefore, that the reality of how everything is implemented and working in practice is fully aligned with the written terms.

So what exactly are “contracted-out services”?

Let’s take a look at some of the typical hallmarks of a genuine contracted-out service:

The engagement process 

• Usually there would be some kind of tender process, or at least written proposals setting out the services the consultancy proposes to provide to fulfil the client’s requirements.
• This would include matters such as fees, resource levels and timeframes, with the consultancy defining the full scope of the work.
• If the client simply approaches the consultancy with a day-rate job spec needing one person, it falls at the first hurdle and becomes near-on impossible to apply a contracted-out service model in practice.

Identification of the workers involved

• Who is going to undertake the work on behalf of the consultancy should be under their complete control.
• It’s acceptable to include skills profiles and the like as part of a tender or proposal, but there should be no workers named in the actual contractual documentation (aside from key personnel such as those who have overall responsibility for the service delivery), and no picking and choosing or interviewing of individuals by the client.
• The consultancy should be in control of the numbers needed and for ensuring the suitability of all workers.
• In typical situations the consultancy would be using whole teams (usually a mix of their own staff and contractors).
• The consultancy should have the contractual right to change who is doing the work for any reason, providing it does not impact the delivery and they can continue to meet their contractual obligations.

Management of the project and workers

• The consultancy should be responsible for managing the whole project.
• If the work only involves a small part of an overall bigger project and the client is co-ordinating everything and deciding what the workers need to be doing from one day to the next, this points to the provision of labour.
• The consultancy should have full responsibility and control over what is being done and when / where / how it is being done.
• It should be fully aware of what is happening at all times, with the workers reporting to and liaising with the consultancy (not the client) in all aspects.
• There should be no integration of the workers into existing client teams and ideally the work is undertaken either remotely or at the consultancy’s premises.
• The matter of control in these situations can be complex depending on the identity of the client and the nature of the work, and it is necessary to consider things on a case by case basis.

Financial risk for the successful delivery of the services

• The consultancy would be responsible for ensuring the quality of service and financially liable if things go wrong or it is not able to deliver.
• There should be mechanisms in the contract covering service levels, dependencies, acceptance criteria and disputes which are implemented in practice.

Basis of payment

• A genuine contracted-out service is usually (at least in part) fixed price deliverable-based.
• The consultancy would agree their fees with the client at the outset and then be responsible for deciding how much it will pay any contractors it is using.
• Time and materials-based contracts bear little financial risk in most situations and unless everything else is firmly in their favour, where a consultancy is simply retaining a margin and paying contractors at individual day rates set by the client, they may as well be holding a sign over their head saying “we are acting as an agency!”.

As you can see there is a lot to consider, and if it is found in reality that a consultancy is in fact simply providing people under the guise of sham contract, they and their public sector or medium/large private sector clients will be sitting firmly within scope of the Off-Payroll rules.

This means the client should be issuing SDSs for all PSC contractors, and the consultancy has its own obligations if it is the Fee Payer, as well as the requirement to comply with all legislation applicable to agencies (including the Conduct Regulations, Agency Worker Regulations etc).

Possible risks for all parties

• No clear establishment of where the responsibility and liability sits within the contractual chain
• Misalignment in understanding between client and consultancy which could result confusion and disputes amongst the parties and project disruption.
• Clients issuing SDSs, potentially categorizing contractors as “inside IR35” without prior notice.
• Contractual indemnities which attempt to transfer the tax risk of the liable party.
• Penalisation in the event of an HMRC audit where it is found parties have not complied with their obligations or taken reasonable care.

We know that HMRC is ramping up its compliance activity and scrutiny into these arrangements.  As the hefty tax bills and penalties we have seen to date show, it is better to get things right sooner rather than later.

Need further assistance?

Bauer & Cottrell provides a comprehensive Contracted-out services supply chain review which will identify your risks and provide clear recommendations.