Short Guide to Contract-Out Scenarios for Off-Payroll (IR35)

18 September 2023

Andrew Webster - MD, Workwell Enterprise

Andrew Webster

MD, Workwell Enterprise

More than two years have now passed since the off-payroll reforms to IR35 were introduced into the private sector.

What the legislation was designed to do is relatively straightforward; HMRC believes that there was widespread non-compliance to the original IR35 rules which – as far as they are concerned – was due to the amount of power that PSCs were given to determine IR35 status.

The essence of the off-payroll reforms to IR35, then, is all about shifting that decision-making power elsewhere in the supply chain. So, under the new rules, responsibility for status determination no longer rests with the PSC, but is instead shifted up the supply chain to the client (sometimes referred to as the engager).

When off-payroll reform applies, the client has a legal obligation to make the IR35 status determination and produce and distribute a Status Determination Statement (SDS) as a means of communicating that determination to the relevant parties in the supply chain. The client is further obligated to take “reasonable care” in reaching its determination and must also have a dispute process in place to deal with any challenges to their determination which can be mounted by either the feepayer (the entity that pays the PSC – usually a recruitment agency) or the PSC itself.

One of the issues that has often been overlooked in discussions around this legislation is how you actually go about identifying who the client is. Knowing who holds the client responsibilities is clearly essential to the proper functioning of the legislation.

If a supply chain doesn’t understand itself in terms of off-payroll, it runs the risk of either no off-payroll compliance activity taking place (for example, there’s no one in the supply chain producing SDSs because everyone thinks that responsibility sits with someone else), or you could even get the bizarre situation where more than one party in the chain acts as if it’s the client and starts producing SDS’s! In either case, HMRC would have a field day over this sort of lack of clarity and supply chain confusion!

Defining the client (the theory)

So, how do we go about determining who the client is, then? If we look at HMRC’s Employment Status Manuals, HMRC confirms “The client is the person who the worker performs services for. In most cases, it will be obvious who the client is. Where there is uncertainty as to who the true client is, consideration should be given to the nature of the relevant contracts and working practices” (ESM10010).

As we’ve said, it’s usually clear who the client is in the supply chain, which means that in most cases what we’re saying is that it’s clear “who the worker performs services for”. But what about those scenarios where it’s not so obvious who the worker is performing services for? This sort of ambiguity can arise when we’re dealing with supply chains that are attempting to deliver what’s known as “contracted-out” services, so let’s have a quick look at what these are and how they’re supposed to work.

Contracted-out scenarios are sometimes referred to as Statement of Works (SOWs). The basic premise is straightforward; the arrangement structures the relationship of the parties in the supply chain in such a way that it has an effect on who would be considered the client (the recipient of the workers’ services) for the purposes of off-payroll.

In a more traditional supply chain where there is a PSC, a recruitment agency, and a business with some sort of requirement, there’s a direct link between the business requiring services and the PSC; that link being that the business has a vacancy or specific requirement that needs fulfilling, and the function of the recruitment agency is to fill that vacancy by finding a suitable worker.

In a contracted-out scenario, however, things work differently; there’s no direct link between the business and the PSC because the entity that sits between them (usually referring to itself as a “consultancy” rather than a recruitment agency) severs that relationship. The consultancy isn’t filling the vacancies of the business, instead, the consultancy is creating and filling its own vacancies in order to deliver on its own contractual obligations to the business in question.

A Real-World Example

Perhaps the easiest way to visualise this difference is with a real-world example. Barclays Bank has its headquarters at One Churchill Place in London’s Docklands.

One Churchill Place is a 32-storey skyscraper and Barclays occupies the entire building. Catering in the building for all the (thousands of) Barclays employees is provided by ISS Group. Barclays Bank has tasked the feeding of its employees to ISS, which means that ISS takes ownership of that project and then must design a suitable programme of work to achieve that task. ISS must decide how many chefs it needs to cook and prepare all the food, and ISS will also decide how much to pay those chefs, managing its own budget based on the overall value of the agreement that it has with Barclays Bank.

In this scenario, HMRC would consider that ISS is providing a contracted-out service to Barclays for the purposes of off-payroll, so if one of those chefs were operating via their own PSC, it would be ISS that would have the responsibility for the IR35 determination, not Barclays. ISS has severed the relationship between Barclays Bank and the chef cooking the food, because ISS hasn’t simply filled a Barclays Bank vacancy for a chef, but rather ISS has created its own vacancy for a chef in order to meet its contractual obligations, meaning that ISS are the client for off-payroll purposes since ISS are the entity to which the worker provides services.

Contrast that with the fictional scenario where the CEO at Barclays instructs the Barclays HR team to reach out to a recruitment agency with 50 chef vacancies. In this scenario the recruitment agency doesn’t take ownership of the project of feeding Barclays employees; Barclays is retaining ownership of this task and the agency is ‘only’ helping Barclays Bank fill Barclays Bank vacancies.

In this fictional scenario, HMRC would consider Barclays to be the client for the purposes of off-payroll; the agency has not severed the relationship between Barclays and the chef working through their PSC because the PSC is working on a Barclays vacancy and therefore providing services to Barclays.

Pitfalls & practical considerations

HMRC has made it clear that supply chains cannot legitimately re-organise themselves in terms of off-payroll obligations simply by changing the contract terms to make traditional recruitment (the supply of workers to fill a client’s vacancies) look like a SOW (the supply of a service). Whilst the contract terms agreed between the parties are crucial, these cannot be considered in isolation; how things work in practice and the day-to-day operation of the engagement must also be considered to determine who will be deemed the client (and therefore the IR35 decision-maker) for off-payroll purposes.

Please note the parallel here with the IR35 status determination itself. When determining IR35 status we do not solely look to contractual terms but must also take into consideration the actual working practices…and just like an outside of IR35 contract can be over-turned by inside of IR35 working practices, a contract that sets out a SOW arrangement which is not reflected in real-world practices can also be undermined.

Here are a few practical considerations when trying to determine whether or not a SOW proposition is robust enough to withstand scrutiny:

  • Was the “consultancy” providing contracted-out services before the off-payroll reforms to IR35, or were they a recruitment agency (filling client vacancies) that suddenly branched out into consultancy? Whilst the latter isn’t inherently problematic per se, HMRC would most likely want to understand the driving force behind the change in direction. If it was done as some sort of tactic to help their clients avoid the new off-payroll responsibilities (through the consultancy taking ownership of those responsibilities) that could be a problem.
  • Was a formal tender submitted? If a consultancy is being engaged to provide a contracted-out service, there should have been a procurement exercise undertaken in order for the consultancy to win the project (we don’t see these sorts of procurement exercises when a recruitment agency is approached simply to fill a specific vacancy).
  • Who owns the vacancy? As we’ve discussed, the fundamental question for off-payroll purposes is the question of who the worker is providing services for. It cannot be a genuine contracted-out service if the consultancy is merely filling a vacancy that has already been identified and created.
  • Does the client have the right to interview the individual before them being engaged? Again, this links back to the issue of who owns the vacancy. In a genuine contracted-out scenario the recipient of the contracted-out services would have no input into who is used to provide the contracted-out service, because the vacancy does not belong to them.
  • Who monitors the day-to-day working of the individual? While some level of oversight of the services would be expected from the recipient of the services, this would be limited to overall progress against agreed deliverables. There should be no management of individuals by the recipient of the services (again, the worker is not working for them, but rather for the consultancy).
  • Who assumes responsibility for the successful delivery of the work, and liability if it goes wrong? This should sit with the consultancy as they “own” the project.
  • Do the invoices reflect a contracted-out engagement? On the invoices raised by the consultancy, is the amount due broken down according to project deliverables, or does it correlate to individual roles or worker timesheets? As an outsourced service provider, the amount invoiced should reflect the entirety of the consultancy’s costs; it should not look like a recruitment agency invoice for labour plus agency margin.


Get in touch

The market has seen a growth in interest in the provision of contracted-out arrangements since the introduction of the off-payroll reforms to IR35. As with IR35 determination itself, assessing the legitimacy of contracted-out arrangements is nuanced and requires a multifactorial approach which acknowledges contractual arrangements, actual working practices, and the underlying intentions of the parties involved.

Many supply chains have sought out professional support to get to grips with making IR35 determinations, but at the same time have largely overlooked the need for professional support in determining exactly where in the supply chain that assessment responsibility sits.

If you are currently engaging under a contracted-out arrangement or are in the process of exploring this method of engagement, we’d love to hear from you and talk you through the support that we can offer.

Please contact myself, Andrew Webster, MD of Workwell Enterprise, or Stuart Marquis, Business Manager, Workwell Enterprise.

Andrew Webster – 07827 810851 [email protected]

Stuart Marquis – 07791 153741 [email protected]

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