Many organizations leverage Contracted Out Services, sometimes referred to as managed services, to streamline and efficiently manage specific aspects of their operations. When considering these arrangements, it’s crucial to determine who the ‘client’ is under off-payroll working rules (IR35). The client could be either the organization that ultimately benefits from the service or the organization providing the services, depending on the extent to which the service is truly contracted out.
Regardless of the terminology used to describe a service, if it incorporates any element of labor supply, the end recipient of these services must ascertain whether they or the service provider assume the role of the ‘client’ for tax purposes. This distinction is vital for compliance with off-payroll working regulations.
Determining Who the Client Is in Contracted Out Services
Identifying the ‘client’ is a fundamental step for your organization to understand each party’s obligations in adhering to off-payroll working rules.
If your assessment concludes that the service is not fully contracted out, and the workers involved deliver their services through their own intermediary, your organization will bear the client responsibilities as detailed in HMRC’s off-payroll working guidance. These responsibilities are further elaborated upon in these guidelines.
Conversely, if a fully contracted out service is provided to your organization by another medium or large-sized business or a public sector entity, the service provider will assume the client responsibilities outlined in HMRC’s off-payroll working guidance and these guidelines. This means the service provider, not your organization, is responsible for assessing the IR35 status of workers they engage.
However, a different scenario arises when a small business outside the public sector provides a fully contracted out service to your organization. In this instance, neither party is considered the ‘client’ under off-payroll working rules. Nevertheless, if a worker provides services to this small business through their own intermediary, that intermediary is responsible for determining the worker’s employment status for tax purposes. This shifts the responsibility away from both your organization and the small business service provider in terms of IR35 client obligations.
For deeper insights, you can explore further information on off-payroll working for intermediaries and contractors providing services to small clients in the private sector. Understanding these nuances is key to correctly applying off-payroll working rules to contracted out services.
Identifying a Truly Fully Contracted Out Service
As part of your organization’s comprehensive off-payroll working compliance framework, it’s imperative to regularly review your contracted out services. This review ensures that the actual delivery of these services aligns with the contractual terms agreed upon.
The determination of whether a service is genuinely fully contracted out hinges on the commercial realities of the arrangement, not solely on the wording of the contract. In most cases, identifying the client will be straightforward. However, when uncertainty arises, a thorough examination of the relevant contracts and the practical working arrangements is necessary. This includes analyzing the relationships between the workers, your organization, and the service provider.
In a scenario where a service is genuinely fully contracted out, the organization receiving the service defines the deliverables expected from the service provider under the contract. Critically, the service recipient has no influence or vested interest in:
- Who the service provider engages to deliver the service.
- How these individuals are contracted or compensated.
The service provider typically holds the responsibility for defining the service specification and ensuring the quality of service delivery. This autonomy in execution is a hallmark of a fully contracted out service.
Your organization must evaluate each managed service arrangement independently on its own merits. Failing to do so can expose your organization to liabilities under the off-payroll working rules. A blanket approach without individual assessment is insufficient for compliance.
To maintain clarity and accountability, there should be no ambiguity regarding where responsibilities lie. Document your decision-making process and retain comprehensive records. Both your organization and the service provider should have a clear, mutual understanding of which party holds the client responsibilities under off-payroll working rules. This documented clarity is essential for demonstrating due diligence.
For more detailed guidance and examples on evaluating contracted out services, refer to HMRC internal manual ESM10010, accessible at HMRC internal manual ESM10010. This resource provides invaluable insights into navigating the complexities of contracted out services and off-payroll working regulations.
The Role of Statements of Work in Contracted Out Services
A statement of work (SOW) is a document that elaborates on the specific details of a service. It complements the overarching agreement between the service provider and the service recipient. Statements of work are frequently utilized in contracted out service arrangements. Typically, an SOW outlines key milestones and deliverables for the service being provided. It’s important to note that a statement of work itself does not constitute a contract but rather details specific aspects of the service agreement. When assessing whether a service is fully contracted out, it is crucial to consider the statement of work alongside the primary service agreement.
Off-payroll workers are often engaged for assignments based on time, such as an hourly or daily rate. When agencies are involved, their responsibility is generally limited to supplying labor. In contrast, engagements structured around a statement of work usually focus on achieving specific milestones outlined in the contract. The service provider is accountable for managing the work and ensuring the deliverables specified in the statement of work are met. This milestone-driven approach differentiates contracted out services from simple labor supply.
HMRC is vigilant about schemes that are advertised as methods to circumvent or bypass off-payroll working rules. These schemes often attempt to mischaracterize a labor supply as a managed service or heavily rely on statements of work to obscure the true nature of the engagement. Organizations should be wary of arrangements that seem designed to avoid IR35 obligations.
The mere existence of a statement of work does not automatically classify an engagement as a genuinely contracted out service. The determining factor is the practical reality of the engagement, not the contractual label. Service providers can range in size, but typically, they employ a workforce to fulfill their contractual commitments. The substance of the working relationship, not just the paperwork, dictates the IR35 status.
Exercise particular caution when the service provider is an individual operating through their own intermediary. Such arrangements warrant closer scrutiny to ensure genuine contracted out service status and compliance with off-payroll working rules.
Examples of Contracted Out Services: Clarifying the Distinction
These examples are designed to illustrate what contracted out services might look like (or not look like) and should not be considered definitive guides. Even if your organization’s circumstances bear resemblance to these examples, a comprehensive evaluation of all pertinent facts is necessary to accurately determine who the client is for off-payroll working purposes.
For further examples and detailed guidance on assessing contracted out services, consult HMRC internal manual ESM10010, available at HMRC internal manual ESM10010.
Example 1: Correctly Identifying a Fully Contracted Out Service
Consider a local council implementing a new recycling program for single-use plastics as part of their household waste collection services. While the council has its own refuse collection workforce, they lack the infrastructure for collecting and processing this specific type of waste. To address this, they engage a medium-sized business – the service provider – to handle this specialized recycling service. The council recognizes the need to consider off-payroll working rules in this context.
The agreement between the council and the service provider outlines the contractual terms and service standards. For an agreed annual fee, the service provider commits to:
- Providing new bins to all residents.
- Collecting single-use plastics from each household.
- Transporting the collected waste to their own recycling center.
- Sorting and recycling materials where possible.
- Deploying specialized teams for collection and recycling.
The agreement incorporates several service level agreements (SLAs), for example:
- Bins must be emptied monthly, according to the council’s recycling schedule.
- A minimum annual weight of plastics must be recycled.
- Workers provided under the agreement must adhere to the council’s code of conduct.
- Penalty clauses are in place for breaches of SLAs or missed targets.
The service provider is obligated to meet these standards of delivery as per the council’s specifications and SLAs. However, they have autonomy in how they achieve these standards in practice. For instance, they decide on staffing levels for vehicles and the recycling center. This operational independence is a key characteristic of a contracted out service.
The service provider can enhance profitability through efficient contract management. Conversely, they face financial penalties for failing to meet the council’s standards. All workers involved report to and are managed by the service provider. The council does not directly manage these workers.
The service provider also prioritizes its own brand reputation, implementing standards that exceed the council’s minimum requirements. For example, they mandate daily vehicle cleaning and uniforms displaying both the council’s and the service provider’s names. This brand ownership and control over worker standards further supports the contracted out service classification.
If the council receives complaints about the service provider’s workers, these are directed to the provider’s area manager for investigation. The area manager is responsible for reporting the investigation outcome and any corrective actions to the council. The council has no authority to challenge or overrule the provider’s decisions in these matters. This lack of direct control over worker management is a significant factor.
After considering all relevant facts and contractual terms, the council correctly concludes that this is a fully contracted out service. Both the council and the service provider agree that the service provider is the ‘client’ for off-payroll working rule purposes. Consequently, the council has no responsibilities under off-payroll working rules, beyond maintaining records of their decision-making process. This example demonstrates a clear understanding and application of the principles related to contracted out services.
Example 2: Correcting Misclassification of Services
Building upon the previous example, the same council contracts with the same service provider for a similar, related service. Impressed with the service quality, the council, facing staff shortages and increased demand from new housing developments, contracts with the service provider to supply workers for their standard refuse collection routes for an initial three-month period.
These workers are integrated into the council’s existing refuse collection teams. Council management dictates their routes, they wear council uniforms, and report directly to council supervisors. Complaint investigations are jointly conducted, but the council has the final say on outcomes. The service provider remains responsible for worker payroll. Despite the involvement of the service provider, the operational control clearly rests with the council in this scenario.
Initially, the council mistakenly assumes this new contract is also a fully contracted out service, simply because the previous contract was. This highlights the danger of applying a blanket classification without individual assessment.
Upon contract renewal consideration, the council re-evaluates the nature of the service. They realize the service provider is essentially supplying additional workers who are integrated into existing council teams. This realization prompts a correction of their initial misclassification.
The council correctly concludes that this is not a fully contracted out service. They inform the service provider that the council is the ‘client’ for off-payroll working rules under this contract. This proactive correction demonstrates responsible governance and attention to compliance.
The council then investigates the engagement arrangements for the workers supplied. Two workers are employees of the service provider and on their payroll. These are treated as seconded employees, exempting them from off-payroll working rules. However, the remaining workers operate through their own intermediaries and are classified as off-payroll workers.
As the ‘client’, the council must assess the employment status for tax purposes of these off-payroll workers. They determine these workers are deemed employees and should have been subject to PAYE from the contract’s inception. Status Determination Statements (SDSs) are issued to the workers and the service provider. Upon receiving the SDS, the service provider becomes the deemed employer, responsible for deducting tax and National Insurance contributions from these workers’ pay. This illustrates the practical steps involved in rectifying misclassification.
The council proactively contacts HMRC to disclose the error and accepts liability for unpaid tax, National Insurance contributions, and the Apprenticeship Levy for the initial three-month period. This example showcases the importance of ongoing review, accurate classification of contracted out services, and the process of correcting errors to ensure compliance.
Example 3: Misinterpreting Statements of Work
An organization transitions to medium-sized status and becomes subject to off-payroll working rules for the first time. Unfamiliar with these regulations and primarily engaging direct employees, they seek IT contractors through an agency that advertises ‘IR35 compliant solutions.’
The agency provides four IT contractors, each operating through their own intermediary, to develop a new website under a statement of work. The agency assures the client that off-payroll working rules are not applicable, based on the statement of work structure. This highlights a common but potentially flawed approach to IR35 compliance.
The statement of work outlines:
- Purpose: Design a new website.
- Scope: Full responsibility for website design and construction.
- Location: Work from any convenient location.
- Period of Performance: Manage own work to ensure timely website delivery.
- Milestones: Design, build, test, and deliver the new website.
However, the practical reality of the engagement significantly deviates from the statement of work. In practice, the contractors are required to work alongside the client’s existing staff at the client’s premises, who are also involved in website design. This integration with the client’s workforce blurs the lines of a truly contracted out service.
The client’s staff exert a degree of control over the contractors’ work and share management responsibilities to ensure project progress. Work schedules are dictated by the client’s opening hours. Contractors are paid a fixed daily rate, not based on milestone achievement. Any errors made by the contractors are rectified at the client’s expense, not the contractors’. These factors indicate a level of control and financial risk inconsistent with a genuine contracted out service.
If HMRC were to conduct a compliance check, they would likely find that the actual working practices do not reflect a genuinely contracted out service. The medium-sized business would be deemed the ‘client’. They would then be obligated to determine the IR35 status of the four agency-supplied off-payroll workers. If these workers are determined to be deemed employees, the liability for unpaid taxes and penalties would rest with the organization as the client, due to their failure to accurately assess the engagement status. This example underscores the critical importance of aligning contractual documentation with actual working practices when classifying contracted out services and complying with off-payroll working rules.
This guide provides a comprehensive overview of contracted out services in the context of off-payroll working rules. Understanding these principles is essential for organizations to ensure compliance and mitigate potential tax liabilities. Remember to always assess each service arrangement based on its individual merits and the practical realities of the working relationship.
