SOW and IR35 – the hidden timebomb?

about 1 month ago Will Jones

Sow And Ir35 – The Hidden Timebomb 1

Word on the street suggests that statement of work (SoW) is the silver bullet for IR35. Correct? That if you bring contractors on through an SoW, this will make them automatically outside IR35. Correct? Contracted-out services mean you’re automatically off the hook from your IR35 responsibilities. Correct?

In actual fact, this is dangerously incorrect. In the opinion of many professional commentators, SoW is the hidden, yet ticking, IR35 timebomb waiting to detonate in many organisations who have taken this route to engage with ‘flexible’ resource and have not appropriately undertaken actual due diligence.

Last week, we attended a session with HMRC focused on the very topic of SoW and IR35 for end client organisations. The subject of tax is not often riveting – but in this instance, it did actually bring to life a number of issues you could potentially face, leaving a number of attendees sitting up in their chairs. I’ve tried to summarise these below.

Firstly – when you buy a contracted-out service you will not be the end client from an HMRC perspective, where IR35 and the off payroll rules are concerned (unless you satisfy the small company exemption). You will be the recipient of a service and the identity of the actual contractor performing that service will be neither here nor there to you. Where taking responsibility for the obligations under the off payroll rules is concerned, the service provider will be both the end client of the contractor’s services and the fee payer. The service provider is therefore the party responsible for the IR35 status determination and making any deemed employment deductions where necessary.

But what happens if the service provider’s client i.e. you, starts taking an active role in managing, assessing, directing, controlling and/or supervising what the actual contractor does and/or how they deliver the service being provided? In that scenario, HMRC is likely to interpret the supply as one of the personal service of a contractor. And that changes everything. Then it is you who becomes the end client for the purposes of the off payroll rules, you who should have done the IR35 status determination and you who is liable for the fact you have not done so. It is therefore crucial to make sure the right entity – the service provider or end client – is responsible for making the IR35 determination on any engagement with a PSC.

In my opinion the easiest way to define this is to look at the factual working practices of the engagement and decide into which camp they fall:

  1. Where an end client is procuring a contracted out fixed price/milestone/deliverables/risk-based service where the service provider is ultimately accountable for successful delivery of the project or service; or

  2.  The supply of flexible resource where ultimately the end client (and not the service provider) takes control of the management and is accountable for successful delivery. Therefore, this is regarded as staffing services.

Additional point – a time and materials or effort-based engagement does not necessarily dictate whether the engagement is staffing or contracted-out services. What dictates which of the two applies is ultimately who is accountable for quality/delivery and therefore risk of the service. If the service provider is providing all the services and materials and taking all the risk on the ultimate delivery, and the end user’s only role is to be a recipient of that service, then it will be a truly contracted-out service and the service provider will carry all the liability under the off payroll IR35 rules.

In order to help define this HMRC have added some guidance which is worth a review: ESM10010 Basic principles: contracted out services.

So how do you manage this and ensure you have the right controls in place to make sure you do not put yourselves at risk?

Our recommendation – review any existing engagements that involve the use of PSC contractors and make sure that review includes both working arrangements and contracts. Any SoW should define the nature of the services together with the milestones and deliverables required, a change control process and a process for approving/withholding approval of the service delivered. However, you should also check who the contractor is reporting to, how service reviews are conducted and by whom, and the point at which invoices are issued. Payments should only be made upon the achievement of milestones/deliverables or if made on a time worked basis, with explicit reference to the outcome of the services delivered in that period.

Speak with your suppliers to ascertain their appreciation of IR35, and between you agree in writing who is ultimately responsible for making IR35 determinations.

Also ensure you have full visibility when a PSC contractor is being utilised to provide services and ask them to evidence/provide the information on the process they have undertaken to reach this decision.

If you find the reality of the engagement is simply for the supply of labour, and the service provider is only accountable for the supply of these resources (rather than the quality and delivery of the project/service) then ultimately you are likely to be the end client for the purpose of the off payroll rules and therefore accountable for making IR35 status determinations. So work with the guidance and take corrective action immediately.

HMRC have released some help on taking corrective action and you can make a voluntary disclosure to HMRC: Guidance overview: How to make a voluntary disclosure to HMRC - GOV.UK (www.gov.uk)

Ultimately, IR35 exists to distinguish between the supply of labour and the supply of a contracted-out service, and to ensure that those earning employment income are taxed appropriately. Arranging for the supply of services through an SoW does nothing to change this if the actual facts of the arrangement point to the supply of a personal service. Our recommendation will always remain the same; SoW is an opportunity to procure services and achieve greater value when the service required can be delivered as an outcome, with all the economies of scale that allows, as well as accountability on delivery on the part of the supplier. But where a simple supply of individual contingent labour is what is really needed, do not try to disguise it behind an SoW.