IR35 – Be wary of the contracted-out services ‘get-out’

IR35 – Contracted-out services

In our previous article we ran through a real-life example when a client asked us to assess the employment status of a worker whose services were provided to another intermediary. You may recall that we concluded that neither the Agency Legislation nor IR35 applied to the engagement between our client and Z ltd as this was a ‘fully contracted-out service’.

HMRC manuals give guidance that when a person (our client) enters into a contract for a fully contracted-out service, they will not be the client. The manuals also confirm 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 the new IR35 in relation to that contract. It is the ‘service provider’ providing the fully contracted-out service who must consider if it is within scope of the IR35 off-payroll working rules.

What is a fully contracted-out service?

Whether a contract is for a fully contracted-out service is a question of fact. The commercial reality of the arrangements should be carefully scrutinised to ensure that a contract has not simply been re-labelled as a managed service when in reality what’s being provided is a source of labour.

HMRC confirm in their manuals that labeling a contract as a contracted-out service or a ‘statement of work’ when in reality the contract contains a provision for labour, will not prevent the IR35 off-payroll working rules from applying.

Relevant factors

There is no legislative definition of a fully contracted-out service, but HMRC provide some guidance as to what they see as ‘relevant factors’. This includes but is not limited to:

1. The nature of the businesses

Where the type of service provided by the worker aligns closely with the nature of a business (or a department within a business), this will be an indicator that the business is the client. For example, a cook working for a catering firm.

2. The nature of the service provider’s contract

Where a service has been fully contracted-out, the service provider will usually have responsibility for agreeing the specification of the service and ensuring the quality of the service. A fully contracted-out service will often involve the provision of goods and materials, as well as labour. 

A service provider will usually have an opportunity for profit, beyond taking a percentage of the worker’s fee, where a service is fully contracted-out.

3. The relationship between the worker, the service provider and their customer

Consideration should be given to who the worker personally provides their services to. This is likely to be the person most akin to the worker’s employer. The extent to which the service provider or their customer control the worker, benefit from the provision of their services, bear risk, and integrate the worker into their business will all be relevant.  

When assessing these factors, the actual working practices must be taken into account as well as the contractual terms. The contractual terms alone will not decide the matter, they must also be followed in practice for the contract to have weight in determining the decision on who the worker personally performs the service for. 

How we can help

As you can imagine – the “Contracted-Out Services Get Out” is being vigorously explored by many organisations, including recruitment, IT and consulting businesses. It is important to tread carefully and ensure a full due diligence is carried out here, otherwise hidden liabilities could arise if HMRC successfully contends that these are not Contracted-Out Services. Our team of employment tax specialists have assisted several clients navigate through this complex part of the tax legislation.  Not only will we consider the factors HMRC describe as listed above, we will also consider other relevant factors e.g. who the workers report to; do they have managerial responsibilities; who has control over the worker; whether the service provider has the skills to deliver the services.

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