Are consultancy arrangements a solution to the Off-Payroll / IR35 rules?

The private sector off-payroll rules, introduced in April 2021, led to much discussion about the use of consultancies and contracted-out services.

A genuine consultancy may take responsibility for delivering a defined service or project to an end customer, using its own people and taking on the commercial risk of delivery.

However, simply placing contractors behind a consultancy or Statement of Work does not mean the arrangement falls outside the off-payroll rules.

Whilst genuine consultancy arrangements are worth considering, they don’t guarantee contractors are necessarily working outside IR35. There are lots of considerations.

What does a genuine contracted-out service look like?

A genuine contracted-out service will usually involve the service provider:

• Taking responsibility for delivering an agreed service, project or outcome.
• Deciding who and how many workers are involved in delivering the work.
• Managing and supervising its own workers.
• Taking responsibility for the quality of the work and correcting problems where necessary.
• Bearing commercial risk, including the possibility of making a loss or an increased profit on the project.

A fixed project price may support this type of arrangement, but it is not essential and does not determine the position on its own.

Consultancy arrangements should not be contrived for tax reasons.

In a genuine contracted-out service, the customer will normally be concerned with what the consultancy delivers rather than which individual workers it uses or how those workers are engaged.

HMRC says the question depends on the commercial reality of the arrangements, including who controls the workers, who bears the risk and who is responsible for delivering and ensuring the quality of the service.

Tax liability

Who carries IR35 responsibility?

Under the off-payroll rules, the first question is who the client is for the worker concerned.

For public sector organisations and medium or large private sector clients, the client is generally responsible for determining IR35 status and issuing a Status Determination Statement (SDS).

Where an engagement is inside the off-payroll rules, the organisation acting as the deemed employer – often the fee-payer immediately above the contractor’s company in the supply chain – is normally responsible for deducting PAYE and employee National Insurance and paying the appropriate employer liabilities.

Responsibility can move within the chain where the rules are not followed correctly, for example where an SDS is not passed down the supply chain.

Consultancies providing contracted-out services

Where there is a genuinely fully contracted-out service, the organisation receiving that service is not treated as the client for the individual workers engaged by the consultancy.

Instead, the service provider becomes the client in relation to those workers and must consider its own responsibilities under the off-payroll rules.

If the service provider is a public authority or a medium or large private sector organisation, it will have the Chapter 10 responsibilities, including determining IR35 status and issuing an SDS where required. If it is a small private sector organisation, the contractor’s intermediary normally remains responsible for determining IR35 status under the original Chapter 8 rules.

That distinction matters. If the arrangement contains any material element of labour supply rather than a fully contracted-out service, the organisation ultimately receiving the services must consider whether it remains the client.

Simply inserting a consultancy into the contractual chain does not transfer the off-payroll responsibilities.

HMRC gives detailed examples in its Employment Status Manual at ESM10010.

Small consultancies and the off-payroll rules

Where a small private sector business provides a genuine fully contracted-out service, Chapter 10 off-payroll responsibilities do not pass to that business.

Instead, where a worker provides their services through their own limited company, the contractor’s company remains responsible for determining IR35 status under the original IR35 rules.

Read more about the small company exemption from the off-payroll rules.

Special size rules also apply to groups and connected persons, so a company that appears small on its own may not qualify as small for off-payroll purposes.

However, size should not be treated as a shortcut.

A small company placed between an end customer and individual contractors does not automatically turn a labour supply arrangement into a contracted-out service. HMRC looks at what is actually happening, not simply the structure or terminology used.

HMRC guidance and current position

HMRC guidance on contracted-out services and labour supply has been updated since 2021 and is clearer than it was when these arrangements first became widely discussed.

The basic position has not changed: simply calling something a ‘consultancy’, ‘managed service’ or using a ‘Statement of Work’ does not make it a contracted-out service.

The reality of who controls the work, who carries the delivery risk, who manages the workers, and what the customer has actually bought matters more than the label on the contract.

Clarity on Statement of Work (SOW)

Consultancy services vs SOW arrangements

There’s lots of confusion about consultancy services in relation to Statement of Work offerings.

A Statement of Work is a contractual document. It will typically describe the work to be done, deliverables, timescales or other requirements. Its existence does not determine who the client is for off-payroll purposes and does not by itself make an engagement a contracted-out service.

A genuine contracted-out service is different. It depends on the commercial reality of the arrangement: the service provider is responsible for delivering the service and normally decides how to resource and manage that delivery.

A project may therefore be documented using a SOW and still amount to labour supply if, in reality, the customer chooses the individuals, directs their work and bears the delivery risk.

HMRC specifically warns organisations not to assume that a Statement of Work demonstrates that a service has been fully contracted out.

Reducing risk

Working practices and control

If consultancies are to be considered a viable option, then working practices need to be revisited, and contracts will often need to be redrafted.

Also, the organisation receiving the supply of consultancy services must be careful not to return to old ways and start managing the consultancy workers as though they were its own resources.

Potential warning signs include:

• The customer selecting or interviewing particular contractors who will perform the work.
• The customer directing individual workers’ day-to-day activities rather than managing the consultancy’s delivery.
• The workers becoming integrated into the customer’s own teams.
• The customer having significant control over whether the consultancy can replace particular workers.
• The consultancy taking little or no responsibility for overruns, defective work or other delivery problems.

None of these factors should be viewed in isolation, but together they may suggest that the customer is receiving labour rather than a fully contracted-out service.

HMRC says the actual working practices must be considered alongside the written contracts.

Inside and outside IR35 within consultancies

It’s worth remembering that a consultancy business, delivering a whole service, doesn’t automatically deliver that project using exclusively ‘outside IR35’ workers.

A consultancy business will often have a mix of permanent employees and subject-matter expert freelancers, who are used occasionally and may be outside IR35 depending on the terms and working practices of their individual engagements.

Where the consultancy is the client for off-payroll purposes and is itself within Chapter 10, it must determine IR35 status for PSC workers it engages and issue an SDS where required.

A consultancy supply, or an SOW assignment, therefore doesn’t guarantee ‘outside’ IR35 status for contractors.

Where the risk lies

In the right situation, a genuine contracted-out service can work for end users, recruitment businesses and contractors.

The important distinction is between buying an outsourced service or outcome and buying the services of particular workers. If the commercial reality is still one of labour supply, inserting a consultancy or SOW into the chain does not remove the off-payroll obligations.

For more on the underlying rules, see our off-payroll working FAQ and guide to reasonable care when determining IR35 status.

Further reading on contracted-out services

• ESM10010: Contracted-out services – HMRC Employment Status Manual – explains how genuine contracted-out services affect who is considered the client under the off-payroll rules.
• Help to Comply – Contracted-out services (Part 7) – guidance on identifying fully contracted-out services and distinguishing them from labour supply.