New and improved ‘contracted out’ guidance on IR35 is welcome from HMRC, despite one big glaring omission

In October 2023, I joined seven contractor recruitment agencies and APSCo to meet with HMRC’s policy and compliance teams to discuss the need for additional guidance in ‘Employment Status Manual ESM10010 - off-payroll working legislation: basic principles: contracted-out services,’ writes Stephen Rookes, director at Strategic Risk & Compliance Consultancy Ltd.

I’m pleased to say that on November 30th 2023, HMRC published – ‘How to comply with the reformed off-payroll working rules (IR35), and avoid common mistakes.’ Even more pleasingly, Part 7 covers contracted-out services.

A good read for services providers...

Having reviewed this new 14-part guidance, it’s clear to me that the document provides much-needed clarity for contractors’ clients -- engagers -- who want to operate under a contracted-out services arrangement. It’s a good read for us independent consultants and freelance services providers too.

Some of the changes are small but significant. Not just because it shows HMRC took on board our comments at the October meeting, but also because terminology should now be less opaque. In particular, HMRC has recognised the term ‘contracted-out services’ was not well understood. The Revenue has now included references to ‘managed services’ and ‘statement of works’ -- terms which are both better understood.

Three new HMRC examples of contracted-out services

Helpfully, there are three new usage examples in the guidance. First, an example of a genuinely contracted-out service; then an example of how through scope-creep such a service becomes the supply of labour (and therefore the Off-payroll Working Rules apply), and third, an example of incorrect management of a statement of works (in which case again the OPW rules apply)

In each of these cases, HMRC quite rightly says it is important to determine if the service includes any element of labour supply and if so, the ultimate recipient of these services must decide whether they, or the service provider are the client.

Although this guidance and the three new examples are useful, it remains clear that it is difficult to maintain a truly genuine contracted-out service. So I’d therefore caution clients and service providers that despite the improved guidance from HMRC, they still need to be very sure on a case-by-case basis that working practices are appropriate. If not, HMRC has made it clear that clients could be exposing themselves to liabilities under the OPW rules. And these are liabilities which are likely to be onerous.

Status Determination Statements, reasonable care, agency indemnities

Under contracted-out service arrangements, the client does not need to issue Status Determination Statements (SDSs) to the service provider. However, if the arrangements are not genuine, then the client will be liable for not providing SDSs and if the OPW rules should have been applied, then the client will be liable for the unpaid tax, NI contributions and Apprenticeship Levy. In this case, the client will be deemed not to have taken ‘reasonable care.’

Less positively, HMRC has not added any reference in its generally ‘new and improved’ guidance regarding the onerous tax indemnities which are often being forced on contractor recruitment agencies. During the October meeting, I made a strong argument to HMRC on this matter. When I was at director-level for a global recruitment company, and even now through various consultancy engagements, I’ve witnessed end-users attempt to bypass their own tax and NI liability due to HMRC where it is determined that the OPW are found to apply, by imposing onerous tax indemnities on agencies. These clauses are unethical in my view, as agencies lack the bargaining power to push back on such inappropriate indemnities.

Organisations are wrongly still getting themselves off the off-payroll hook, but HMRC just turned a blind eye

As such, clients who use cleverly-worded contractual documents to create a contract-out service which HMRC subsequently determines is not genuine, then as noted above, the client will be liable for not producing SDSs. However, if the contracts include a tax indemnity, then the client is ‘off the hook,’ as even though not legally liable, the recruitment agency would pick up the tax bill from HMRC.

This is a massively unfair practice and while HMRC cannot interfere with contractual matters, a comment in the new guidance that such practice was ‘inappropriate’ would have given agencies some leverage in their negotiations. HMRC not addressing such indemnities is a glaring omission that will disappoint stakeholders -- those of us who were at the October meeting and the contractor-agency community at large.