Statement of Work and IR35 – an Analysis of Risks and Rewards

19th November, 2020

Statement of Work and IR35 – an Analysis of Risks and Rewards

Delayed legislation

The countdown to 6^th April 2021 has begun, with now less than five months to prepare for the Off-Payroll legislation (“Off-Payroll”). We understand that there will be no further deferral and, in fairness, clients, agencies and contractors alike have now had more than enough warning and time to prepare. So, what is the current attitude of clients regarding engaging contractors either on an outside IR35 basis or alternatively through a Statement of Work (SOW)?

This time last year many clients were in panic mode, taking a knee jerk approach and pronouncing “blanket bans” on all contractors. There was a huge rush to assess everyone “inside IR35” (which caused much grief to those who received an inside assessment which had no legal basis when the legislation was delayed). It also led to an exodus of contractors to umbrella providers. Ultimately, this panic unfortunately resulted in a huge loss of talent and chaos within the market.

Reasonable care

There is no doubt that the year’s delay to the legislation has given clients some badly needed breathing space and an opportunity to calmly reassess the risks. Now that the dust has settled and many clients have taken appropriate advice and considered their options, most now realise that taking a blanket approach will fail to meet the “reasonable care” standard imposed by the legislation and may pose even more tax risk for them. Additionally, many clients clearly do not want to risk another “brain drain”- the loss of talent and skill that results from pushing contractors who are used to working independently and running their own businesses into perm or umbrella solutions.

Clients are now slowly realising that they CAN continue to engage contractors on an outside IR35 basis compliantly, as long as they ensure that they have adequate in-house expertise to assess the risks or have outsourced the assessments to experts who are backed by insurance. Alternatively, many clients are considering the advantages of engaging consultancies on a Statement of Work.

What are the advantages of a SOW for clients?

The SOW model, when structured and operated correctly, is particularly beneficial to clients from an Off-Payroll perspective because where the service is genuinely outsourced, the IR35 status risk will shift to the consultancy providing the service rather than the client. This means that the consultancy (if it is not entitled to the “small company” exemption) must conduct the status determinations of any sub-contractors it engages.

A SOW also provides the client with more certainty on project price or output and shifts most of the financial risk onto the service provider as payment is not made until certain milestones are met. Furthermore, SOWs can be far more cost efficient and effective when scoped, managed and contracted properly.

What does a Statement of Work look like?

There is no prescribed format for a SoW but usually this would take the form of a Master Services Agreement (“MSA”) which would operate as the framework agreement governing individual SOWs.  Sitting under the MSA, each SOW is a legally binding, business to business contract for services between two parties.

It provides a structure describing the project including the scope, specification, deliverables, timescales, payment and acceptance criteria. The more robust the SOW, the more likely it will be deemed a genuine, outsourced agreement as opposed to the provision of “labour”. The devil is in the detail- the more specific the deliverables and acceptance criteria, the less likely that “scope creep” will occur which can result in disputes.

How is it different from working through a limited company on an “outside IR35” basis?

In addition to complying with all of the factors which typically indicate an outside IR35 status (lack of mutuality of obligation, right of substitution, lack of supervision, direction and control, financial risk etc), a SOW involves more risk to the contractor. This is because payment is conditional upon meeting milestones and targets, subject to agreed acceptance criteria. Furthermore, it usually includes indemnities and an obligation to remedy any defective work.

However, it is important to emphasise that working under a Statement of Work is certainly not the “silver bullet” for all contractors seeking to work outside IR35 as it can be very difficult to “shoehorn” a time and materials engagement into an outcome-based arrangement, so it is only appropriate for certain types of project-based engagements.

What type of business can provide their services on this basis?

• Medium to large consultancies

Many traditional consultancies have been delivering their services to clients on a SOW basis for years. They generally have a pool of independent contractors, using them to provide specialist expertise on an ad hoc project basis. However, under Off Payroll, the consultancy will assume the risk and responsibility for assessing status of their sub-contractors (i.e. the consultancy becomes the “client” for the purposes of the legislation). Consultancies engaging on this basis must review their existing contracts and ensure that the working practices reflect those clauses.

• Small consultancies

Some contractors are forming small consultancies. These are either delivering their services themselves on a project basis to clients and/or engaging sub-contractors to deliver the services. As long as these consultancies qualify as “small” they will be entirely exempt from Off-Payroll. Where sub-contractors are engaged through such small consultancies the “old IR35 rules” will apply (i.e. sub-contractors will retain the right to determine their own IR35 status).

But contractors considering this model should remember that there’s a big difference between providing a service as a traditional contractor and doing so through a consultancy. The services must not merely be a provision of labour, disguised as a consultancy agreement – adapting an existing time and materials-based contract into a consultancy arrangement with a client may be very difficult – particularly if you are continuing to provide the services yourself. To work compliantly, contractors adopting this model will need to entirely renegotiate terms with the client and, more importantly, ensure that their working practices reflect a genuinely outsourced service.

• Recruitment Agencies

Agencies are experts in providing skills and people quickly and are capitalising on this ability by morphing into consultancies. However, this means having to change their business model from delivering recruitment services to service provider which will inevitably increase their business and financial risk.

This is because they will no longer be providing “a post filler” but instead providing a service – an entirely different business model from traditional recruitment, leading to higher insurance premiums and more financial risk. We predict that smaller agencies will not be able to keep up with the larger agencies who have already seized this opportunity of providing consultancy services to clients.

Is a SOW the right approach in uncertain times?

It is clear that Off-Payroll will shift the IR35 risk from contractors to clients. This is consequently leading to significant change and new models emerging within the private sector. It is predicted that many agencies will be delivering more projects with defined outcomes on a SOW as opposed to a “body” for a defined period. There are also new insurance products available to protect agencies or clients using contractors against potential liabilities.

Despite this uncertainty in this changing landscape, there are clear opportunities for contractors who are able to offer their services on a project-basis through a consultancy. They can continue to use their existing limited company, or perhaps a limited liability partnership (“LLP”) will offer more flexibility, depending on their business growth strategy. Adapting and transitioning to this model will however, require investment, strategy and planning, and a willingness to take more financial risk. However, in turn, the SOW model presents considerable opportunities for private sector consultancies as we see more clients preferring to obtain services rather than labour.

How can WTT Legal help?

Should you be interested in working on a Statement of Work basis or forming a consultancy, or if you are a client or agency considering the benefits of this model, we can offer you a free consultation to conduct a risk assessment to determine whether this is a suitable model of engagement for your business.

Please contact info@WTTlegal.co.uk to book an appointment.