How to be IR35 compliant through a Statement of Work (SoW)
With businesses struggling to understand what constitutes ‘inside’ or ‘outside’ of IR35 legislation, a Statement of Work model and approach to project management can help ensure IR35 compliance when engaging interim managers or a consultancy partners.
What is a Statement of Work?
A Statement of Work (or SoW) is a legally binding, contractual agreement which is used to define and measure the delivery of a piece of work – the project or outcome.
A SoW should clearly state the specific set of activities (deliverables) that the supplier (PSC worker or consultancy) is responsible for completing. It should further detail the duration of the project/engagement and document how and when payments will be made. All this activity will be based against completion of specific milestones and can be paid on a time and materials, capped T&M or fixed price basis.
The importance of IR35 changes
IR35 is a piece of anti-avoidance tax legislation introduced in April 2021. It only applies to contractors who supply their services through a limited company (also referred to as ‘Personal Service Company´ or ´PSC´).
IR35 requires the PSC to pay equivalent employment tax as directly engaged employees if the reality of the work is akin to employment – aka disguised employment.
Historically, it was always the responsibility of the PSC to assess whether their arrangement fell within the IR35 rules and to pay any employment taxes due if deemed inside IR35.
However, this changed in 2017 for the public sector when the off payroll working rules were introduced. The burden of assessing whether IR35 applied moved from the PSC to the end-client and the responsibility for making income tax/NIC deductions passed to the party paying the PSC (typically the end client or recruitment agency).
Changes to the IR35 legislation will extend the off-payroll rules into the private sector for all medium and large companies that engage with PSCs. Where an end client buys a SoW style service, it will not have the obligation to assess the IR35 status of the PSC contractor(s) involved in providing the service. This will be the responsibility of the provider of the SoW service (who becomes the end client).
How to be IR35 compliant through a statement of work approach
When used correctly, the SoW model will ensure outside IR35 compliance for all PSC workers provided as part of the service but merely labelling an assignment as a SoW will not be enough – the SoW must be legitimate:
- On the client side, where a piece of work is required that can be measured on a set of outcomes, with a definitive end date and a set of milestones (yard sticks) this will lend itself well to the SoW model.
- For the PSC contractor, the SoW model provides the ability to operate without any control/direction and to deliver freely against the client’s requirements.
How to write a statement of work that’s IR35 compliant
When writing a statement of work that’s compliant within IR35 legislation, it’s important to include the following:
- Scope: Overview of the whole project/set of outcomes required, detailing what the client wants and expects to see upon completion
- Deliverables: The actual output required to be provided by the PSC as part of the engagement, these can be incremental (as the project progresses), total (at the end of the project) or most commonly a mixture of both
- Milestones: The measurement of progress/outcomes which often relates to the trigger of payments based on successful completion
- Dependencies: What we expect/need the client to provide in order for the PSC to complete an outcome/milestone/deliverable. Any dependency failure should not impact the financial position of the SoW provider/PSC.
- Caveat/assumption: A set of conditions we make in order to define the SoW deliverables and milestones, the vaguer the client’s requirements, the more conditions we might look to include to base our solution (and cost) on.
Developing your statement of work template
A statement of work template is a communicative tool that will support the project manager and dependents so that all stakeholders remain informed, thereby enabling the success of the project. When prepared by the consultancy partner or interim service provider and is deemed commercially and legally binding, it can support IR35 compliance.
How to stay outside of IR35
The true requirements to be to be determined as ‘outside IR35’ are:
- Zero Supervision Direction and Control (SDC) on the activity being undertaken by the PSC Contractor. The client must facilitate the correct working practices and culture for the PSC Contractor to operate freely in achieving the defined outcomes (the deliverables).
- The PSC has the freedom to deploy, as it deems appropriate, any suitable replacement (i.e. it has the right to use a substitute contractor) or possibly add more people to the project/outcome – at the PSC’s cost. Critically important is that the PSC pays the costs of any substitute PSC directly themselves.
- The PSC should risk incurring financial impact/ hardship for any failure arising in the delivery of any outcome for which they are accountable & responsible. Of course, if a failure can be tracked back to the client failing to provide something required for delivery – the PSC should not suffer.
Taking all of the above elements, detailing and documenting them well and in-turn defining payments based on performance will all help to ensure any PSCs are operating outside of IR35. By further including a clause in the SoW holding back an element of payment (up to 25%) until the client has signed-off on successful completion of the project clearly demonstrates financial impact should sign-off not be gained.
For a more detailed report into this legislation of the IR35, download our official report.