September 27, 2023
Consultancy agreements play a pivotal role in defining the working relationships between clients (usually a business), individual consultants and personal service companies (PSCs). The aim of a consultancy agreement is to establish the rules of engagement, duties, and responsibilities between the parties, while also addressing the critical issue of employment status (particularly in relation to IR35 legislation). In this article, we will explain what consultancy agreements are (for both individual consultants and those operating through PSCs), when and why you might need to use them, as well as the significance of IR35 in relation to these agreements.
A consultancy agreement is a formal document that defines the scope of work, responsibilities, deliverables, payment terms, and other crucial aspects of a consulting engagement. It is a legal contract that protects the interests of both the consultant and the client. They provide a clear framework for the consulting relationship, helping to prevent misunderstandings and disputes.
Consultants often work independently as self-employed consultants or freelancers. An individual consultancy agreement is a contract between an individual consultant and a client. Here are some situations of when you might need this type of consultancy agreement:
A personal service company (PSC) is a separate legal entity established to provide the services of an individual consultant. PSC consultancy agreements are designed to accommodate this business structure. Here's when you might opt for a PSC consultancy agreement:
The key elements typically included in a consultancy agreement, are as follows:
IR35 was introduced with the primary goal of addressing what the government perceived as tax avoidance and unfair employment practices within the consultancy sector. The legislation was designed to tackle the issue of “off-payroll working”, where individuals who would otherwise be classified as employees engage in work as a consultant to reduce their tax liabilities.
The ultimate objective of IR35 is to ensure that individuals who were, in essence, working as employees would be taxed and be entitled to various employment rights, regardless of the contractual arrangements they used.
IR35 doesn’t apply to consultancy agreements where the client engages with the individual consultant directly. The responsibility for determining the employment status of individuals engaged in consultancy agreements lies with the engaging client. This means that the client must assess whether the individuals they engage should be classified as employees. To determine this, clients should consider employment factors such as control, substitution, and mutuality of obligation. There is also a useful online test (CEST test) which you can use to check employment status.
If the consultant is found to be an employee for practical purposes, the individual is treated as an employee of the client. This means the client is on the hook for all applicable tax liabilities and they need to ensure they do not breach any employment rights of the individual.
Given all the concern around IR35, it may sound strange, but small businesses may prefer to engage with corporate entities, such as PSCs, due to IR35 compliance concerns. This is because, when the client is categorised as a small business the PSC (i.e. the intermediary) is required to determine whether the arrangement meets the employment factors and therefore deemed an employee, rather than the business/client. However, if the client is a medium or large private sector organisation and IR35 is found to apply then the client will be on the hook for the tax liabilities. You can of course seek to address this risk in any consultancy agreement by way of indemnities, but it is certainly worth considering before you enter into the relationship.
So, in summary, consultancy agreements are fundamental in defining the rules and expectations within consulting engagements. They are not only essential for protecting the interests of both consultants and clients but are also critical in the context of IR35 compliance.