IR35 contracts & risk: 10 things to be wary of when signing a consultancy contract

An important aspect of reducing your commercial risk is assessing the commercial terms of all contracts that your business agrees. These will include the trading contracts signed with clients or agencies as well as contracts with suppliers. It is vital that you are fully aware of rights, obligations and restrictions contained in commercial contracts. This requires checking the extent and enforceability of liability, indemnity and restriction provisions and determining which terms are absolute obligations, which terms require the business to use its reasonable endeavours and which terms require using best endeavours. There are important legal distinctions and being aware of these will be an important part of a strategy to minimise liabilities.

Another point to be aware of is the difference between signing a contract with a client to "supply a worker" to perform services and signing a contract to directly perform services. Different liabilities will arise under each form of contract and there may be arguments that your limited company is acting akin to an agency when "providing personnel" and consequently subject to unexpected regulations and tax legislation.

IR35 contracts

With regard to IR35, it is worth bearing in mind that the contract must reflect the specific terms of the engagement, which are invariably unique. In order to be outside IR35, those terms must in turn reflect an engagement that would not be deemed as employment under the established case law. For the layperson this is often a difficult distinction to make so if you are unsure it is probably more prudent to seek the advice of a specialist in the area such as Lawspeed.

Some key points to look out for in a contract are:

Nature of Work and Schedules - First and foremost, the work must be described accurately and for IR35 purposes should be either a project or projects, or have some form of deliverable that is consistent with a discrete piece of work that is not ongoing. It is fundamentally important that the description in the contract is accurate, as you will be contractually bound to deliver the stated services.

Right of Control - Old style standard agency contracts usually contain a clause requiring the contractor to be under the direction, supervision and control of the client. Such a clause should always be avoided, leaving method and manner of performance for the contractor to decide.

Substitution - The substitution clause has received much publicity as the panacea to cure all IR35 ills. Whilst this approach is simplistic it is an important clause to look out for in a contract. The right need not be unfettered (not many clients will realistically agree to an unfettered right) but must be valid. Caution should always be exercised before relying on a substitute clause to avoid IR35, unless substitution has actually taken place. The relevant clause must be a genuine right to substitute and many clauses we have seen fall well short of what is required.

Mutuality of Obligation - An ongoing obligation to provide work and do work provided should not be an explicit or implicit term of the contract. Further work should be under a separate contract. Provisions enabling the client or agency to extend without the consent of the contractor should be avoided.

Termination - Generally a 'contract for services' (i.e. which is not likely to be affected by IR35) is for a specific project and will end when the project is completed (or alternatively if there is an early breach of the contract). It is therefore advisable to link the contract duration to timeframes for completion of the actual services.

Financial Risk - Running a genuine business enterprise appropriate to a contractor intending to operate outside IR35 usually involves taking on a level of financial risk. Financial risk can exist in many ways such as incorporating indemnity provisions, agreeing to fix faulty work or maintaining professional indemnity insurance.

Payment terms - Payment terms should reflect those that exist between commercial companies rather than those that exist for employees, so payment should always be contingent on invoices being issued. Many professionals and sole traders charge an hourly or daily rate without compromising their self-employment status, so whilst fixed price contracts are ideal, payment based on time can be acceptable.

Exclusivity - It is entirely inappropriate for an independent contractor to be unduly restricted from providing services for other clients.

Equipment and Premises - If the working arrangements are such that elements of the work are to be performed from the contractor's own premises then it is clearly inappropriate for the contract terms to stipulate a fixed client site as the sole location for performance of the services.

Intention - As the intention of the parties is not to create a relationship of employer/employee, a clause should confirm the independence of the parties and that there is no relationship of employment. To support this intention it is important to avoid language and concepts usually only found in an employment context such as procedures for notification of absence, references to misconduct or overtime.

Under IR35 it is all the circumstances of the arrangements, including the working practices that are relevant. The strongest evidential source for demonstrating the actual working practices will usually be a written agreement between the relevant parties, but only if this can reasonably be relied upon as an accurate representation of the facts. It is important to remember that there are continual changes in the law and specialist legal skills are required to review, draft and negotiate contracts effectively to accurately reflect the actual working practices. For this reason it is often best to engage specialist contract draftsman with IR35 expertise to ensure commercial risks are mitigated and IR35 issues are properly and accurately dealt with.

James May LLB (Hons) is Manager, Contractor Services at Lawspeed Limited, experts in IR35, contract, recruitment and employment law. For advice on all aspects of contracts including commercial terms and IR35 status visit for further details.


Friday 1st October 2010