Contractors' Questions: How to set an IR35-friendly substitution clause?

Contractor’s Question: To limit any exposure to IR35, I want to put a valid substitution clause in my IT contract, but I am unclear how a substitution would work in practice.

If my limited company has only one employee, would a substitution clause where the ‘Ltd’ used an employment agency be valid? Or can the supplier have a fellow contractor that they can use as a substitute? I have read many articles saying that although the substitution clause was unfettered and therefore fine, the contractor could never act on it - thus HMRC deemed them inside IR35.

Expert’s Answer: There is no doubt that the issue of substitution, and how it relates to IR35, is surrounded by confusion and misunderstanding.

Firstly, on the logistics of substitution, it doesn't matter if you don't have another employee in your own limited company that you could use. Theoretically you could use any type of worker, whether they be an employee or a fellow contractor. 

You could indeed use a recruitment agency to source a replacement, but the key point is that your company must be responsible for paying the substitute and must remain responsible for the successful completion of the services. To this end, your company's contract with the agency must remain in force and unchanged - you would simply have a separate contract with the substitute. 

It would not be considered a genuine substitution if the agency simply replaced your limited company with an alternative.

As you suggest, a contract with an excellent written substitution clause is worth nothing if this right is not reflected in reality. Therefore, regardless of how unlikely it is to happen in reality, it's worth putting some thought into how you would actually go about exercising the right in advance. Having a basic agreement with a potential replacement would show HM Revenue & Customs that you clearly believe the right to be genuine.

Even better would be to get some kind of clarification from the end client that you would be able to send a substitute if the need ever arose, although organisations are often unwilling to provide such reassurances on an individual basis.

The expert was Seb Maley of employment status specialists Qdos Consulting.

Thursday 19th June 2014