Does the right of substitution defeat IR35?

There has been a lot of debate recently over substitution clauses in agency contracts, and whether they do indeed defeat IR35. In this article I will sum up the Revenue's thinking toward the subject, quoting directly from their employment status manuals.

Is the right genuine?

ESM1055 says :

"The right to provide a substitute is a strong pointer towards self-employment. However, a right to send a substitute must be genuine for it to be taken into account in deciding employment status. Where the true agreement between the parties is that the worker must undertake the work personally but a written contractual term allowing substitution exists the written clause will be ignored as a 'sham'."

It is important to note at this point that it is the contract with the agent (i.e. the one the contractor signed) that is pertinent here.

How then do the Revenue contend successfully that the right is a 'sham'?

To quote:

"The Commissioners and Courts will accept a written contractual clause unless they have evidence that it does not represent the true agreement between the parties. This means that if we (the Revenue) are to dispute such a clause the onus is on us to demonstrate that it is a sham (or has been varied by an agreement subsequent to the contract being signed)."

"Disproving a claimed right of substitution can be difficult. Unless there is reason to doubt a claimed right of substitution it may normally be accepted at face value. If the claim later turns out to be untrue we will normally be able to rectify the matter later. Enquiries are more likely to be appropriate where other alleged terms are found to be false or a claimed right of substitution does not seem to make sense in relation to the contract. For example, an engager is unlikely to want to accept a substitute where the work involves a complex task worked on a team basis and is likely to take some time to complete and where ongoing work relies on a knowledge of the whole system being worked on (for example, in some computer programming situations)."

We now get to exactly how the Revenue will want to challenge these claimed rights of substitution. Bearing in mind the above it would be wise, if your contract purports to allow substitution, to figure out exactly how in practice you would be able to substitute. Not necessarily names, but a simple outline to show how it could be feasible were the need to arise. This will then counter any objection the Revenue may have based on the above.

Do you have to send a substitute, or do you just need to have the right?

The Revenue say:

"As explained above it is the right of substitution that is important. The fact that substitution has not actually occurred during a contract is not necessarily relevant. Workers with such a right are of course entirely free to carry out the work themselves if they wish. We may want to consider claims that there is a right of substitution critically if substitution does not occur over a long period of time. However, we should not automatically assume, in such cases, that this means that there is no real right of substitution."

This is clear cut and unambiguous. You do not need to actually invoke the right. The right is enough in itself.

Is the right of substitution a guarantee I will pass IR35?

In 99.99% of cases, undoubtedly yes. ESM1057 says:

"If, exceptionally, you decide a right of substitution is genuine but there are other terms that appear wholly inconsistent with self-employment, Personal Tax (Technical) can provide advice. Such cases will be exceptional (for example, membership of the employer's pension scheme and a common intention for employment expressed in the contract – but the employer alleges the worker is self-employed because of the right of substitution). Submissions should not be made simply because control exists alongside a right of substitution."

In other words there would need to be exceptional circumstances to contend employment where a right of substitution exists.

It is important to point out that the need for personal service (i.e. a lack of the right of substitution) does NOT mean you fail IR35. There are many other factors to be considered. However if you have a genuine right it is fair to say that in all but the most exceptional cases you will pass IR35.

Article by Simon Dolan of SJD Accountancy.

For more information -Inland Revenue
 

May 12, 2004