Contractors, don’t fight IR35 without a substitute
Once perceived as a contractor’s ‘silver bullet’ to shoot down an IR35 enquiry, Substitution is back on the table not long after warnings were issued that it shouldn’t be relied on if misunderstood.
Well, as we approach the end of 2018, it’s well-known that HMRC’s much-maligned IR35 tool -- CEST -- relies heavily on the right of substitution, and in most cases, contractors can pass it simply by agreeing to the CEST questions centred on this aspect of the legislation.
For many years, Substitution has been considered the ultimate must-have when defending IR35 enquiries and, if a contractor could provide one then, in HMRC’s eyes, they typically belonged outside IR35. That said, things have changed somewhat and if recent IR35 cases are anything to go by, Control has taken over as the key pointer to determine whether a contract sits outside the rules.
The Jensal Software Limited (JSL) case that we worked on earlier this year is a case in point. Control was deemed to be pivotal, but that isn’t to say the right of substitution was overlooked. Mr Jensal’s argument was significantly strengthened given he had a clear contractual right to provide a substitute -- something confirmed in writing with the agency and the end-client.
Because of this, substitution -- while not the deciding factor in recent IR35 cases -- remains a key test in determining IR35 status. And to be safe, a contractor should always have it recognised by all parties when taking on a contract outside IR35.
Let’s look at what officialdom says. The introduction to HMRC’s Employment Status Manual states; “Where two individuals are engaged to carry out similar work, it is possible for one to be self- employed and the other to be an employee because they have been taken on under contracts with different terms and conditions.”
This means that for a contractor to be considered a genuine business-owner and outside IR35, they need to ensure their relationship is clearly different from those who are employed. One key way of doing so is not only to have a clear right of substitution, but to also actually exercise that right.
Again, let’s refer to HMRC’s Employment Status Manual. which explains; “The basic issue in relation to substitution or delegation of work is whether or not an engager requires a worker to perform services personally…where the worker has complete freedom over who will do the job it will be inconsistent with a contract of service.”
Of course, quoting from a HMRC manual is a simple way of showing that substitution was important (the manual was last updated in 2010), and still is important. Yet to really succeed at keeping IR35 at bay (now or post-2020), contractors need to put this into practice.
Fortunately, HMRC’s CEST tool sets out numerous criteria for substitution to be tangible. One of those being that the substitute “was not from a pool or bank of workers regularly engaged by the end-client.” This removes from feasibility the ‘if you scratch my back, I’ll scratch yours’ approach that many contractors may have relied on in the past.
However the CEST tool, despite being designed to help simplify IR35 decisions, has its flaws. And it is the view of many experts that the result cannot necessarily be relied upon in the event of an enquiry.
Should HMRC decide to investigate, when focusing on whether a contractor has a legitimate right of substitution, the taxman will tend to ask the following Substitution-related questions:
1. Is the right to provide a substitution addressed in the contract, or verbally agreed?
Ideally, every outside IR35 contract should contain a solid right of substitution clause. But this isn’t always the case -- agencies are sometimes unhappy to amend their terms to include one. Therefore, it should be directly agreed with the end-client in writing. Verbally is fine, but having evidence to turn to in the event of an investigation is even better.
2. Under what circumstances can the right to provide a substitute be exercised and are there any restrictions?
A contractor should have the right to send a substitute at any time, without any restrictions. They should be able to substitute if they have been offered another contract and are looking to grow their business with multiple clients. The only acceptable restriction on substitution is that the replacement must be skilled enough and qualified to provide the services.
3. Who decides when a substitute is engaged and recruits the substitute?
The contractor should decide when they substitute and remains responsible for sourcing the substitute. However, it’s acceptable for the end-client to request one. For example; if the original personnel is unwell or on holiday and the client wants to minimise disruption or, if the original substitute is not qualified.
4. Who is responsible for the substitute’s payment and quality of work?
The contractor must remain responsible for the payment of the substitute and should also remain liable for the service and quality.
With further IR35 and CEST changes looming, contractors should consider reviewing both existing and new working arrangements and ensure they have the right to provide a substitute because while its silver colour might have dulled a little, it’s still a bullet worth having in your armoury, almost regardless of the changes which surface. To reiterate, Substitution is not the only factor taken into consideration in an IR35 investigation, but don’t go without it because it remains integral to strengthening any argument for sitting outside the rules.