IR35 indemnity clauses not being enforceable? Wishful thinking

It’s always good to have a debate about risk, and into the off-payroll working arena comes a discussion around the enforceability of IR35 indemnity clauses, writes Adrian Marlowe, managing director of Lawspeed.

Reliance, pursuit, enforceability

The type of indemnity clause under discussion is one which the hirer has designed to rely upon in the event that HMRC pursues a claim for IR35 taxes. In my article last week for ContractorUK. ‘Four types of contract breach contractors need to beware,’ I listed these types of clauses as they are quite common. However, it has been suggested that these clauses may not be enforceable. Is there an argument? Let’s consider a scenario.

IR35 indemnity clauses, a case study

A couple of years after the end of a contract which the end-hirer had determined was outside IR35 and the contractor had been paid without any tax deductions, HMRC opens an enquiry. The hirer admits that work was done outside the scope of the work contracted for, and that the contractor, in practice, had submitted to the control of the hirer’s project manager, even though at the time of signing the contract both parties thought that the arrangement was outside IR35. HMRC sets out its claim to the hirer for £30,000 unpaid PAYE and NICs plus penalties and interest for late payment.

In this scenario, the contract required the contractor to:

“Indemnify and keep indemnified the hirer against any costs (including legal costs), claims, or demands for taxes, interest and/or penalties arising from or required to be paid by the hirer to HMRC as a result of the application of Chapter 10 ITEPA”.

In my experience, this is typical wording for an IR35 indemnity clause.

Top 5 reasons why IR35 indemnity clauses ARE enforceable

In this scenario, there are several points here about enforceability, in practice, that I take issue with -- in response to this article.

1. The hirer is always likely to rely on the clause; that is the clause’s purpose, and so the hirer will make the demand. Such a demand will of course not be welcomed by the contractor.
2. Although it is correct to say that there needs to be a loss to the hirer, the clause (phrased as it is above) does not require the hirer to have already paid HMRC; there has been a demand for payment by HMRC -- that is all which is required for the hirer to make a claim on the indemnity.
3. It’s not correct to assert that for such a clause to be enforced, the HMRC enquiry and/or subsequent appeals would have to be concluded. Such an assertion implies that there would need to be some kind of tax tribunal action before the debt is crystalised. However, the hirer may simply accept the HMRC claim is properly evidenced and demand the monies from the contractor. There is no obligation on the hirer to argue with HMRC; an appeal in any event may be fruitless and incur yet more cost.
4. There is no authority that such a clause is not enforceable, and asserting that there is no authority that such a clause is enforceable in the context of IR35 does not help – tax indemnity clauses have been around for a long time and are generally enforceable.
5. We don’t believe it is correct to assert that the contractor is unable to affect the events which caused the liability, because it will have been the actions of the contractor in conjunction with the hirer (submitting to control etc) that brought about the liability in the first place, and the contractor, will have received the benefit of gross payment from the fee-payer.

To me, a more acceptable argument would be…

It is more creditable to argue that IR35 indemnity clauses might not be enforceable on the basis of the technical argument that such clauses are potentially contrary to public policy. However, since the taxpayer at large is the one that loses out and the contractor makes the saving, and there is no supporting statement in the legislation, even this argument may not stand up to closer scrutiny.

The bigger point, though? It’s this. Why would a contractor want to sign up to this kind of clause anyway? Why invite the hassle? Why take the risk?

Lastly, here's what we’re advising on IR35 indemnities

We certainly won’t be encouraging contractors to sign up to these IR35 indemnity clauses, but, if they have to, then we’d recommend you negotiate and/or go into it with eyes wide open.