Many contractors ask which factors (written or carried out in practice) are most important in determining the IR35 status of a contract. Employment status experts often state the existence of a right to provide a subsitute as a key ‘outside IR35’ pointer.
Although a combination of factors determine whether or not a contractor is caught by IR35, some do carry more weight than others.
The ‘holy trinity’ of factors – according to IR35 case law – are control, mutuality of obligation, and substitution.
Here, Martyn Valentine, director of The Law Place Limited looks at one of these key factors – the right to substitution.
What is a right of substitution?
In the context of IR35 a right to substitute means a contractually enforceable right for a limited company contractor to replace its representative subject only to reasonable criteria such as suitability.
This is also vital to show that the end-client’s requirement is for the professional contractor to provide a service and not merely supply a specific individual.
The existence of an obligation to personally provide the services in question is a fundamental test for determining IR35 status.
The IR35 legislation applies where the worker ‘personally performs or is under an obligation personally to perform’ the services for a client.
A properly drafted right to substitute will help to remove this obligation and if substitution occurs then the duration and expense of an HMRC inquiry will be greatly reduced.
Substitution is not simply a device to avoid liability for IR35 as HMRC may complain.
If a professional contractor becomes ill then a contractually enforceable right to substitute will enable the performance of services to continue and avoid the risk of a claim for breach of contract.
Potential problems with IR35 substitution clauses
However, problems can occur with the drafting of substitution clauses.
In cases such as Creasey, the courts have held that a right to substitute cannot be effective if ‘fettered’ by an obligation for the professional contractor to demonstrate an inability to undertake the work.
The choice of whether to use a substitute must rest solely with the professional contractor.
In recruitment contracts, it is common for an apparent right to substitute to be no more than an obligation to provide a replacement if the professional contractor’s representative is ‘absent’.
In such cases, HMRC may argue that even if substitution occurs there remains an ongoing obligation to supply a specific individual. Therefore, professional contractors must be vigilant as to whether an apparent right to substitute is a sham.
Expert advice is essential
In short, a contractually enforceable right to substitute is absolutely vital to determining IR35 status and competent legal advice must be sought to check the drafting of the contract.
A professional contractor should never rely on the verbal assurances of a recruiter that the contract is ‘IR35 compliant’ or assume that IR35 does not apply where the services are simply to undertake a specific role.
What does HMRC say about substitution clauses
As Martyn Valentine describes in his guidance above, the right to provide must be a genuine one, not merely a clause inserted into a contract for the purposes of demonstrating ‘outside IR35’ status.
In ESM8565, HMRC specifically discusses ‘ineffective or sham substitution clauses’.
Where such clauses exist, the tax authority states:
It seems likely that many of these clauses have only been inserted to try and break the requirement for personal service and change the contract from one of service to one for services.
The employment status manual goes on to state the need to prove that there is a genuine right to provide a substitute:
You should only accept that such a right exists where there is an explicit right for a substitute to be sent and that this right has been accepted by the client.
Clearly, if a contractor can prove that they have already exercised their right to provide a substitute, this is a very strong pointer towards being in business on their own account.
A right of substitution is considered alongside other factors to paint an overall picture of a worker’s employment status.
For this reason, collect any evidence you have – either written or in terms of your working practices – to help prove your outside IR35 status if it is every questioned.
