Why a right of substitution is vital in determining IR35 status

Many contractors ask which factors (written or carried out in practice) are most important in determining the IR35 status of a contract. Although a combination of factors will determine whether or not a contractor is caught by IR35, some do carry more weight than others.

Here, Martyn Valentine, director of The Law Place Limited looks at one key factor – the right to 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 and 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.

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.

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.

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