Clauses and provisions spelling out substitution’s handling and enactment are, paradoxically, a red flag, as they show your RoS has conditions. Otherwise, why the paperwork?
With an absence of substitution potentially being regarded by some as part of Sky Sports rugby commentator Stuart Barnes’s downfall on IR35 at the Upper Tribunal, it’s little wonder that ‘RoS’ is back on contractors’ minds, writes Charlie Hemsworth, a director at off-payroll tax specialists Bauer & Cottrell.
And while the judgment in Barnes’s S&L Ltd vs HMRC is new, the interest in Right of Substitution (RoS) isn’t.
How Right of Substitution has become all the rage
In fact, since the advent of the Off-Payroll Working Rules in the public and private sectors (April 6th 2017 and 2021 respectively), and HMRC’s CEST to assist with IR35 status decisions, much emphasis has been placed on the importance of having a RoS in place, when determining whether a contract falls outside IR35.
Some industry offerings you can snap up right now as an IT contractor, with accompanying ‘guidance,’ suggest that having a Status Determination Statement (SDS) and written contract that confirms a RoS, alongside policy documents or provisions on the procedural handling and enactment of substitution, is critical.
In some cases, the ‘guidance’ goes as far as implying that having this three-part bundle is determinative, to securing an outside IR35 position.
Comprehensive? Yes. Reflecting IR35’s complexities? Not so much
While these steps seem comprehensive on the surface, they don’t always reflect the complexities of IR35 and practicalities of real-world engagements.
We have been advising on IR35 for 21 years, and our stance is (and always has been) that relying on a RoS alone as a safeguard against IR35 isn’t just risky – it’s potentially misleading.
Yes, in theory, having a RoS in your contract can point towards a business relationship rather than employment. But in practice, the story is more complicated.
Here’s a simple way to look at (and understand) substitution
The issue of substitution is quite simple.
It needs to be demonstrated that the client is engaging a business, not a person, and that the client does not care who does the work from one day to the next, as long as they can do it.
Okay, in this scenario the relationship is clearly that of business-to-business, but in our experience of typical Personal Service Company engagements, RoS is frequently just not realistic or possible.
Why RoS just isn’t really a reality very often
Why? Well, first, many contractors are ‘one-person operators’ who don’t have access to readily available and equally skilled and equally equipped alternative resources that they could send in their place from one day to the next.
Second, client restrictions.
For example, in the vast majority of cases, PSC contractors are at least interviewed by the client, and this can extend to vetting and security clearance in many environments where strict regulatory and security protocols must be followed.
Procedural policy on substitution = fettered
In such a scenario, having a substitution policy might seem like a necessary step, but the existence of a procedural policy that outlines exactly how a substitution should be handled could unintentionally reveal the restrictions placed on the RoS, effectively fettering it and reducing its effectiveness as a status indicator.
HMRC’s own CEST tool is probably largely responsible for the common misconceptions that have grown around RoS in recent years. That’s because the substitution question gives a guaranteed “outside IR35” result when answered favourably.
Just this week, we reviewed a large organisation’s CEST determination that confirmed the client could not reject a substitute, resulting in an automatic ‘outside IR35’ outcome.
But hold on, not so fast!
The how, when, and where of a contractor’s work is key
Upon inspection, we discovered that the client retained control over how, when, and where the work was done.
Furthermore, the answers to questions about financial risk and the contractor working for other clients were unfavourable.
Upon even further investigation, it was revealed that the worker, “Joe”, had not yet started the contract, and was four weeks into waiting for security clearance, which was expected to take at least another two weeks.
‘Hi, I’m here to do Joe’s security-cleared work’
Well, I doubt a written substitution policy would help or demonstrate “reasonable care” in this situation, and the hiring manager’s reaction would likely be quite something if Joe turns up in week one, and announces he’s sending someone else to do his security-cleared work for the next four weeks!
A substitution clause that exists only in the contract, but is never exercised or is so heavily “fettered” in reality that it’s practically unusable, will carry little weight with HMRC or the courts.
The simple fact is, in a lot of cases – personal service is required.
IR35: Personal service isn’t a slam dunk for HMRC
But this by no means puts the engagement inside IR35. HMRC and tribunals often give far more credence to factors like Control, Mutuality of Obligation (MoO), and Financial Risk over a theoretical RoS that has no real-life application.
The safest approach to cementing outside IR35 status is to ensure that all elements of the working relationship align with the position of not being inside IR35.
This includes not just a RoS, but also a lack of control, MoO, and demonstrable financial risk, plus in-business features.
Stuart didn’t have it and lost; Kaye and Lorraine didn’t have it either – but won
High-profile IR35 cases found in favour of the contractor have echoed this sentiment and the need to stand back and look at the “whole picture.” Notable examples include the Kaye Adams case (Atholl House Productions Ltd v HMRC) and the Lorraine Kelly case (Canal Street Productions v HMRC). In both cases, the high-profile limited company director was found to have had no RoS, but was determined by the courts as outside IR35, based on other factors and the relationship with the engager – as a whole.
As Stuart Barnes will likely tell you after his defeat at the UT, a RoS can be a useful component of an IR35 defence, but as Adams and Kelly will likely tell you, it’s not necessary to achieving outside IR35 status.
Put another way, substitution and a right of substitution should not be relied upon in isolation.
Why need a policy document if there’s not conditions attached to the right of substitution?
Contractors and clients alike should ensure that all aspects of the engagement – control, MoO, financial risk, and actual working practice – are aligned with the contractual terms.
A robust, unfettered RoS that is supported by real-world practicalities and evidence of independence, is far more defensible than a theoretical clause or policy that exists only to check a compliance box and arguably, back-fire, by potentially proving the RoS is fettered; otherwise why would there need to be a policy document if there’s not conditions attached to the right of substitution? And as ever, then step back from the detail – it’s crucial to remember that IR35 status is determined by the entirety of the working relationship, not just one aspect of it.
