Expert advice Q&A on IR35 for The HR Director Readership
Q: Why should I care as a client, if a contractor I engage is inside or outside IR35? It’s their problem, right?
A: Indeed the immediate impact is upon contractors. However, there is a substantial resulting threat to clients. Those that fail to embrace outside IR35 will be sourcing services from a smaller and lower quality pool of available resources. A large number of highly skilled contractors are confident of securing engagements elsewhere outside IR35 because of the quality of their service. Many contractors simply will not provide their services inside IR35 There are numerous financial and other benefits for contractors to be outside IR35. These benefits help to offset the substantially increased risk versus permanent employment, plus the absence of permanent employee rights, both from the employer and from the government.
Q: Why should I increase my own IR35 risk and exposure as a client just to help a contractor?
A: Firstly, as just explained, you are very much helping yourself as well as the contractor. But also, it isn’t necessarily true that outside IR35 engagements present greater risks to clients than inside IR35 engagements. The risks are simply different. With inside IR35, clients risk disenfranchising key resources, suffering crippling talent drain, a knock-on disruption or derailing of critical projects and transformations, and EVEN HMRC tribunals they are trying to avoid, if contractors decide to pursue an employee rights claim. There’s also a likelihood of status determination statement disputes and the resulting administrative headaches you won’t get with outside IR35.
Further, engineering legitimate outside IR35 engagements and working practices such that your risk is negligible, is not difficult or complex. It is more straightforward to construct outside IR35 engagements that are nowhere near borderline, than it is inside IR35 engagements. A right of substitution, which many clients dismiss due to a lack of understanding, is the single most defining aspect of IR35 status. It strikes at the heart of the personal service definition, cementing an engagement as a contract FOR services as opposed to a contract OF service. There is no such potentially sole defining aspect upon which to derive an inside IR35 status.
Q: What’s the point in me selecting my contractor candidate and then signing up to a right of substitution? It’s the candidate I chose that I want.
A: Right of substitution is arguably the most misrepresented and misunderstood concept in connection with IR35, and at the same time it’s the most powerful. It is rarely used and should be viewed by clients as not dissimilar to an insurance policy or disaster recovery plan. It does not have to be used in order to be a valid justification for outside IR35. It’s a facility and mechanism that allows the contract with the limited company of the contractor to remain intact even in a scenario where the chosen contractor is not present, hence it eliminates the presence of a personal service.
It’s actually a client benefit, not a client risk If you have engaged a candidate outside IR35, you have in fact chosen their limited company and not them specifically. That limited company is then responsible for providing a service that meets or exceeds their contract obligations to you, the client. The value-add for clients is that if your chosen resource is unavailable, for whatever reason, at a point when active service delivery is critical to maintaining contractual obligations and client requirements, it is THEIR responsibility and not yours to ensure your services continue to be delivered to your satisfaction. It’s as much about saying as a client that you won’t provide your own cover for an absent contractor outside of their limited company’s control, because if you did do that, their limited company cannot be held responsible for its contractual obligations.
Clients no doubt fear that a chosen resource could simply abuse the right and send in substitutes whenever they please. The reality is contractors typically want to be working and are highly protective of the quality of their service. In a scenario where a contractor abuses the right to the detriment in any way of that service, the client can simply terminate the contract due to unsatisfactory service. When clients are asked the question, do they have a right to reject a substitute, you should say no you don’t. What you DO have the right to do in any case is to reject and terminate unsatisfactory service delivery by the contractor’s limited company.
Q: Isn’t right of substitution now seen by HMRC as the contracting parties trying to exploit a loophole?
A: No it isn’t. In HMRC’s own IR35 status determination tool, a confirmed right of substitution with the requisite attributes is a direct path to an outside IR35 status, irrespective of how any other questions are answered. It’s designed that way because it’s aligned with the law. There are numerous caselaw precedents that support right of substitution as a potentially sole determinant of the absence of personal service and of an outside IR35 status.
Q: Is there a way to guarantee safe outside IR35 status and remove all risk for clients?
A: HMRC pursues employment status disputes with a risk-based approach. What that means is they don’t pursue a dispute where there is at the outset, a high risk of defeat and failure. In 36 case histories analysed by 34square, HMRC’s victory rate with no strong right of substitution evidenced has been approaching 70%. Where a strong right of substitution was evidenced in the tribunal, their victory rate has been zero. They have lost every time a strong right of substitution has been evidenced. So, whilst it is impossible to totally eliminate risk, an evidenceable, bona fide right of substitution is probably as close as it gets to no risk. It is in fact possible to secure insurance against uncollected tax and penalties from some assessment service providers, however that insurance would not be valid unless reasonable care had been taken in determining status. HMRC has incorporated in the legislation that if a client has taken reasonable care, they will NOT be held liable. So absence of reasonable care means insurance can’t pay out and presence of reasonable care means no insurance needed.