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The Application of IR35 in Practice

So, you believe that your contract places you outside of IR35 and you are confident you are entitled to the benefits it brings, but, how do you reassure yourself that is actually the case? Well, since the introduction of IR35 there have been ‘tests’ developed which are the result of legal cases and the precedent they set and which indicate if the working practices of a contractor results in them being inside or outside of IR35. The tests are used to assist in deciding if it were not for the intermediary would the contractor be an employee of the end client. The contract(s) in question must be completely representative of the contractors working practices, else the IR35 test is failed.

Not many contractors realise that their working practices are more important and hold more weight than their contract. The reason for this is the that working practices are deemed to be the what actually happens as opposed to a contract and what is supposed to happen, a key difference. HMRC uses a myriad of status test to determine if a contractor is outside of IR35 and operating as a genuine business, or if you are in fact operating as a disguised employee and therefore inside IR35, with the three main status tests being:

     Bullet Point    Control
     Bullet Point    Right of substitution
  Bullet Point    Mutuality of obligation
  Bullet Point   Genuine business & financial risk
  Bullet Point   Provision of own equipment & training
  Bullet Point   Payment terms
  Bullet Point   Exclusivity
  Bullet Point   In business on own account
  Bullet Point   Part and parcel of the end client
  Bullet Point   The contract


Looking at each one in turn we analyse the test and advise on how best to ensure you prove yourself outside of IR35:

Control

Any business should have a reasonable degree of control as to where, when and how they undertake your work, whereas an employee is told where and when to undertake their work. Therefore, the control an end client has over the contractor is crucial in defending a status test, specifically the ‘what, where and when’. A contract might not contain the specifics of this, but your working practices will and means that the end client must be in agreement with how you provide your services.

In terms of the ‘what’ element of control, this should be clear. If a contractor is forever advised by their line manager over what needs to be done, then there is control. There is a theory that as the end client has contracted you they do not have the required skills and expertise in house. Therefore, you know what you are doing and how do it, and whilst some liaison with employees of the end client is likely required i.e. reporting at set stages to ensure the project is being completed as expected, you should have full control over your work and how you complete it.

In terms of the ‘where’ element of control, working at the end clients’ location(s) does not alone indicate control, as this will often be the only way the work can be done. An employee will likely have defined in their contract where they are required to work, so a contractor should not have this, similarly, they should refrain from having it stated that the end client can move the contractor from job to job due to priorities and circumstances changing.

In terms of the ‘when’ element of control, a contractor should be able to decide when they work so that they can get the task completed. An employee on the other hand has their hours of work stated in their contract.

Overall it is accepted that as long as the contractor fulfils the contract within the required timeframe then the ‘where’ and ‘when’ are irrelevant. Some contracts require the contractor to work under control for the ‘where’ and ‘when’ such as when working on a security restricted site that is only open at set times or you need to be in personal contact with certain staff who are only in the office in normal working hours, but it is accepted that this is a must and so cannot be worked around.

Right of substitution

This is one of the most important and strongest status tests, with many cases won and lost on such. The contractor, as a business, must ensure that they do not have to personally provide contracted services and that a substitute can be sent instead and/or an assistant engaged, giving the company the power of unlimited delegation. This means that there is no restriction on the same person, who is often the only person in the company, providing the service that the company has been engaged to do. If this is the case and a named person is explicitly required to undertake the work then they are a disguised employee and should be considered such of the end client rather than a genuine business in their own right, meaning any defence will therefore fail.

It is common for the contractor to feel that they are the expert and only person who can fulfil the contract having sourced and secured it themselves, but the fact is that the vast majority of contractors will never have to exercise this clause. The reason to exercise the clause must be genuine and the substitute, their wages and payment etc are the responsibility of the contractor’s business. An end client can veto the substitute if they have reasonable grounds to do so, which is often that the substitute does not have the required skill set, qualifications or experience required.

If investigation by HMRC, the starting point will be the contract. A clear right of substitution clause must be within the contract, but not only that it must be genuine. HMRC will often contact an end client during an investigation to see if the business is able to send a substitute, so ensure that the end client is aware of this and that you are in agreement as to the terms of the contract, as remember, what happens on real life is a far better defence than what is written on paper and supposed to happen.

Mutuality of obligation

Quite simply the issue of the continuation of work between a contractor and the end client should not mirror that of employee and employer, in fact it should be the complete opposite. A contractor should not expect continuous work and the end client should not provide it, whereas an employer will endeavour to provide continuous work for every employee and for that work to be undertaken as and when required. Historically, where a contract was renewed, often regularly, there was an argument put forward that this created and employer-employee relationship and therefore the contractor became a disguised employee.

Ultimately the contractor must have a contractual right to walk away else HMRC likely to take a viewpoint that there is a presumed continuation of work as a result and any defence to this test will fail. Therefore, a contract should have clear start and end dates. If work is continued to be provided to the contractor by the end client and there are not clear start and end dates, HMRC may well deem that by habit an employer-employee relationship has been created, irrespective if this was the intention or not. The inclusion of a clear non-mutuality of obligations clause in addition to clear start and end dates is key to providing the best defence to HMRC. If the contract contains no end date and there is no clear non-mutuality of obligations clause, then the contractor will struggle to prove to HMRC their case.

Genuine business & financial risk

A contractor that is genuinely in business will bear a financial risk, a disguised employee will not, making this test a significant one in the eyes of HMRC. Being genuinely in business means that the contractor will provide their own equipment, pay for their own training, pays for employees and overall incurs a great deal of financial risk, all at the risk of obtaining significant financial reward for being a successful contractor. No financial risk will normally point HMRC towards the individual being a disguised employee and not in business on their own account.

Provision of own equipment & training

A contractor should provide all of their own equipment, whereas an employee expects to be provided with everything they need to be able to do their job. The more important the equipment is to the role the more important it become that the contractor provide this themselves. Training must also be paid for by the contractor and not the end client, so checking every clause within the contract is a must to ensure that this is the case.

Payment terms

An employee will typically receive payment either monthly, weekly or hourly, whereas a contractor will negotiate a rate, normally a day rate, for a job and will invoice the end client on a periodic basis and await payment within the agreed terms. HMRC do state that as professions such as lawyers charge an hourly rate, merely charging an hourly or day rate is not conclusive proof to assist in proving the IR35 status of an individual.

Exclusivity

A fair presumption is often made when an individual works solely for one client, in that they are an employee of the employer. Another presumption made is that a self-employed individual will often work for more than one client. However, what cannot be assumed, and a contractor must ensure, is that they have the right to work for more than one end client at once, with their contract(s) clearly stating that that they are able to provide their services to other clients on a concurrent basis. One accepted caveat to this is for clauses to be inserted that prohibit the contractor not to provide their services to direct competitors of the end client, or where a conflict of interest arises.

In business on own account

The final key point to remember is that you are a business. Issues such as taking out business insurances such as Professional Indemnity, Public Liability and IR35 Tax Investigation Cover prove to HMRC that this is the case. As a business you also need to ensure you have registered for Corporation Tax and VAT (if applicable) and that you comply with all Health & Safety legislation, and it is crucial that, as all businesses do, you have your own stationery and website etc to show that you market and advertise the business. A genuine business will need and invest time and money in to all of these, reap the benefit of them, and you can prove without doubt you are a genuine business to HMRC if called upon to do so. Ultimately, the above ten status tests are the main ones, not all of them. HMRC have many status tests and the importance of each changes on a case by case basis, so always ensure you are up to date with the latest developments.

Part and parcel of the end client

A key failing for some contractors is that they inadvertently become part and parcel of the end client without meaning to, acting and/or benefiting as if they were an employee. A contractor must not appear to be an employee by having things like have an email signature with the end client logo or contact details on, have end client business cards or appear on employee lists, and they must not benefit as an employee does by taking advantage of items like a subsidised staff canteen, gym, pension or bonus schemes etc. As well as ensuring the contactor doesn’t benefit like an employee does, they must ensure they are not under the same monitoring i.e. subject to a performance review of disciplinary action. If in doubt always decline the benefit on offer i.e. a Christmas party invite and err on the side of caution, one action could have deadly implications when reviewed by HMRC.

The contract

An employee and a self-employed person have very different contracts with a business, with the intention behind the relationship outlined accordingly within the terms of the contract. An employee will work under a ‘contract of service’, whilst a self-employed person will work under a ‘contract for services’, the difference between the two is huge, and engaging in the wrong one can have very large ramifications.

A contract does not have to be written as it is accepted that oral or implied contracts are also valid, although as always a written contract provides clarity and which can be especially helpful when presenting evidence to HMRC. If there is nothing in writing, then the basis of the contract can be ascertained from the circumstances of what happened during the engagement.

Finally, HMRC does view the contract as a decisive factor, and whilst important in assisting to decide on status, if all other evidence has been reviewed and a final decision remains unclear it will often be used as the final piece of evidence as to the intended relationship and so can ultimately tip the balance one way or the other.

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