Contracting Under IR35: What's In A Name?

The Intermediaries Legislation, otherwise known as IR35, is six years old. Although there is much uncertainty over the statistics, it would appear that the Revenue have lost many more IR35 arguments than they have won. Of course, the IR35 apologists will say that its value lies in the additional tax revenue obtained from those contractors who have decided to avoid uncertainty and tick the box to say that they are caught. It must also be remembered, that even if the individual Status Inspector were to win only one IR35 dispute per year, because of the very substantial amount of tax liability typically at stake, the yield from just one victory would look good in his annual stats. However, there can be no doubt that a very large number of contractors have successfully defended their claim to operate outside of the IR35 regime.

The most important factor in defending the contractor's IR35 status is to have a right of substitution. This demonstrates that a personal service is not required and that the contractor is operating as a genuine business. This is entirely logical. What employee would be allowed to engage and pay an alternative worker to replace him in his work, at times of his own choosing, and potentially to his own profit? This argument was conveniently supported by a legal precedent set in 1999: Express and Echo Publications Ltd v Tanton. The Court of Appeal stated that Mr. Tanton's ability to provide a substitute worker was inconsistent with a contract of employment.

Unfortunately subsequent landmark cases have not been so supportive. In the Synaptek case, because no substitute worker had been used in practice, the judge said that the claim to a right of substitution was inconclusive and that other factors had to be considered. In the Usetech case, it was decided that the absence of a right of substitution in the "upper level" contract, between the contractor's agency and the end client, meant that a personal service was required, making the arrangement more characteristic of employment. Thus the whole IR35 debate has become centred on the right of substitution issue, but not always to the contractor's benefit.

The Status Inspectors now use the following approach to counter any claim to a right of substitution:

Point out that a right to provide a substitute worker is not enough. In the Tanton case, the worker had an "obligation" to provide a replacement, in the event that he was unavailable, not just a "right".

Refer to the Synaptek judgement, in which the absence of a substitution in practice weakened the contractor's case.

Approach the end client to obtain a copy of the "upper level" contract, and if that indicates that a personal service is required, rely upon the precedent set in the Usetech case. Use security and other practical considerations to try to persuade the end client that substitution would not be possible.

The result is that it is now harder to defend IR35 challenges. Gone are the days when we could point to the "IR35 friendly" wording of the contractor's agency contract and expect to win the argument. Now we find ourselves in the uncertain position of having to rely upon the contents of documents that we have never seen, and to which we have no right of access. Some contractors could be presented with huge IR35 tax bills, simply because they were unaware that the terms of their agency contract were not reflected in the agreement between the agency and the end client.

What can be done about this worrying trend? The solution must be a change in our basic approach to contracting under the IR35 regime. We need relationships between contractors and their clients to be put upon a proper footing. The new approach should be as follows:

Contractors must realise that if they want the tax advantages of incorporation, then they must represent themselves as companies and not as individuals. Services provided to clients must be supplied by companies or firms, which might engage any number of employees or subcontractors in doing so.

The names of individual workers must be kept out of all documents, along with any other expressions suggesting that a personal service might be required (e.g. "approved consultant").

Contracts should be "tendered for", in preference to the common use of personal interviews and CVs.

The word "contractor" suggests to many clients that they are engaging an individual. The word "consultancy" would be a much more appropriate description of the service provider. We need to get around the substitution argument by the use of contractual clauses such as: "In providing the services, the consultancy may use any workers of its own choice, provided the workers concerned have the requisite skills to deliver the services effectively". Ensure that both agencies and their clients are aware of IR35 and the pressing need to describe their arrangements in suitable terminology.

We can circumvent the whole right of substitution debate, by emphasising that there is no presupposition that a specific individual will undertake the work. But in order to do this, contractors must stop thinking of themselves as individuals. In this context, the very use of the word "contractor" is unhelpful. A less personal emphasis would also assist in avoiding some of the difficulties that can occur around the issues of control and mutuality of obligation. This approach should also help the end clients to avoid the unwitting creation of an employment situation, so it can be shown to be in their best interests.

Keith Preece - Qdos Consulting Ltd

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Posted 09/02/05

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