IT contractors warned on IR35 substitution clauses

IT contractors are today warned over their IR35 substitution clauses if they work via an agency, as HMRC is increasingly relying on the clauses to launch IR35 investigations.

Right of substitution is the ability of a contractor to send someone else in their place to complete a role, and is one of the official tests used to establish IR35 employment status.

Twenty contractors were recently deemed employees after the Appeal Court said that their substitution clause was a sham, partly due to them not knowing it was in the contract.

Now, HM Revenue & Customs is launching a growing number of probes into the employment status of contract workers where the substitution clause may be too flimsy.

In particular, full blown IR35 investigations, which often start out as 'normal' tax enquiries, are targeting those IT contractors who supply client companies through agencies.

Exactly how IT contractors agree a robust substitution clause with a client where an agent is 'in the middle' has always been a challenge, says IR35 firm Bauer & Cottrell.

But since the Appeal Court's ruling, the firm says that all the signs indicate that more contractors will be deemed employees due to their substitution clause not standing up.

This suggests that while the ruling has returned 'right of substitution' to the headlines, the clause appears to have less clout in determining employment status than it had before.

Kate Cottrell said: "We are seeing more and more IR35 investigation cases where a claimed substitution clause has simply been treated as one clause amongst many carrying little weight in the [employment] status argument."

Speaking to CUK, the former Inland Revenue tax inspector said that, in her experience, "most substitution rights are unrealistic where there is an agency in the middle."

This is the case, she said, unless contracts are back-to-back, and unless the client truly understands that, despite numerous other candidates to carry out the contract, the selected candidate can send someone else.

Ms Cottrell added: "In most cases the client will state that they would expect the agency to provide the replacement, if this was necessary, and there would be nothing wrong in a contract that passed this down the line."

Addressing IT contractors, she advised: "It all comes down to educating all the parties in the contractual chain and ideally at the outset. A contractor should seek the views of the client if they are planning to rely upon a right of substitution to take them outside IR35.

"On the basis that most substitution clauses are unreasonably fettered and do not work, I would recommend concentrating on the control issues in the contract which is the most important status issue."