Contractors staying outside IR35: setting expectations with a letter to the client

Contractors starting work with a new client – especially if that client is a former employer – are frequently battling entrenched views that they are just another worker, an attitude by clients that is likely to tip contractors straight into IR35 with all the financial implications that go with it.

But according to Andy Vessey of Qdos Consulting, contractors can easily manage the expectations of their clients before even setting foot on site. This is best done by sending a confirmation of arrangements document that has a covering letter explaining exactly how the contractor is not just another employee.

“The best IR35 investigation is one that never starts,” states Vessey. “One key route to this outcome is ensuring the client understands that their relationship with their contractors is not one of manager and employee,” explains Vessey. “A covering letter to the client accompanying the confirmation of arrangements and spelling out the nature of the relationship is one key step.”

Start with a businesslike approach

As Vessey explains, a contractor’s IR35 status will be determined by their written contract and the reality of the actual working relationship with the client, from which a ‘notional contract’ can be created by tax inspectors, tribunals and the High Court. Other supporting evidence for a contractor’s status includes indicators that the contractor is genuinely in business on their own account. A key piece of evidence detailing the reality of the working relationship is the confirmation of arrangements.

“Many limited company contractors intent on staying outside IR35 are used to creating a confirmation of arrangements detailing the exact nature of their relationship with the client,” continues Vessey. “The covering letter, or email, that accompanies the confirmation of arrangements [COA] to be signed by the client provides the contractor with an opportunity to manage the client’s expectations about the working relationship they are about to embark upon. This is also an early indication to warn the client of the consequences of deviating from the ‘COA’.”

The consequences of the client ignoring the COA and the contractor as a result being found inside of IR35 could be a claim for employment rights and all the expensive benefits that comes with them, such as holiday pay, redundancy and sick pay. Although any claim is almost certain to be unsuccessful following the O'Murphy v Hewlett Packard ruling in 2001, any contractor action of this type would be costly to the client in cash, time and public image having its name dragged through the courts, and this can be diplomatically alluded to in the covering letter.

Vessey says that simply acknowledging that both parties are seeking to create a business-to-business relationship is an important and often overlooked starting point. For former employees returning to an ex-line manager as a contractor, it is essential for setting the tone as one of a business supplier to a client.

Plan to work like a contractor, not an employee

Although it is not always possible, particularly with contractors such as offshore engineers or IT contractors requiring access to sensitive secure internal systems where there is a genuine need to work on-site within prescribed hours, Vessey advises contractors to include an opening paragraph about hours and location; this should include statements along the following lines:

  • Start and end times of the day are at the contractor’s discretion, allowing for factors such as professional courtesy and access to systems and key client personnel
  • Where possible and where work schedules and the practicalities of the project permit, the contractor shall be able to work at their own premises.

Where the contractors must adhere to time and location constraints, the covering letter should explain why this is required, for example because health and safety requirements only allow access to a site at specific times.

Supervision and control – nip it in the bud

Vessey stresses that a key point for a contractor to emphasise to the client, and one that could be a pivotal factor in determining their IR35 status, is that contractors must at all times throughout their contract be in ‘control’. He explains: “The client sets the specifications and expectations of the work to be completed, but that’s where their controlling input should end.

“From the outset, the contractor should make clear that they are the skilled professional or knowledge worker whose business has been contracted to complete a specific project. As such, the contractor is not subject to supervision, although it is of course acceptable that the client checks the work has been completed to the client’s satisfaction and within agreed deadlines.”

Vessey draws on the analogy of a builder building a wall. “If you ask a builder to build a wall, you tell them where and how high, but you don’t tell the builder how to mix the mortar and lay the bricks. Clients should extend the same professional courtesy to contractors.”

Substitutes and sub-contractors

According to Vessey, when it comes to IR35, substitutes and sub-contractors are not the same: “Being able to supply a substitute to completely replace the contractor is a key factor that can be used to prove a contract is outside IR35. Bringing on board a subcontractor helps establish a contractor is in business on their own account and is significant in disproving personal service, but is not quite as powerful.”

The covering letter or email that accompanies the confirmation of arrangements to be signed by the client provides the contractor with an opportunity to manage the client's expectations about the working relationship they are about to embark upon

Andy Vessey, Qdos Consulting

Ideally, when submitting the confirmation of arrangements with the covering letter, contractors should also supply a list of their preferred substitutes, possibly even including brief CVs and inviting the client to inspect these potential replacements.

A pipe dream not grounded in reality? Not so, says Vessey: “Many of our contractor clients start off almost scoffing at the thought of presenting their client with a list of potential substitutes as almost a ‘fait accompli’, but when dressed-up as potential sickness and holiday cover, it’s surprising how many clients sign off on the list.”

And Vessey says one of the ways to handle objections is to say: ‘If you have a deadline to meet, and I’m ill, would you take my substitute under these circumstances?’ He explains: “Our clients’ experience is that if a contractor can actually use a substitute once or twice their professional standing actually increases significantly in the eyes of their client, so pointing this out in the covering letter is a ‘win win’.”

Falling into the ‘MOO’ trap

As case law has moved the IR35 goalposts, so the old principles of ‘mutuality of obligation’ have changed, and contractors must be wary of work offered by a client mid- or end-contract. It is important to use the right language and handle such situations properly, to ensure contractors don’t find themselves dropped into IR35 territory.

“Any work a contractor accepts outside the original contract specification, and this could include extensions and renewals without watertight project specifications, can lead to a contractor being considered to have accepted mutuality of obligation,” warns Vessey.

A covering letter to counter this eventuality could include the following: ‘I would welcome the opportunity to work on additional projects, but I understand that I am under no obligation to do so, and any I do consider are at my discretion. Any work outside of the original contract specifications will require a separate specification, negotiation for the rate or project fee and separate contract.’

Contracting’s part and parcel traps

Finally, Vessey warns all contractors, and particularly those returning to a former employer, against being considered ‘part and parcel’. “Make sure the HR department knows you are no longer an employee,” he says. “Get yourself removed entirely from organisation charts, clarify which facilities you can and can’t use, on the understanding that you may not be barred from them all, but that if you do use them you should pay the client the market rate to use them.”

Fire warden duties and even attending office social events are out, unless the contractor makes a financial contribution. But staff-only events are definitely a no-no, says Vessey. “It might look churlish to turn down invites to the staff Christmas party. But it is important for contactors to realise that if they work like an employee and take advantage of opportunities only available to staff, an HMRC inspector is likely to tax them as an employee, no matter what their written contract says.

Vessey sums up what is needed for a strong covering letter: “Each contractor will have individual needs, but the core components of the letter should include a preamble covering time and location, a bit on control and substitution, a sentence about mutuality of obligation, and, of course, deal with the part and parcel issue. And,” he concludes, “remember you’re starting a new business relationship, so don’t forget to thank the client for their business!”

Published: Wednesday, April 28, 2010

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