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Contractor Doctor: Does hiring other contractors put me outside IR35?

Dear Contractor Doctor

I have been contracting via my own limited company with the same client for two years. I have always been keenly aware of my IR35 status and take what measures I can, such as checking my contracts, to ensure I am not caught by the legislation.

I have recently started to subcontract work to another contractor, who I pay via my limited company. I anticipate she will be spending about twenty days a year working directly on my client’s projects.

Does hiring other contractors put me outside IR35?

Thanks

Stuart

Contractor Doctor says:

“To determine whether a subcontractor is a substitute for IR35 purposes, one must ask whether the subcontractor has been engaged to do what the contractor has been engaged to do, or is it something extra?” explains Roger Sinclair of contractor legal specialist Egos.

This distinction is critical, because if a subcontractor is genuinely substituting, delivering an element of what the contractor has been contracted to deliver, then that demonstrates in the clearest possible way that the contract is not one of personal service: “Without personal service, the hypothetical contract imposed by IR35 cannot be one of service - which means IR35 does not apply.”

Furthermore, if a contractor has legitimately substituted and then applied the business entity tests (BETs) before their abolition in April 2015, this will automatically put most contractors in the ‘low risk’ zone, as a substitution gives 20 points.

If the contractor took the tests before April 2015, they will earn the three-year exemption from an IR35 review that HMRC has promised to honour after the abolition of the tests, as long as the contractor’s circumstances do not change.

Personal service is essential for a contract of service to exist

It was originally a landmark Court of Appeal ruling in the Express and Echo Publications v Tanton case in 1999 that reinforced that personal service remains an essential element of a contract of service, or employment contract. And now, according to Sinclair, actual substitution is the closest thing to a silver bullet for contractors seeking to prove that they are outside IR35.

Without personal service, the hypothetical contract imposed by IR35 cannot be one of service - which means IR35 does not apply

Roger Sinclair, Egos

“When applying IR35, one has to imagine that the relationship between the contractor and the end client is governed by a contract, and divine what the terms of that contract would be, having regard to the provisions of the existing contracts,” says Sinclair. “If the hypothetical contract includes personal service and should properly be categorised as falling within the ‘box’ labelled ‘employment’, then IR35 applies.”

It was because of the principle of personal service as illustrated in Express and Echo Publications v Tanton that substitution became an important factor in IR35 and employment status cases. So, if a contract has an unfettered right of substitution clause, which the contractor has exercised, the hypothetical contract cannot be one of employment because the facts themselves have demonstrated that there is clearly no requirement for personal service.

Substitutions must fulfil certain criteria to be genuine

But Sinclair warns that conditions apply to substitutions, because HMRC has wised-up to the fact that contractors might include an ‘artificial’ substitution clause in their contracts, purely for the purposes of assisting their IR35 position, even though substitution might not be a realistic possibility.

Strictly speaking, the client does not have to be aware that a substitution is taking place. A subcontractor could be quietly delivering on a part of the contract in the background. But if there is no right of substitution, if the client would not have been happy about the subcontractor and does not in fact know that substitution has taken place, then that would not be sufficient.

“Substitution is all about demonstrating that there is no obligation to provide personal service,” continues Sinclair, “so if the client knows a subcontractor is fulfilling an element of the contract, then clearly personal service is not required, and the hypothetical contract would be one for services, and not of service.”

Right of substitutions must be unfettered

“For actual substitution to be genuine and accepted by HMRC, the right must actually be exercised, and the contractor must pay for the substitute, not the client. The right to substitute should ideally be unfettered, or (if not) then the substitute should have client approval,”

In conclusion, Sinclair believes that there are several ways in which Stuart’s substitution might be turned to his advantage, depending on the full facts of his situation: “If a contractor can demonstrate that their personal service is not required, the contract cannot be one of employment and IR35 will not apply.”

Good luck with your contracting!

Contractor Doctor

Updated: Wednesday, December 10, 2014

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