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IR35 and contracting bonuses – how to manage bonus payments

Contractors receiving bonus payments can find themselves pitched straight into IR35, as HMRC is likely to see such bonuses as being evidence of the contractor actually being a disguised employee. But contractors can legitimately receive ‘bonuses’ and remain outside IR35 if they pay attention to detail.

Something as simple as the wrong word on a document could tip the balance against a contractor in an IR35 investigation. So the first lesson is, never to call a bonus a ‘bonus’, because that is associated with employment. In fact, that simple word on a contract may be sufficient to spark an IR35 enquiry.

So contractors offered a bonus during contract negotiations should ensure that the contract and surrounding ‘paperwork’ never refers to the payment as a ‘bonus’. The wording should always be amended to say ‘completion payment’.

Expert contract reviews are essential

Whilst the contract is only one piece of the jigsaw used by HMRC to determine a contractor’s employment status, having it professionally reviewed for IR35 status is a vital step in identifying and correcting inappropriately worded clauses, such as those for incentive payments.

In addition to correcting the terminology, a contract review will also confirm that the incentive payments are specifically related to a project and will only be paid on completion of milestones, or once the project has been successfully completed and the specifications met.

To accept a contract that includes automatic payment of a ‘bonus’ would place the contractor on dangerous IR35 ground. That’s because the implication would be that the contractor is ‘owed’ the bonus, as an employee might be entitled to one.

Tests of employment

Although the bonus issue can be a tipping point in a borderline case, the key tests of employment will take precedence – things like control, substitution and mutuality of obligation.

Mutuality of obligation can be an in issue with an incentive scheme if the contractor is locked in for a period of time, because the contractor is therefore under an obligation to perform work in exchange for the incentive payment.

And, although mutuality of obligation is considered by most IR35 experts to be of less importance in IR35 cases than substitution and control, the courts have increasingly been siding moving away from HMRC’s simplistic view of mutuality in status decisions and taking into account ongoing obligations required between the parties.

Always get a review

In addition to identifying issues such as inappropriate or unhelpful contractual clauses, seeking a professional contract review can also assist contractors with demonstrating they have taken due care with the tax affairs. This is helpful as failing in this duty of care can result in steep penalties.

Contractors should not be discouraged from working on a performance-related basis, as that’s precisely how many businesses operate. But it’s clear this area is an IR35 minefield and so expert reviews are essential.

Updated: 30 December 2020

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