IR35 compliance and the right of substitution

Despite requests by industry groups to delay, the publicised IR35 reforms will be rolled out to the private sector on 6 April 2020, with final legislation expected in the spring budget on 11 March. This means affected businesses will have a minimal amount of time to make necessary adjustments in the face of potentially complex payroll systems.  It also means that a detailed understanding of exactly how HMRC interprets IR35 is very useful.

This article clarifies one aspect of IR35 legislation that can be contentious – the right of substitution. Many experts regard this as a ‘silver bullet’ clause because it has been found to be an important indicator in some cases heard by the courts, that companies do not fall within the IR35 regime.

What is the right of substitution in this context?

Substitution – the right for a consultant to use someone else to deliver their service – has been found in some cases to be one of the main indicators of true self-employed status. As the workplace continues to evolve with the use of more gig workers, consultants and contractors, the nature of substitution is also evolving. Business owners who use self-employed workers and contractors should be aware of how HMRC views substitution, which is that where the right to substitution is included in a contract it must be both “practical and plausible”.

There must therefore be a right of substitution written into an engagement contract for the right of substitution to apply. This is in addition to there being an opportunity for substitution to occur in practice. Even in cases where substitution has not occurred, it should still be included in a contract where it may be applicable, to offer protection to both engager and contractor.

IR35 Compliance – unfettered contracts explained

There are some important caveats to consider regarding substitution. When a clause is included, the right to substitution should be provided in an ‘unfettered’ (unrestricted) contract clause, or it could be rendered invalid if challenged. This is different from including commercial fettering, for instance, specifying that a substitute must have appropriate skills and qualifications. So, when creating a contract that is appropriate for IR35 purposes, it is fine to include that the service provider can provide a substitute, provided that they are adequately qualified to, and perhaps in the event that they are unable or unwilling to provide their service as usual.

To offer protection to the engager, a contract may state that the engager is under no obligation to accept an individual provided as a substitute. This means it would be possible to specify in advance that a substitute can only be selected from a pre-agreed pool of resources, offering the insurance of a quality service to an engager, whilst not exposing them to potential IR35 non-compliance. Linked to this, an engager may also have the right to reject a substitute if the proposal made is not in line with the terms of a contract. Acceptable grounds for rejection can include timescales, the nature of the work, security or qualification concerns.

Substitution vs replacement in IR35 compliance

Finally, for the substitution to be effective, it is important that any payment is made directly by the original contactor to the substitute and not by the engager. This is an important requirement – if payment is made to the substitute they then become a replacement, which is not the same thing.

If you have concerns about the IR35 substitution rules or wish to discuss any aspect of IR35 compliance, please contact partners@rjp.co.uk.