Financial risk is one test that HMRC will look at when determining a contractor’s IR35 status, however it is not currently as powerful of a determining factor as substitution or control. With this in mind, it is still very important for an independent contractor to demonstrate that they are taking a financial risk as this helps to show that they are in business on their own account.
Self-employed contractors are likely to be exposed to a higher level of financial risk than an employee would be. For example, contractors invest in their own business for things such as training, tools, and marketing. Contractors can also make a profit from sound business management i.e. finishing the services earlier than expected and making a profit on the fixed fee agreed.
Where a contractor completes work which in the client’s opinion is faulty or substandard, it is then normal for the client to expect a contractor to correct the faulty work in their own time and at their own cost. This helps to show that the contractor is exposed to a financial risk.
Some other examples of demonstrating financial risk are as detailed below:
“Where a worker is required to and does correct sub-standard work in the workers own time i.e. the worker does not get paid again for correcting the work, then this is a pointer towards self-employment.” (ESM0541) Correcting any faults or omissions in the services provided is a fairly simple way for contractors to demonstrate an exposure to financial risk and is also a positive indication of being in business on own account.
Holding business insurance is another way to show that you are in business on your own account. It helps determine that a contractor has acknowledged their financial risk exposure and has therefore taken the precaution to protect themselves against any claim that could lead to a financial loss against their company. This may also be a contractual requirement.
Financial risk may also arise where a contractor incurs significant amounts of expenditure on training to provide themselves with a skill which is required for a particular engagement. Investing in training is a good pointer toward being a genuine business and “this can be treated as a pointer to self-employment if there is a real risk that the investment would not be recovered from income from future engagements.” (ESM0541)
It is always encouraging that contractors provide their own equipment. A common misconception can be that the size of the equipment provided is of more relevance, however this is incorrect. Where a contractor provides important equipment that is essential to the services being provided, this is a very strong pointer to being in business - for example by providing your own vital IT software purchased at your own expense. The example provided by HMRC reads as follows; “the fact that drivers provided their own lorries was a major factor in Ready Mixed Concrete (South East) Ltd v The Minister of Pensions and National Insurance. The Court decided that the contracts with the company were contracts of carriage rather than contracts of employment.” (ESM0540)
Ultimately a lack of financial risk would not be considered a conclusive issue (provided all other key status tests are evident), however in the event HMRC were to enquire into a limited company and they were ‘on the fence’ regarding the overall status, this is a factor that could tip the scales towards a contract being considered one of employment, where there is no evidence of financial risk being taken and the right of substitution and control tests are ambiguous.
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