Financial risk

Financial risk in IR35 status

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.

Examples of demonstrating financial risk

Correcting faulty work

“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.

Business insurance

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.

Training

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)

Provision of equipment

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)