Since the introduction of the IR35 legislation in 2000, the ‘substitution’ clause has played an important role in determining whether a contractor belongs inside or outside the rules.
But following the arrival of public sector IR35 reform and the release of HMRC’s much-maligned IR35 tool, CEST, is it fair to say that substitution is now more vital than ever? Quite possibly.
Typically, an outside IR35 contract includes the right for the worker to provide a competent substitute should they not be able to carry out the service themselves. It’s considered one of the three key status tests, along with Control and Mutuality of Obligation (MoO) and is a crucial - albeit not definitive - indicator of an outside IR35 engagement.
While a number of recent IR35 tribunals have been won by contractors without the right of substitution, since the rollout in 2017 of CEST, there is a case to be made that substitution has actually grown in importance. This is largely due to the sheer number of IR35 decisions that CEST now plays a part in.
As you might know, one of the many failings of CEST is that it tends to advise that a contractor should sit inside the legislation if substitution isn’t present. In some circumstances, the worker could tick many of the other boxes for belonging outside the rules, but if it isn’t stated in the contract that they can send a substitute, in HMRC’s eyes, the contractor will often belong inside IR35.
Numerous recent IR35 tribunals have found differently though, demonstrating that even without the right of substitution, contractors are still able to work outside the scope of the legislation. However, the widespread use of CEST, which relies heavily on substitution when delivering an answer, suggests that contractors would be wise to ensure their contract includes this.
That HMRC likes to ensure substitution is present but IR35 tribunals can look beyond this particular area of the legislation doesn’t quite stack up. And understandably, it has led many IR35 specialists to ask why HMRC hasn’t overhauled CEST’s logic around substitution.
The tax office regularly promises to improve the tool, but usually fails to specify which areas it will focus on. The following HMRC statement, for example, shows how vague the tax office has been in the past when pledging to refine its IR35 tool.
“HMRC continues to work with stakeholders to make improvements to CEST and wider guidance. Enhancements will be rigorously tested with stakeholders, and operational and legal experts, and will be available for use later in 2019.”
Granted, in a recent IR35 forum, HMRC did give members the opportunity to help shape it. The taxman invited several IR35 experts to have their say on the fact that CEST assumes Mutuality of Obligation (MoO) is present in every contractor engagement - a view that at Qdos, we strongly disagree with having handled over 1,600 IR35 investigations.
That HMRC has at least promised to explore ways to introduce MoO to CEST is a positive development, but it doesn’t make up for the fact the tool is built so a contractor’s IR35 status will very often be decided on substitution - particularly when it doesn’t necessarily in reality.
We’re told that an enhanced version of CEST will be released in due course - presumably before the introduction of further IR35 reform - but HMRC has said little, if anything, about reconsidering the role of substitution when the tool delivers an answer.
So as we look ahead to the arrival of further IR35 changes, contractors, many of whom are concerned that their clients and agencies will not be able to accurately set tax status, should include substitution in their contract. Better still, they must look to exercise this right to demonstrate that it is genuine.
While on its own, substitution will not always ensure a contractor is classed outside IR35 in court, should an engager set IR35 status solely based on the advice of CEST - which is unadvisable anyway - the chance of being able to work outside the legislation without substitution is slim.
For recruitment agencies and end-clients, either of which will carry the liability as the fee-payer when further IR35 reform is enforced, much like in the public sector, CEST’s over-reliance on substitution is yet another reason not to rely on the tool when determining a contractor’s status.
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