Substitution is one of the hottest IR35 topics, and is often a cause for confusion resulting in consultants and contractors being needlessly pushed inside IR35.
What is an IR35 substitute?
A substitute is generally regarded as a short-term resource to cover you should you be unexpectedly sick or otherwise incapacitated or unavailable. You would seek, arrange and pay to send in a substitute to replace you. The contract between your client and your company does not change – your client engages your company, your company engages the substitute. There is no direct contractual relationship between your substitute and your client.
Substitutes don’t have to be your employees. It is perfectly acceptable for you to engage another contractor or temporary worker to provide a substitute to your client.
By being able to send a substitute, you break the chain of personal service. Your relationship with your client is one of a business supplying a service, rather than being an individual supplying a personal service who happens to operate via a company. The distinction is subtle but important.
You can probably see why this is such an important factor: if you can send a substitute, then personal service from you is not required. If personal service isn’t required, this cannot be an employment relationship. That’s why the ability to provide a substitute is a strong indicator of being outside IR35.
Helpers and subcontractors
While distinct from substitutes, using helpers or subcontractors can have a strong, positive impact on your IR35 status. Are there any opportunities for you to engage helpers to deliver your contract? Could you engage specialist technical resource to do something quicker than you? Can they review your work or provide advice to you? Can you engage junior or admin resource to free your time up? Could you use a blend of part-time resources from gig marketplaces? If you are running late, can you bring in a helper (at no extra cost to the client)?
A genuine right of substitution
You need to establish your right to send a substitute, and your contract is the starting point. Keep in mind that HMRC says that “a right to send a substitute must be genuine for it to be taken into account in deciding employment status”, which means they’re on the lookout for “sham” clauses that don’t represent the true working practices between your company and your client.
From this comes a paradox. Substitution may be a rare event, so how can HMRC decide in advance, or in the absence of an actual substitution, if the hypothetical arrangements are a sham or not? Even HMRC recognise that this is a challenge, stating that “disproving a claimed right of substitution can be difficult”. Instead, what they’ll do is look at other examples in the contract or working practices that prove that the right to substitution does not make sense – for example, if the individual is deeply ingrained in a project, process or activity and it’s not realistic to provide a substitute. But even then, it’s not clear cut – as Lorraine Kelly has taught us.
Lorraine Kelly’s IR35 case
Lorraine Kelly, the softly-spoken Scottish host of the ITV show ‘Lorraine’, is, in fact, a contractor, and ITV is her client. Given there’s only one Lorraine Kelly, presenting a show called Lorraine, you’d think that substitution would be impossible, which could be an indicator of being inside IR35. That’s what HMRC thought too, but Lorraine is a smart businesswoman and a controlling force in her relationship with ITV. She beat HMRC in court and proved that she was outside IR35.
HMRC argued that ITV had the final say in substitutes when Lorraine wasn’t available, meaning she didn’t have a genuine right to substitution. The judge rejected HMRC’s case, based on the overall level of control of the services that Lorraine provided to ITV, including the fact that she was instrumental in identifying substitute presenters during her holidays. Therefore, even though Lorraine’s substitution approach wasn’t bulletproof, the judge down-weighted the importance of it on the strength of Lorraine’s control and overall relationship with her client.
Do I have to have sent a substitute to pass this test?
No. Just because it hasn’t occurred, doesn’t mean you don’t have the right to send a substitute. If your contract says you can, but you haven’t, it’s down to HMRC to build a compelling case to show that you couldn’t – which isn’t straightforward, as we see in the above example. On the other hand, if you can, and you genuinely have, your case for being outside IR35 is incredibly strong.
IR35 substitution in practice
There are three tests for effective substitution practices, all of which must be met:
- Your client must allow the substitution taking place
- Your client cannot refuse any substitute who is suitable qualified
- You must pay the substitute from your company
In order for a substitution right to be genuine, you’ll need to retain some control of the process. This means whilst it’s ok for your end client to check the suitability of your proposed substitute, clauses that state that your client must approve the substitute or have a right to veto them altogether may be problematic.
The gold-standard is an unconditional right to provide any substitute you see fit, without approval or refusal from your end client. But the reality of business is somewhat different: clients will no doubt raise questions of practicality, security, continuity, or thinking it gives you the right to command a premium rate whilst drafting in lower-cost resource to deliver the work.
Overcoming the challenges of substitution is rooted in the benefits of a true business to business relationship. Your company is contracted by an end client to deliver work. Even if you are unavailable for unforeseen reasons, the work should still be delivered – on time, and for the same cost. You manage the substitution process, you pay them, you cover the hand over costs, and you shoulder the risk: this theoretically makes you a far more attractive proposition compared to an employee, or worker inside IR35.
But what happens if you send a substitute, the client was denied the right to vet them, and they’re doing a terrible job or can’t get up to speed quick enough? Or what if you can’t find a suitable substitute? At this point, your company may be in breach of its original contract to supply the agreed services, paving the way for a contract termination clause to be triggered by the end client.
And it’s this tension that allows us to see a route through substitution. Your client may find it undesirable for you to send a substitute and you’re not particularly excited about the idea, because if you do you have to manage it at your own cost, and if it goes wrong the contract may be terminated. Whilst contractually a substitute can be sent, it is in the best interest of all parties for this not to happen.
Avoid IR35 substitution problems
Get tips on what you can do to avoid encountering substitution problems when it comes to IR35 by watching this video.
