IR35 and Personal Service: why the right to substitution is so important
Out of the three major IR35 employment status tests – the other two being mutuality of obligation (MOO) and client control – personal service is often the trickiest.
It can easily swing an IR35 investigation in the right direction should a contractor be able demonstrate a lack of personal service to provide a substitute, and it’s a relatively easy issue to fix within a contract. However, thanks to miseducation and a lot of murky caselaw, it’s easy to see why recruiters, end clients, and contractors alike get confused over this particular test.
What exactly is personal service, or ‘substitution’, and how can it effect an IR35 status decision?
What is personal service, or substitution?
The main difference between a contractor and an employee is that when a contractor is engaged, it’s their specific services and skills being paid for – if they need time off sick, they can ask an equally qualified contractor to take up those services and skills in their absence. An employee, however, is paid for their time to complete a number of day-to-day jobs, and in many cases couldn’t simply send someone else to fill their role at work for the day.
Let’s give some context. If you were to call an engineer to carry out an on-site audit for your ongoing building work,call a plumber to fix a leaking boiler, would you care if it was specifically the engineer plumber you spoke to on the phone that carried out the work, or just someone qualified? This is the right to substitution and is a good test of if a contractor is genuine.
Ask yourself if a contractor could realistically supply a substitute to do their role. If no, then their personal service is required, as an employee would be, and it could mean the difference between landing inside or outside IR35.
Eamonn Holmes lost his IR35 tribunal due to substitution
Red, White & Green Ltd (RWG), Eamonn Holmes’ personal service company (PSC) through which he provided most of his presenting services to the likes of ITV and Sky, was first brought to tribunal back in June 2018. Holmes lost his IR35 appeal, with the judge ruling in HMRC’s favour that he was indeed a so-called ‘disguised employee’. The amount of tax owed could be as much as £250,000, as reported by the Daily Mail, and his lack of a substitute contributed heavily to that ruling.
Holmes accepted that ITV wanted his services specifically and that he wasn’t permitted to provide a replacement even in theory (which is often how the right to substitution is accepted when considering employment status). If he couldn’t provide his services, it was up to ITV to find someone else to take his place, as an employer would have to.
There’re certainly grounds to claim that Holmes was selling a specific ‘personality’ or ‘brand’ as part of their services like fellow presenter Lorraine Kelly (who managed to win her own IR35 tribunal shortly before Eamon’s). However, Kelly did, in fact, supply a substitute on occasion, whom she chose, organised, and paid for herself. In Holmes’ case, the broadcaster specifically wanted his services and stipulated that Holmes’ participation was ‘integral to the programme and a material term of the agreement’.
How can I avoid falling foul of personal service in an IR35 tribunal?
Firstly, it’s important to communicate openly throughout the supply chain to make sure everyone is educated about IR35 and understands the implications to an ‘inside’ determination. Whether that’s recommending some professional consultation consultancy to an end client or asking contractors to have a third-party employment status test carried out, it’s important that everyone is on the same wavelength before attempting to negotiate a change of contract wording.
Secondly, have a frank discussion with whoever may be affected by any personal service within a contract and look honestly at whether there could be expectations that aren’t fair to the contractor. Does the end client want the contractor to work for them like an employee? Perhaps they have a specific ‘no substitute’ clause like ITV stipulated for Eamonn Holmes? Making some small wording changes within a contract can be the difference between a happy, mutually beneficial working relationship or a substantial tax debt.
Lastly, many people misunderstand this particular status test to mean that a contractor must have a viable substitute waiting in the wings. The idea of a substitute is largely hypothetical; if a client would accept a suitable substitute in theory to fill the skills of an absent contractor, then that’s good enough to show that no personal service is expected and that they are genuinely self-employed.
How to prepare for the 2021 IR35 reform
For the time being, the delay to the private sector IR35 reform (which you can read more about here) dictates that contractors must determine their own employment status for another year – this means that the liability of a wrong determination still sits with the contractor for that time too.
It’s crucial that all points of the supply chains understand their IR35 position with every contract taken on or filled. Getting a professional contract and working practices review is pivotal to making sure you know where you stand, while IR35 investigation insurance is also a worthy investment and can provide a lifeline should you fall foul of an HMRC enquiry.
A good policy will include an IR35 status review, as well as cover for the unpaid tax debts, interest, fines, and legal fees, and will flex with the reform roll out to cover the contractor, recruiter, and end client. Our IR35 Protect product offers the above in one comprehensive package.
For more information on how Kingsbridge can assist your business in preparing for off-payroll 2021, please email IR35@kingsbridge.co.uk