HM Revenue and Customs (HMRC) introduced the ‘intermediaries legislation’ commonly known as IR35, in April 2000. The legislation was brought in to tackle tax avoidance by individuals who would be classed and taxed as an employee were it not for the fact they provide their services through their own personal service company (PSC), this is often referred to as a ‘disguised employment’. Working in this manner can enable the individual to make substantial tax and NIC savings.

Many contractors are genuinely independent, though face the same struggle to prove this fact to HMRC. Therefore, it is essential that all contractors working through their own companies are aware of the legislation and do everything possible to ensure that they remain legitimately ‘outside’ of IR35. A contractor’s position is determined by a series of ‘status tests’ interpreted by IR35 historic case law, as such, determining factors surrounding IR35 change over time and certain issues become more prominent following each significant case.

Below are the key areas that must be considered to remain compliant.

Personal Service and Substitution

A self-employed contractor enters into a contract to provide the services of their company and not the services and skills of a specific individual and therefore should be able to send a substitute in their place, or engage a helper to provide the service. An employee would be employed for their specific skill and therefore provide services personally.

The right of substitution is one of the strongest tests of self-employment. The majority of contractors never exercise this right, however, the right to send a substitute to undertake the work must be there and genuine. The substitute must be answerable to and paid by, the company who originally undertook to complete the contract.

The client may retain the right to veto a substitution, though only on reasonable grounds and should be limited to circumstances such as a lack of qualifications and/or experience or security issues.

In most cases, a contract without an explicit ‘right of substitution clause’ will fail a contract review. An attempted substitution clause that contains any of the following will also cause a contract to fail:

  • If the client is given ‘sole discretion’ over a proposed substitution - In order for a substitution clause to be valid, the client may only reject a proposed substitute on reasonable grounds. Reasonable grounds would relate to the suitability of the proposed substitute, or security issues.
  • If the contractor is required to give anything more than ‘reasonable notice’ of a proposed substitution – anything longer than 7 days can be seen as unreasonable (although more flexibility can be given to those with clients with particular security risks, such as MOD)
  • If the client requires to ‘interview' a proposed substitute.
  • Rights to subcontract do not constitute a right of substitution.

Please see below example of a compliant substitution clause:
The Supplier shall provide the services using suitably qualified personnel of their own choosing. The Supplier reserves the right to substitute any personnel, provided the Client is reasonably satisfied that any proposed substitute possesses the necessary skills and qualifications for the satisfactory completion of the services. The Supplier will remain liable for the services completed by substitute personnel and will bear any costs.


The degree of control exercised by the client over the services to be completed by the contractor is one of the key areas HMRC will look into during an investigation. A contractor should be able to determine when, where and how they perform the service they are contracted to do, whereas an employee would be likely to have these terms prescribed by their employer.

Having a client constantly advise a contractor on how to provide their service or being switched from job to job due to changing priorities would be a strong indicator that the contractor is subject to a right of control by the client. A contractor is brought in to provide a specific specialist service and therefore will know the best way to fulfil that service and should have full control over their working methods.

There are some instances where a contractor having complete control over how the tasks can be completed can be difficult. In the case of Morren v Swinton Borough Council, it was said:

“Clearly superintendence and control cannot be the decisive test when one is dealing with a professional man or man of some particular skill and experience. Instances of that have been given the form of a master of a ship, an engine driver or a professional architect or, as in this case, a consulting engineer. In such cases, there can be no question of the employer telling him how to do the work, therefore the absence of control and direction in that sense can be of little, if any, use as a test.”

Control over where the contractor provides the service is usually considered to be neutral, as it is often unpractical for a contractor to perform certain tasks from anywhere other than their clients premises. For example, an offshore energy sector contractor could only carry out their services on site, or an IT contractor needing access to a clients IT systems would need to work from their clients premises to be able to fulfil the contract.

Control over when the contractor does the work is obvious; an employee would be required to work set hours; a self-employed contractor would be expected to arrange hours to suit the task at their own convenience. It is acknowledged that there may be certain circumstances where it may be necessary for the contractor to carry out their services between particular times of the day. For example, needing to liaise with client staff during client office hours may be necessary for the fulfilment of the contract, although this should not be a requirement with strict hours attached.

If a contract remains silent on the issue of control, this would not cause the contract to fail a review outright, however closer attention should be paid to other key issues. Contracts that contain any combination of the following are likely to fail an IR35 contract review:

  • The client is given control over the working methods
  • The contractor is required to follow client instructions and direction in the same way an employee would
  • The contract must be carried out a time and location as directed by the client (although some contractors will have mitigating circumstances making this aspect of control less problematic
  • The contract specifies that the contractor will have a ‘line manager’

Please see below example of a good control clause:

The Client shall have no right to, nor shall seek to, exercise any direction, control, or supervision over the Supplier in the provision of the services. The Supplier shall endeavour to co-operate with the Client’s reasonable requests within the scope of the services, however it is acknowledged that the Supplier shall have autonomy over their working methods.

The Supplier may at any time and without giving the client prior notification, make any changes to the specified service which are necessary to comply with any applicable safety or other statutory requirements, or make any changes to the specified service which do not materially affect the nature or quality of the specified service.

The services shall be provided at such locations, and during such hours, as the Supplier deems appropriate for the satisfactory provision of the services.

Mutuality of Obligation (MOO)

An employer will try to ensure that employees have a continuous supply of work and will expect the employees to carry out the work when required. A self-employed contractor will do the work as contracted to do and when complete, will have no expectation of further work.

Further work regularly being given to the contractor and accepted over a period of time could cause HMRC to take the view that employee status has been created by custom and habit.

Although mutuality of obligation is a key determining factor surrounding IR35, it should be noted that HMRC’s lack of understanding and misinterpretation makes it difficult to mount a successful defence on this test alone. Much focus is being placed on non-mutuality of obligation during the contractual term, therefore it is important that the contractor (and the end client) has the right to terminate a contract early, if they so choose.

In cases where no clear end date is included in the agreement and there is no explicit non-mutuality of obligation clause, a contract will likely fail an IR35 contract review. If there is no end date, it may be appropriate for certain contracts to terminate upon the completion of the services – this would be acceptable in cases where the contract is based on clear deliverables.

Example of a non- mutuality of obligation clause…

The Client is under no obligation to offer further contracts or services to the Supplier nor is the Supplier under obligation to accept such contracts or services if offered. The Supplier is not obliged to make its services available except for the performance of its obligations under this Agreement. Both parties agree and intend that there be no mutuality of obligations either during or following the agreement, whatsoever.

Provision of Equipment

An employee of a company would have all necessary equipment, facilities and training provided by their employer. A contractor is contracted to provide a specific service and therefore should have the appropriate tools and skills to complete that service. The more essential the equipment is to the service provided, the more important this factor becomes. For example, a self employed Web Developer who does not own his own computer.

If a contract contains clauses that state the client will purchase any training or equipment (other than particularly specialised equipment) on behalf of the contractor is likely to fall inside of IR35.


Financial Risk

A self-employed contractor is a genuine business and therefore responsible for the running of that business, with this responsibility comes financial risk. For example, having an obligation to correct any defective work at no extra cost to the client. Having the correct insurance policies in place to cover against any damages or financial loss to the client caused by error or omission also shows that the contractor is responsible for their own financial risk. An employee of a company wouldn’t be required to do any of this.


Exclusive Services

Contractors must not be restricted to providing services to only one client at a time, they should have the right to take on additional clients on a concurrent basis should they choose to. If a contract explicitly states that the supplier is not able to supply their services to other clients, it is likely to fail an IR35 contract review. It is acceptable, however, for clauses to be included that prevent the contractor from working with the clients direct competitors, or if any other conflict of interest is created.

Part and Parcel of the Organisation

Contractors must not be ‘part and parcel’ of the client’s business as if they were one of their employees. Receiving any employee benefits such as bonuses, pensions and use of facilities such as a staff gym as well as appearing on any internal lists of employees can be perceived as direct employment.

Any contract clauses that stipulate that a contractor will be subject to performance reviews or disciplinary action (as would be expected of employees) would cause a contract to fall within IR35.

Right of Termination

The option to terminate a contract early demonstrates a financial risk on the part of the contractor as well as a lack of MOO.

A contract stating that the contractor is unable to terminate their contract early or that they must provide a substantial notice period could indicate that mutuality of obligation exists.


Intention of the Two Parties

A self-employed person works under a ‘contract for services’ and an employee under a ‘contract of service’.

The terms of the contract can be collected from the circumstances surrounding the engagement. Where there is a written contract, HMRC may look through the contract to find the facts of the case. While often important in deciding an individual’s status, the terms of the contract are not a conclusive element. If a contractor’s status is unclear after consideration of the other issues surrounding IR35, the intended relationship of the parties can be used determine the outcome of an enquiry.

Business-like Trading

Other matters such as VAT registration, business insurances, advertising etc. are all good indicators of a genuine business.