Ensuring compliance with the off-payroll working rules (IR35) is a critical responsibility for businesses engaging contractors.
When HMRC conducts an IR35 compliance check and examines whether status determinations are correct, they will always consider the contractual agreements in place. The clarity and comprehensiveness of these contracts can significantly impact a business's ability to defend its IR35 status determinations.
Investing in well-drafted agreements helps safeguard businesses against tax liabilities and compliance disputes.
Why Contracts Matter in IR35 Compliance
IR35 status determinations rely on two key factors: the written contract and actual working practices. Working practices refer to how the engagement operates in reality, and understanding those is central to correctly construing the contractual terms and then applying the status tests.
The Court of Appeal reaffirmed in April 2022 the importance of the contract in the Atholl House case, stating, "the terms of the contracts remain central to the enquiry." While working practices provide context, legally binding, unambiguous contractual provisions take precedence and cannot be disregarded. Rights and obligations that are not exercised are still legally binding.
If contracts are ambiguous, inconsistent, or contain employment-style clauses, HMRC may argue that a contractor is, in reality, an employee for tax purposes, potentially leading to costly liabilities.
Contractual uncertainty ended in April 2022
Before April 2022, parties (taxpayers and HMRC) believed contractual terms could be disregarded in tax cases by leveraging the case law defined in a 2011 case called Autoclenz. Autoclenz was an employment rights case about Worker Status, and the courts sanctioned that a "purposiveness" approach could be used in such cases to look through the contract, thereby allowing the working practices to take precedence.
The Court of Appeal in Atholl House ruled that Autoclenz was irrelevant to tax cases and could not be used, and instead, the standard rules around contractual interpretation are to be used. That means a contract is to be construed by examining the terms and understanding those in light of the surrounding facts – the working conditions.
In layperson's terms, contracts can be relied upon, and the IR35 uncertainty ended in April 2022.
However, the outcome means that a taxpayer can no longer rely on poorly drafted contracts and expect to use a "reverse Autoclenz approach" and attempt to claim clauses are irrelevant. All terms are legally binding on the parties. Likewise, HMRC cannot ignore the contract either.
To repeat what Lord Richard said in Atholl House, "the terms of the contracts remain central to the enquiry."
What is Considered a Poorly Drafted Contract?
Businesses must ensure their contracts reflect genuine business-to-business engagements. However, several typical contract types present significant risks:
- Generic Template Contracts: These often lack the necessary clauses to support an "Outside IR35" determination. Their vague wording can expose businesses to HMRC challenges.
- Repurposed Employment Contracts: Some businesses attempt to modify employment contracts for contractors. However, these typically contain employer-employee indicators, making it difficult to argue that the contractor is self-employed.
- Agency Contracts: Contracts structured around job roles, set hours, and ongoing supervision are inherently "Inside IR35." These contracts indicate employment rather than the provision of independent services.
Building a Strong IR35 Defence with Robust Contracts
To protect against HMRC challenges, businesses must ensure their contracts:
- Clearly define a provision for services rather than employment.
- Include key employment status indicators aligning with IR35 status factors.
- Accurately reflect the working arrangements to prevent discrepancies.
- Provide a strong legal foundation for defending compliance checks.
Remember, even the most thorough IR35 assessment can be undermined by a weak contract. All companies should ensure they have robust agreements to safeguard their business against the consequences of status misclassification.
Taking Action: Questions You Need To Ask
A proactive approach to IR35 compliance starts with ensuring contracts are fit for purpose. Start with this quick checklist to assess if your contracts may stand up to scrutiny:
- Do your contracts portray the engagement as a business-to-business relationship (i.e. a contract for services)?
- Do your contracts cover all the relevant case law factors, as clarified by the Supreme Court in September 2024?
- Do your contracts contain clear, unambiguous terms?
- Have IR35 legal experts reviewed them?
If your contracts have not been given the attention they deserve, now is the time to review and strengthen them before HMRC scrutiny arises.
Speak to us today to ensure your contracts are robust and IR35-compliant.
