An understanding of the types of contracts between clients, agencies and contractors and employees is vital for contractors and hiring firms to be able to determine whether they are working inside or outside of IR35 or Off-payroll working.
Where contractors are working for clients that are small, defined by the Companies Act 2006, the original IR35 rules apply due to the small companies exemption, and the contractor is required to consider the IR35 status of the contract and also holds the tax liability. Where the client is medium or large, the new Off-payroll working legislation comes into play, and the client has the responsibility for checking the IR35 status and holds the tax liability.
The original IR35 rules have been in statute since April 2000. The more recent Off-payroll rules, arrived in 2017 for the public sector, and then rolled out to the private sector in April 2021.
There is no defintion in statute for an employee, and therefore the common law needs to be considered when seeking to classify engagments correctly. The common law means the case decisions released by the courts over decades. For status cases, the law stems from a case called Ready Mixed Concrete (1968) which refers to the concept of discerning between contracts that are "of service" or "for services."
Please explain the differences between a ‘contract of services’ and a ‘contract for services’ – does it change my IR35 status?
The debate over contracts "of service" and contracts "for service" has a long history in both employment and tax law, as has the status of agency workers long before the contracting sector took off and IR35 was introduced. This guide will explain the IR35 issues related to these types of contracts and how they affect contractors and hiring firms.
An easy way to explain the difference for IR35 status purposes is:
- An employee-employer contract is a contract of service
- A contractor-client contract is a contract for services
The question being asked when dealing with status is whether (a) the hirer is paying for a person to make themselves and their skills available to then be allocated work by the hirer,or whether (b) the hiring organisation is paying for a set of pre-agreed services to be delivered. If the service is simply the provision of a person (e.g. job title and hours), then it's (a). If the services are pre-defined and outcome-based, then it's (b).
A simple example is the difference between paying a programmer for 40 hours a week to turn up, and then work on whatever is allocated to them, compared to paying a company to build a specific module for a computer system.
In each of these types of contract, both parties have specific rights and responsibilities, which differ according to the type of contract in place.
Contractors should be aware of their rights and responsibilities when they have a contract for services between their limited company and their agency or end-user client as it will affect their IR35 status.
Employer-employee contract of service
Permanent employees have a contract of service with their employer. By definition, if a worker has a contract of service with an organisation, they are an employee for IR35 purposes.
The key rights and responsibilities of employee status under a contract of service are:
- The worker is controlled by their employer – they must perform the tasks they are instructed to by a line manager according to their job description
- The worker is expected to work at a specific place during specific hours on specific days (even flexi-time has core hours)
- The worker must present themselves for work and cannot send someone else as a substitute
- Employees have statutory rights to holiday pay, sick pay, maternity and paternity rights and redundancy payments
- Employees have statutory rights regarding how they can be asked to leave their employment
- Employees enjoy a range of additional benefits, which can vary according to the employer, but might include company cars, private health insurance, staff canteens, health clubs and gyms and so on
- Employees are not personally liable for any errors they make when completing work for their employer, nor are they expected to make good in their own time.
There is also a key status factor between an employee and employer called ‘mutuality of obligation’, often referred to in shorthand as ‘MOO’. Mutuality of obligation is one of the key tests of employment status and whether a contract is inside or outside of IR35.
Mutuality of obligation is widely understood in employment tribunals to mean that an employer is obliged to provide work for an employee or pay for their time anyway, and the employee is obliged to complete the work offered. Within the scope of their job description, employees have to complete the work that ‘comes down the pipe’, which is one of their fundamental distinctions from a contractor. However, mutuality in the tax context is contentious, because the HMRC policy view is that it simply means someone getting paid if they do some work - what's referred to as the "irreducible minimum of obligation." This contention is (at the time of writing in July 2023) unresolved by the courts, but the Supreme Court case of Commissioners for His Majesty's Revenue and Customs (Respondent) v Professional Game Match Officials Ltd (Appellant), may provide some clarity once a decision is reached.
If the employee fails to fulfil their obligations, the employer can take action that may ultimately result in the employee’s dismissal. Similarly, if the employer does not fulfil their obligation to the employee, the employee can take action that might result in an industrial tribunal.
If you are investigated by HMRC they will consider all these issues when determining your IR35 status and they will probe areas where they find discrepancies.
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START YOUR ASSESSMENTHow does a ‘contractor-client contract for services’ affect my IR35 status?
Contractors have a contract for services with their client or agency. Or to be more precise, the contractor’s limited company has a contract for services with the client or agency.
A contract for services is a strictly business to business contract between two firms on a buyer and supplier basis. The client, or agency, is a buyer and the contractor’s limited company is the supplier. There is no question of any employment relationship.
Contractor’s companies that enter into a contract for services with another organisation (including public sector organisations or not-for-profit companies) have clear rights and obligations.
The key rights, obligations and responsibilities that a contractor’s limited company have under a contract for services include:
- A requirement to supply services to the client according to the contract schedule’s specification
- A requirement to complete the project, and any milestones, according to the contract schedule
- A requirement to provide services to the standard required by the client as agreed in the contract
- An obligation to make right any errors or defective work, without additional remuneration
- Liability for any errors or defects in work completed for clients, and this may expand to personal liability (assuming the contractor is a director) for worst-case scenarios, such as corporate manslaughter
- The right to be paid the rate agreed in the contract, assuming the services have been provided according to the contract’s requirements
- The right to be paid according to the terms agreed, such as within 7 days, or 30 days depending on the terms agreed in the contract
- The right to provide a substitute to complete the work specified in the contract
- Often the contractor is required to abide by any health and safety and security arrangements when working on the client’s site
- The client is obliged to provide a safe working environment for the contractor.
As directors of their own limited companies, contractors also have a range of duties, responsibilities and potential liabilities under company law, which employees do not have.
If either party fails to fulfil their obligations under the terms of the contract, they are in breach of contract and can take legal action to remedy the situation.
In effect, the relationship between a contractor’s limited company and the client or agency is no different from a major international corporation’s relationship with its suppliers.
Contractors and firms who are aware of the full range of issues surrounding contracts of service and contracts for service are in a much better position to judge whether their employment status is affected by IR35, and can seek professional assistance accordingly.
How can IR35 Shield help firms?
IR35 Shield is a niche tax consultancy firm that provides tools and expertise for conducting accurate IR35 status assessments, so that when HMRC checks your IR35 compliance, they will be satisifed your firm is compliant. You can book a free chat with the experts here: IR35 Shield - free consultation.