IR35: What Does Actual Substitution Mean?

The vast majority of contractors should now all be familiar with the business entity tests published back in May by HMRC as part of the new improved IR35 administration.

A contractor can score 20 points by passing the 'Actual Substitution' test thereby guaranteeing themselves to be at low risk from a full blown IR35 review and immunity from such for the next 3 years.

The test asks whether the contractor has hired a worker in the last 24 months to do the work that they have taken on, either by sending a substitute or by engaging a sub-contractor. The contractor however has to remain responsible for the work and for paying the person who does the work the freelancer has taken on.

As long as a contractor can produce the necessary evidence to demonstrate that an actual substitution took place then the points are in the bag. This consists of:

• Details of end client;
• Details of who was hired;
• Details of why the substitute was hired;
• Details of who was responsible for finding the substitute;
• Details of who was responsible for paying the substitute;
• Payment terms; and
• Audit trail of payment from end client to intermediary and from intermediary to substitute.

Some confusion has arisen of late however due to one sentence that appears in the guidance to this test that states, 'You can still pass this test if you had to tell your end client the name of the person who would be doing the work you took on'. There are some that have interpreted this as meaning that all a freelancer has to do to secure the 20 points is to provide the name of a substitute to the end client. If it were that simple then virtually every contractor would become a low risk.

Whilst the information may be ambiguous it cannot be taken out of context because to do so would create a false impression of how this test is passed. The clue is in the title, 'actual  substitution'. This is not the 'Right of Substitution' test which only scores 2 points.

So what are HMRC inferring by a named substitute? In the writer's opinion the Revenue are seeking to clarify the situation where an end client has a reasonable right of veto, e.g. wanting to ensure that the proposed replacement worker has the right skills, experience and qualifications to carry out the work before they can undertake the services. A reasonable right of veto on the end client's part does not diminish a genuine right of substitution and it appears to be this that HMRC are trying to convey in an awkward and clumsy fashion.

If only it were that easy for a contractor to become a low risk by simply naming a substitute, then HMRC's role would nearly become redundant!