For contractors and engagers, having a well-drafted agreement for an outside IR35 contract is essential. A strong contract not only assists in demonstrating a genuine self-employed relationship, but also serves as critical evidence if HMRC challenges the employment or IR35 status.

In this guide, we will explore why contracts matter for being outside IR35, key clauses that need to be included, common mistakes to avoid, and best practices for maintaining compliance.

Why contracts matter for being outside IR35

A contract is often the first document HMRC will look at during an IR35 investigation, as it sets the foundation for how the working relationship is perceived. If a contractor is treated as outside IR35, in addition to ensuring the working practices back this up, the written contracts must clearly demonstrate that the relationship is one of genuine self-employment.

A strong contract helps:

• Establish the contractor’s self-employed / outside IR35 status.
• Protect the parties from unexpected tax liabilities.
• Clearly define the nature of the working relationship, minimising risk.

A common theme in recent IR35 cases has been the weight given to the contractual framework. In some cases, the terms outlined in the contract have outweighed the reality of working practices. For example, a contractual framework of control that may not be exercised day-to-day can still point to an inside IR35 position.

So, getting the contract right from the outset is key, as it could ultimately determine the IR35 outcome – even if the actual working practices suggest otherwise.

What does an outside IR35 contract look like?

An outside IR35 contract should clearly demonstrate a genuine business-to-business relationship, covering the key tests for establishing status such as:

1. An adequate services description: the services description should be as specific and detailed as possible, so all parties are in agreement as to what the contractor has been engaged to deliver. Projects should be named where applicable, setting out any relevant deliverables and milestones. And, it should be just that – a “services” description, so avoid the use of job titles or terms that are not relevant to the engagement of a business.
2. Control: the contract should clearly demonstrate the lack of control the client has over the contractor’s work, ideally the contractor’s autonomy in deciding how, when, and where the work is completed, and covering issues such as the use of their own equipment and offices. It should also include provisions setting out that any additional work outside of the agreed scope requires the drafting and mutual agreement of a new contract.
3. Substitution: a genuine right of substitution is a key indicator of self-employment. If this right exists in practice, the contract should clearly state that the contractor is entitled to appoint a substitute, and it should be practically feasible to implement. If the client retains the right to reject a substitute for reasons unrelated to skills or qualifications, or if there are factors that make substitution unrealistic, this test is probably failed. Including a theoretical substitution clause that has no real-world application won’t help. It’s important to note that the mere requirement for personal service on its own, doesn’t automatically put a contractor inside IR35.
4. Mutuality of Obligation (MOO): case law around MOO has evolved in recent years, with the higher courts setting out that simply providing “work for pay” constitutes MOO within an individual contract. However, the extent of MOO still holds significance. A strong contract should clearly state that the client is not obligated to offer further or additional work, and the contractor is not obliged to accept it if offered. It should also include a “no-work-no pay” clause.
5. Financial risk: the contract should show that the contractor is liable for the successful delivery of the services, responsible for errors and rectifying mistakes at their own cost (where applicable), and financially liable for negligence.
6. Intention of the parties: a well-drafted contract should clearly set out the intention of both parties to establish an independent business-to-business relationship rather than one of employer-employee. This helps strengthen the argument against IR35. It should also specify that the contractor is responsible for their own tax affairs and business expenses.
7. Basis of payment: the strongest payment basis for demonstrating an outside IR35 position is fixed price on successful delivery. Time and materials (daily or hourly rates) are generally acceptable providing payment is only made for periods where work is performed. payments that resemble salaries (like fixed monthly fees) can be problematic, depending on the overall context of the engagement.
8. Termination clauses: notice periods are generally considered an employment feature. However, depending on the context of the engagement and the nature of work being performed, they can be acceptable providing they are of reasonably short duration.

Remember – it’s essential that the contract accurately reflects the reality of the working relationship and isn’t just padded out with clauses to make it appear outside IR35.

Common mistakes when issuing an outside IR35 contract

• Using generic or outdated contract templates that do not reflect current legislation or case law.
• Using “IR35-friendly” clauses without ensuring they accurately reflect working practices.
• Failing to update contracts when working practices change.
• Overemphasising substitution clauses without practical evidence of implementation.
• Failing to clearly define the contractor’s independence and business-to-business relationship.

Conclusion

A strong and well-structured contract is fundamental for demonstrating a genuine business-to-business relationship and defensible outside IR35 position. But also remember, it’s equally important that the working practices align with the terms set out in the agreement. By carefully drafting and regularly reviewing contracts, contractors and engagers can significantly reduce the risk of HMRC disputes.

If in doubt, engage the services of a specialist to assist you. At Bauer & Cottrell, all our services for contractors and engagers include a thorough review of the written contract against the working arrangements, serving to protect your business from unexpected tax liabilities.

Browse our full range of services  here.