Employment lawyers spread FUD over IR35 contracts

Several web sites (such as silicon.com and znet.co.uk) reported recently that lawyers Tarlo Lyons were warning about the risks of criminal prosecution for freelancers, agents and clients who engaged in constructing IR35 friendly contracts that did not reflect reality.

According to Tarlo Lyons’ employment law partner, Kevin Barrows, the Inland Revenue are looking for a high profile offender to make an example of.

One article also warned that employment law experts are warning that those who “collude in designing contracts that give the impression the worker is a genuine contractor” are breaking the law and face unlimited fines and a maximum of seven years in jail.”

All very alarming stuff, which must have had senior Revenue officers rubbing their hands in glee. Nothing like having "experts" spreading fear and uncertainty as a way of encouraging compliance with legislation – even when the message is somewhat misleading!

Obviously employment lawyers are correct to warn that deliberately constructing a contract, that all parties to it know is a sham - purely to enable one or more of the parties to avoid tax, is fraud. And fraud of this nature can be punished by jail sentences.

For some firms of lawyers employment agencies are a major source of work and a little FUD goes a long way in encouraging agencies to seek their professional advice. However, articles like this also create great concern amongst ordinary freelancers, who are already stressed out by the state of the market, the impact of IR35 and the new danger that section 660A seems to represent.

Suggestions that they may face up to seven years in prison are very unsettling for freelancers and may well lead them to believe that they have no alternative, but to bow to the fear and uncertainty inherent in IR35, declare themselves caught, and pay up the additional tax and NIC.

However, it is important to recognise that one of the main reasons why contracts may not reflect the reality of the working relationship is because agents (and clients) insist upon using a standard contract which may in fact be at odds with the contract between the agent and the freelancer and which may not reflect the reality of the relationship between the freelancer and the end client.

In this situation it is both acceptable and desirable for the freelancer to seek to change a contract if this is still possible. Equally if this results in a contract that passes the IR35 status tests this is not “colluding” in tax fraud.

However, if the agent and/or client will not amend the contract to reflect reality then it is also acceptable and desirable for the freelancer to seek clarification and confirmation from the client as to the reality of the relationship. This is best done by the freelancer asking the client to provide written confirmations concerning the issues in question. The UKTECH Freelancers Outside IR35 system (FO35) provides detailed guidance on issues such as what are the key attributes of an IR35 friendly contract and obtaining client confirmations.

Freelancers also need to remember that status is based on more than just the wording of a contract. It is also affected by such issues as whether the freelancer (through his or her business) is in business on his or her own account?

There is pressure for agents and clients to adopt IR35 ‘friendly’ contracts. However, this is not tax fraud but a totally sensible commercial reaction to a changing market place. The best freelancers are determined to protect their status as a separate, independent business and to ensure that their contracts reflect this fact. Agents and clients who wish to have access to the best freelancers recognise that having a contract that is outside IR35 is an important factor.

Adopting such a contract is not colluding in tax fraud when it reflects the reality of the working relationship. Increasingly clients are beginning to appreciate that engaging freelancers on "self employment " terms outside IR35 represents a sound commercial decision. It may mean a slight loss of control but this is outweighed by the benefits of obtaining the necessary skills for the most cost effective rates.

At UKTECH we know from experience of negotiating with clients that when they understand the issues involved they soon recognise that using a contract that is clearly outside IR35 does not leave them worse off than before. For example, a frequent issue for clients is the question of substitution. Many clients think that allowing substitution means that they are at risk of freelancers substituting on a whim and of being saddled with someone unsuitable.

Clients need to understand that substitution clauses can be drafted that are commercially secure and offer them suitable protection. At the same time these clauses can still meet the freelancer’s objective of providing them with a valid right of substitution that will support their claims to be self-employed under the IR35 tests. Substitution can be carried out in the context of adequate notice to all parties, suitable safeguards to ensure suitable experience and expertise and financial safeguards to ensure that the client does not suffer during any learning period.

When lawyers warn of the risks of using contracts that do not reflect reality they tend to overlook the fact that many so called ‘standard’ agency contracts (often drawn up with expensive legal advice) often fail to reflect reality. In addition, agencies are often the guilty party when it comes to issuing contracts that they know to be a fiction. How many agencies have issued so-called IR35 friendly contracts to freelancers knowing full well that the terms of that contract do not mirror their contract with the client? How often do they tell the freelancer that their contract is a sham?

Agencies need to recognise that, working with freelancers to persuade clients to accept IR35 friendly terms, which are genuinely reflected in the working relationship, is the long term solution to providing clients with the resources they require at a cost they can afford. And lawyers need to recognise that as well as advising clients on the risks of colluding in tax fraud they also need to advise clients about the commercial advantages of ensuring that they contract with freelancers on a business to business basis.

For freelancers the key message is that it is perfectly acceptable to ask for working relationships that are outside IR35 and for contracts to support those relationships. By using a system such as Freelancers Outside IR35 (FO35) freelancers can keep themselves properly informed so they can recognise the key status issues in contracts and compare agency contracts with the model contracts that FO35 provides.