Outside IR35 indemnity clauses are everywhere, but are they enforceable?

In the last few weeks IPSE has seen an increasing number of queries from members about new indemnity clauses. These clauses seek to indemnify a party in the contractual chain – typically a recruitment business – against any adverse IR35 decision that may come about at a later date. It seems that virtually every ‘outside IR35’ contract being presented to contractors now contains a clause such as this. Why is this happening?

What are indemnity clauses?

The new off-payroll working (IR35) legislation is now in effect – much as we wish it wasn’t. Clients, unless they are small businesses, must make the IR35 determination. Where they decide IR35 applies, the ‘fee-payer’ – usually an agency – must deduct tax at source. If the client takes reasonable care when making the determination and decides IR35 doesn’t apply, the fee-payer can pay the contractor gross. However, if HMRC decides that the client’s determination was wrong, it is the ‘fee-payer’ or agency that will be held liable for the unpaid tax and National Insurance.

Even if, therefore, the client has said unequivocally that IR35 does not apply, there is a still a risk for the agency if they accept that determination. After all, determining IR35 is complicated. It’s inevitable that clients will make determinations which HMRC will disagree with and that will spell trouble for the agency that took the client’s determination at face value. In effect then, these clauses are an attempt by the agency to shift that risk back down to the contractor.

Are they enforceable?

What no-one yet knows is whether these clauses are enforceable. There are a few reasons why they might not be, and I am grateful here to Paul Mason from Markel who I have had a few long conversations with on this and has informed much of what comes next:

• The law doesn’t allow an ‘innocent bystander’ to accept liability for something that he or she has not been involved in or caused – the legislation makes it clear that except in instances of collusion by a contractor, the liability never rests with the contractor and always goes ‘up the chain’
• Courts don’t like open-ended liability
• A court might feel that there is inequality in the bargaining position – and considering every available contract contains these clauses this is surely the case
• As a large element of the tax bill arriving at the door of the fee payer is Employer’s NICs, which cannot be passed on to other parties, the court might set that element aside
• Even if allowed, the fee payer would still need to pay the tax bill to demonstrate that they had suffered a loss
• It’s also worth noting that, from a reputational perspective, end clients and agencies may not want to become known for suing their contractors

Having said all that, it is still a contract and if you sign it the risk is there. Courts may dismiss the contract for the reasons above, but they may not, and the resulting bill could be significant, even if Employers’ NI is set aside.

The upshot

If you are presented with one of these clauses, the good news is you have secured an outside IR35 contract – well done! The emergence of these clauses, and the frequency with which members are contacting us about them, at least confirms not all clients are blanket banning contractors, which is reassuring. The whole supply chain is trying to get used to the new rules while using the flexible expertise that has served them so well in the past – contractors.

In some ways then there is a positive angle to all this, but there is also something unfolding here which concerns us. We noted above that clients might get determinations wrong. Well, HMRC get them wrong too – all the time in fact. Just because HMRC say IR35 applies doesn’t make it so. That’s why we don’t like the idea that the agency will immediately fold when HMRC declares the initial client determination was wrong. Agencies, perhaps reassured by the indemnity clauses, might automatically cough up the tax and then ask the contractor to pay for it.

We’d like to see some ability to challenge the HMRC decision that the client / agency got the determination wrong. We are currently trying to work out if there is some way to secure this right in a contract, but it may be a while before we get an answer – this is a legal minefield and one which is yet to be tested in court.

In the meantime, although we absolutely don’t like the risk these clauses potentially create, it may be that you will have to take a deep breath and sign on the dotted line, unless that is, you can find an alternative contract, which is outside IR35 and which doesn’t contain the indemnity clauses – but these are getting harder to find with each passing day.

Visit our IR35 News page to keep up with the latest updates, and you can find more support and useful information with our IR35 advice.