IPSE exclusive: New stats show IR35 indemnity clauses are on the rise – and that they can be unpicked

By Fred Hicks , Senior Policy and Communications Adviser?

Since the advent of the 2021 private sector off payroll working (OPW) reforms, IPSE has heard a growing volume of reports from members on the use of ‘indemnity clauses’ – a means (albeit untested) of ‘insuring’ clients and agencies against IR35 tax bills for potential non-compliance with the rules, at the behest of the contractor.

To quantify these reports we recently asked 1,500 contractors – as part of IPSE’s first annual IR35 survey – whether they have encountered IR35 indemnity clauses during contract negotiations.

Ahead of the release of the full report later this week, today we can reveal that one in four (24%) contractors have been asked – or required – to sign an indemnity clause since OPW was introduced. This raises the question of what contractors are doing in response.

Quick recap – what are indemnity clauses?

Since the rollout of the OPW rules to the private sector in April 2021, medium and large sized businesses that engage contractors via their limited companies have been required to undertake an IR35 status assessment of each engagement.

Clients must take ‘reasonable care’ when assessing IR35 status and can continue to pay the contractor gross via their limited company provided the assessment outcome deems the engagement to be ‘outside IR35’ (if you also need a reminder of how IR35 and OPW works, visit IPSE’s IR35 hub).

However, there is still a risk that HMRC could disagree with a client’s assessment, even if they have taken “reasonable care”. In this case, the ‘fee-payer’ – usually the agency that connects the two parties – is held liable for unpaid Income tax and National Insurance.

An indemnity clause is therefore intended to insure or ‘indemnify’ the fee-payer from IR35 risk, shifting it back onto the contractor as a condition of engaging them via their limited company.

In short, if the agency or client gets a tax bill after engaging you, they’ll chase you for reimbursement.

Indemnity clauses are common – but most still haven’t encountered one

At one stage, the level of correspondence IPSE received from its members, as well discussion at forums such as our Member Meet-Ups and our Policy and Research Committee, had us convinced that virtually every outside IR35 contract had one of these clauses.

However, responding to the first of IPSE’s annual IR35 surveys earlier this year, just under one quarter (24%) of contractors have been asked to or required to agree to an indemnity clause as a condition of securing an outside IR35 role.

This data, whilst a concerning sign of the prevalence of these untested clauses, is simultaneously a reassuring reminder that most contractors have not encountered them.

Of those contractors who were asked to accept an indemnity clause, 63 per cent simply accepted and signed the contract.

But, interestingly, 18 per cent said that they successfully negotiated it out of their contract before proceeding with the engagement.

Whilst we don’t (yet) have more detailed information on exactly how these contractors convinced their clients to back down on their approach – much of which is likely to be circumstantial – it suggests that other contractors should absolutely consider trying it for themselves unless they are completely comfortable with the implications of accepting one.

Why are indemnity clauses a contentious issue?

Whilst indemnifying someone for IR35 risk sounds straightforward, there is a big question mark hanging over the enforceability of these clauses, and whether the liability for unpaid Income Tax and National Insurance can even be transferred. This is because the OPW legislation sets out that the fee-payer will be liable for 100% of the unpaid tax, National Insurance and Apprenticeship Levy if a HMRC investigation concludes they made inaccurate IR35 determinations.

To the best of IPSE’s knowledge, an IR35 indemnity clause has never been tested in a court of law, which would create an interesting tension between contract law and tax law.

After all, the policy goal of OPW legislation was to reduce ‘disguised employment’ by giving clients and agencies a stake in the tax status of the contractors they work with. For them to pass this risk back to contractors seems to run contrary to the spirit of the rules; if someone else picks up the fee-payer’s IR35 bill, it weakens the incentive for clients and agencies to learn lessons from an ‘incorrect’ determination (even if made with reasonable care) and to make more ‘accurate’ assessments in future.

It's difficult to say whether a court battle over an IR35 indemnity clause would help or hinder contractors. It could potentially set a precedent that effectively green lights the use of these clauses in every contract. On the other hand, perhaps a judge would rule in favour of upholding the primacy of the fee-payer’s obligations under the rules.

As with the ‘double National Insurance’ issue when working via umbrella companies, one might suspect HMRC is more interested in seeing an IR35 obligation settled, and less so in who covers that cost in reality. With this in mind, perhaps the independent hand of a judge ruling over these clauses might not be something to fear.