IR35 off-payroll: the four questions every PSC file should answer

A PSC contractor signs a new engagement with a long-term client. The contract has a substitution clause near the back. The accountant notes the clause, marks the IR35 file as low risk, and moves on to the next return. Two years later, HMRC opens a status determination review and asks the practice for the file. The substitution clause is still in the contract. Nothing else on the file mentions substitution at all.

That is the version of the IR35 substitution story most practices are quietly running, and it is the one HMRC compliance teams have learned to recognise from across the desk. The substitution clause on its own is no longer doing the work it used to do. The case law has moved, and the way HMRC looks at PSC files has moved with it.

The clause is the start of the file, not the end

Most well-drafted PSC contracts contain a substitution clause. Some are watertight, some are window-dressing, most sit somewhere in the middle. A common form says the contractor "may at any time provide a substitute, subject to the client's reasonable approval and provided that the substitute holds equivalent qualifications and clearances."

On the page that reads quite solid. In front of a tribunal it is the start of the analysis, not the end of it. Autoclenz v Belcher [2011] UKSC 41 made clear that contractual terms are not the final word where they do not reflect the real agreement between the parties. A substitution right that exists on paper but would in practice never be honoured is no real substitution right at all, and that is the test the tribunal is actually running.

Four questions worth asking on every PSC file

The case law since Autoclenz, including the Court of Appeal in HMRC v Atholl House Productions [2022] EWCA Civ 501 (the Kaye Adams case) and the Supreme Court in PGMOL v HMRC [2024] UKSC 29 (the football referees case from September 2024), points at four questions any accountant reviewing a PSC engagement should be able to answer in writing.

1. Can the contractor send a substitute without the client's prior approval? If approval is required, on what basis can the client refuse?
2. Who pays the substitute? If the client pays the substitute directly, the substitution right has lost most of its commercial reality.
3. Is the right to substitute a right to send anyone competent, or only specific named individuals from a defined pool?
4. Has substitution ever been offered, considered, or actually used during the engagement? If not, why not?

A clause that requires personal approval, lets the client refuse on any reasonable ground, and has never been used in two years of engagement is not really a substitution right. It is a sentence in a contract that says very little about how the work is being done.

What the file should hold alongside the contract

Most IR35 files treat the substitution clause as the end of the analysis. The contract is read, the clause is spotted, the box is ticked, and the IR35 review is closed. Then the engagement runs for two or three years and nothing else on the file mentions substitution at any point during that time. When HMRC opens a review, the only piece of substitution evidence on the file is the clause itself, with no record of how that clause was understood by the parties or whether it was ever capable of being exercised.

What needs to sit on the file alongside the contract is a short record of how the substitution right was understood at the time of contracting, whether it has been used or could realistically be used, and what the working pattern of the engagement actually looked like. The contract clause counts as evidence. The working practice usually counts for more, because it shows what the parties actually intended when they agreed the wording in the first place.

Substitution is no longer a standalone defence

Even a genuine and unfettered substitution right does not automatically defeat IR35 anymore. The Court of Appeal in Atholl House said clearly that status is determined on the whole picture, with no single test doing the heavy lifting on its own. The Supreme Court in PGMOL then confirmed that mutuality of obligation operates at a lower threshold than many practitioners had been assuming, which means a contractor with a real substitution right can still be inside IR35 if the broader relationship looks like employment.

What that means in practice is that the substitution test cannot do all the work anymore. Where substitution is the strongest factor in favour of self-employment on a particular engagement, control and mutuality and the wider working pattern still need to be analysed and recorded on the file. An IR35 file that rests entirely on the substitution clause is the kind of file that benefits most from additional evidence behind it, and HMRC compliance teams know that as well as anyone.

What a good file actually looks like

A practice that is running the substitution test properly can hand four things to HMRC on request:

1. The contract clause itself, plus a short note on whether the wording has been tested against the four questions above.
2. A record of any discussion or correspondence between the contractor and the client at the time of contracting that bears on substitution.
3. Any actual instances of substitution offered, refused, considered, or exercised during the engagement, with dates.
4. A summary of how the substitution analysis fits alongside control, mutuality, and the rest of the working pattern.

If the file does not have those four items, the substitution test has only been part-recorded. The clause is mentioned, but the working evidence sitting behind it is not. HMRC compliance teams have got quite good at telling the difference between the two, and tribunals follow.

What I would do this quarter

If a practice is reviewing PSC engagements at any point before the next Self Assessment cycle, the substitution test is one of the higher-value items to look at first. It is also one of the easier items to get right with a small amount of documentation discipline, which is what makes the difference between a file that holds up under review and one that needs more behind it.

Read three or four of your PSC contracts and check the substitution clauses against the four questions above. If any of them need more behind them, write a short note to the file before HMRC is the one asking. That is most of the work, and it is the work most practices have yet to add.

Lexendo's IR35 Status Review module runs each PSC engagement against the four-factor substitution analysis above, alongside control and mutuality, and produces a status file that includes the contract review, the working practice analysis, and a defensible status conclusion for the contractor's records. See plans at lexendo.co.uk.

Lexendo

Find the risk across your client portfolio — before HMRC does.

Six domains of UK tax and compliance coverage. 198 HMRC sources. 265 tribunal decisions. 30-day money-back guarantee.

If Lexendo doesn't find a risk worth acting on in your first 30 days — full refund.