Contractors are signing indemnity clauses and putting themselves at risk. Photo by Alexandre Cubateli Zanin
According to IPSE research, there’s a rising trend of indemnity clauses in contracts that seek to transfer potential tax liabilities from HMRC onto contractors.
A significant number of contractors are agreeing to these indemnities without receiving adequate information from the client. With the responsibility for IR35 status determination on medium and large-sized clients, these clauses are designed to protect businesses from financial fallout if HMRC later considers a contractor to be inside IR35. But are they legally sound, and what should contractors be asking?
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SDS: did your client carry one out?
The Intermediaries Legislation, or IR35, aims to prevent tax avoidance by those working as “disguised employees” through personal service companies (PSCs).
Since April 2021, medium and large businesses have been legally required to carry out the IR35 status determination and provide a Status Determination Statement (SDS) to all contractors based on ‘reasonable care’ in their assessment. However, many contractors report not receiving these statements, raising questions about compliance and potentially fuelling the desire for indemnity clauses.
A SDS is a document or email that must be provided to the contractor for every contract that is agreed and based on the outcome of an IR35 assessment. Despite this being a legal requirement for medium and large-sized businesses, nearly three-fifths of contractors (57%) indicated that their client had not provided them with an SDS in their current engagement, according to an IPSE survey.
IPSE stated in the report, “This closely aligns with our findings from both 2024 and 2023, where 63 per cent and 60 per cent of contractors had not been issued with one respectively.”
This is where things get interesting and puts into question why clients would add an indemnity clause.
Clients must carry out “reasonable care” in their IR35 assessments. When they don’t, this leaves them liable for unpaid taxes, even with a fee-payer involved (i.e. recruitment agency). This raises the question: can a client claim indemnity if their assessment was negligent?
An indemnity clause suggests a contractor agrees to cover a client’s financial losses in specific situations, in this case, a potential HMRC investigation. While generally enforceable in contract law, their application to IR35 is contentious. It is going to put a thorn in the side of any legal arguments.
If a contractor behaves like an employee, despite an “outside IR35” determination, a client might argue the resulting tax liability is partly the contractor’s fault (to understand what is meant by “inside IR35”, read this article).
However, this argument is likely to be challenged by HMRC. Clients cannot contract out of their statutory obligations. Under IR35, the medium to large-sized client is responsible for determining status and the fee-payer (often the client or agency) for unpaid taxes. Shifting this liability to the contractor could be seen as circumventing the law. Concerns also exist about public policy and whether a contractor has a legitimate “insurable interest” in a client’s tax liability.
How common are these indemnity clauses?
Despite not knowing if these clauses are legally enforceable, IPSE has been aware of clients using such clauses for outside IR35 engagements to cover against any retrospective HMRC investigation relating to IR35.
To track the prevalence of indemnity clauses in supply chains, IPSE asked contractors whether one of their clients has ever asked or required them to agree to an indemnity clause as a contractual condition for an outside IR35 engagement.
Over a quarter of contractors (28%) now report that they have been asked or required to agree to an indemnity clause, representing an increase on our reports from 2024 (23%) and 2023 (24%), said IPSE.
“Of those that had been asked or required to accept an indemnity clause (28%), the overwhelming majority (80%) simply accepted the indemnity clause and signed the contract. For comparison, this figure stood at 76 per cent last year,” said IPSE.
IPSE continued, “On the other hand, 20% indicated that they successfully negotiated the indemnity clause out of their contract, representing a small decrease on our findings from last year (26%) but a small increase on our findings from 2023 (18%).”
What questions should contractors ask before signing a contract with an indemnity clause?
An indemnity clause could expose a contractor to substantial financial liability, covering back taxes, penalties, and legal costs. Even if the clause is ultimately unenforceable, the contractor faces the financial and emotional burdens of legal challenges.
- Has a comprehensive SDS been provided? This document will assist in understanding the reasoning behind the IR35 determination.
- What steps were taken to ensure “reasonable care” in the status assessment? Ask for evidence of the assessment process and any professional advice sought.
- What specific working practices are expected, and how do they align with the “outside IR35” determination? Ensure the contract accurately reflects your working relationship.
- Can the indemnity clause be removed or significantly limited? Aim to negotiate this, or at least ensure it only applies if the client took reasonable care and the inside IR35 finding is solely due to your actions.
- What are the precise terms of the indemnity, including what costs are covered? Carefully review the wording and seek legal advice.
- Does your IR35 insurance cover the potential liabilities outlined in the indemnity clause? If you already have indemnity insurance, ask your insurer to look at the indemnity clause to see what they suggest. Do not presume anything. Understand the limitations of your insurance.
No legal precedent yet
The lack of clear legal precedent leaves contractors in a tricky position. Therefore, it would be wise to get independent professional guidance and advice. Where possible, contractors should prioritise working with clients who can show they understand their IR35 obligations and allocate risk fairly.
However, that cannot always be the case. In those situations, get the contract looked over to ensure you are not at risk and are covered by your insurance. Also seek for the indemnity clause to be taken out of the contract.