IR35 is why it pays to have no notice period

Contracting through a limited company, rather than as an individual, has a number of advantages for the person concerned, despite fresh suggestions that the structure of an ‘Ltd’ is burdensome.

First there’s the ability to limit your personal liability and, where appropriate, the possibility of being able to sell-on a valuable company at a later date, writes Richard Nicholas, an IT lawyer at Browne Jacobson LLP.

One advantage, since the dawn of IR35, is no longer available however. This is the ability to achieve favourable tax treatment of income, by choosing to be paid in dividends by the company you work for, rather than receiving a salary direct from your employer.

Close that loophole

Anti-avoidance rules, enacted under the Intermediaries legislation in 2000, closed this particular loophole by requiring payment of taxes broadly equivalent to those payable on a salary, where the individual providing the service was providing a function broadly comparable to an employee. What is legislatively key for the individual, as the recent case of MBF Design Services shows, is the question of whether they as the contractor truly acts independently or is in reality, but for the fact he or she is contracting through a limited company, acting as an employee.

In the case, Mr Fitzpatrick, trading through his company MBF, provided engineering design services for Airbus, through a recruitment agency. The First Tier Tribunal to hear the case looked at a number of employment status factors and came to the conclusion that IR35 would apply. So for tax and other purposes, Mr Fitzpatrick should be treated as an employee.

How MBF went on to beat IR35

- By being dispensable

However the subsequent judgement, in MBF Vs the Commissioners for HM Revenue & Customs, overturned the lower court’s ruling, following an appeal by Mr Fitzpatrick. Potentially important to contractors in a similar contractual chain, the judgement indicates that a right by the employer/end-user to ‘terminate without notice’ is likely to have a significant bearing on the applicability of IR35.

Because although Tribunal Judge Malachy Cornwell-Kelly agreed that much of the Mr Fitzpatrick’s terms were ambiguous and could be treated as creating either an employee or contractor relationship, Airbus’ right to terminate the contract without giving either notice or compensation was among the determining factors of his contract status.

-   With MOO (a lack of)

This right, the judge said, is “characteristic of a contract for services but quite foreign to the world of employment.” Against this background, other terms of the contract were given less weight, yet not before it helped MDF further by implying a lack of mutuality of obligation (MOO) – a key test of employment which HMRC alleged MDF passed. The judge disagreed, telling HMRC: “There remains an absence of the mutuality of obligation needed for a contract of employment to exist.”

Recalling case law history, the tribunal was reminded that “the requirement for mutuality [of obligation] is satisfied if in each individual contract there is an obligation on the employer to continue paying, and the employee to continue working, until the specified work is complete.”

Fortunately for MDF, not only did Airbus have the right to terminate the contract without giving notice, but its contractors also had to go home unpaid in the event of systems downtime or failure (while payroll staff had to stay on-site).

Implications for IT contractors

So the lack of mutuality of obligation between MBF and Airbus clearly helped the contractor to defeat the taxman’s claim that  there was a liability under IR35. It even means that factors such as being required to work from the end-user’s premises; on their provided systems, or even having broadly similar hours from one week to the next, as MBF did, need not necessarily lead to an ‘inside-IR35’ outcome. This can be true provided the contractor is in a fundamentally insecure position – facing termination at will.

As a result, the judgement will no doubt give some comfort to contractors who work on large manufacturing, construction and IT projects, where typically the contractor is required to use certain client systems (and even adhere to certain ‘employee-style’ procedures), and who have no true guarantee of work from one week to the next. If you’re still unsure or wondering about being caught by IR35, you may want to check your day-to-day practices and contract terms. For once it may be good news to find out that you’re entirely dispensable.

Wednesday 23rd February 2011