Island Consultants Ltd: IT contractor loses IR35 appeal

A contractor lost his IR35 appeal after a judge ruled that the freelance became "integrated" and "part and parcel" of the organisation that was in receipt of his IT services.

Island Consultants Ltd has failed to overturn HMRC's bid to make it pay three years' PAYE, despite advisors' claims last night that ICL controlled where, when and how it worked.

Ian Hough, a freelance business/data analyst, supplied his services through ICL, his own company, to Severn Trent Water through a series of three-month contracts over five years.

Engaged by Spring Ltd, Hough wore a badge identifying himself as an IT contractor when he worked on STW sites; unsupervised and without any instruction on how to supply his service.

In 2003, he and STW agreed a clause stating that he had the right to subcontract his services, though this was later retracted, to state STW would merely consider a replacement.

Throughout his period of work, Hough was contracted to work four days a week, but he sometimes worked for six and seven days, with no way of earning more for such extra work.

Although there was no obligation to renew his contract every three months, the work, on STW's billing system, was to last five years, meaning plenty of labour was required by ICL.

In the first of three determining factors, Special Commissioner John Jones said IR35 should apply as "sufficient obligation [existed] with each contract for STW to provide work and pay the agreed rate."

Both worker and client knew the project's lifetime, and knew that the skills ICL was supplying were unavailable in-house, meaning there was a mutual "expectation" of renewal, Jones said.

During his three years at STW, Hough failed to work for other clients or offer his services elsewhere, and could not increase his pay above the daily rate, which was set by STW.

"By working more than the contractual four-day week he was similar to an employee working paid [sic] overtime," argued Peter Death, representing HM Revenue & Customs.

Making his case, Mr Death, whose analysis was largely accepted by Judge Jones, said Hough had virtually no overheads and faced no possibility of making a loss.

Similarly, and besides a hiccup to VAT, Hough faced minimal financial risk – the only one being not earning during the period before payment - a risk incurred by employees, Judge Jones noted.

And despite STW offering no instruction on how Hough's service should be carried out, mainly because its project manager – a Mr Carson - was devoid of IT expertise, it still exercised sufficient "control."

The judge said control, the second factor cited as determining IR35, was in play: Hough had to work at the company's sites sometimes when it said so. Working at home was allowed but only if Carson approved.

Both Carson and Hough met weekly to discuss progress on the project, further to Hough having to comply with data requests from STW, and having to work with other personnel.

Moreover, although Carson initially supported the contractual right of substitution, HMRC asked him to retract this in 2005, to state that STW only needed to consider a proposed replacement.

Crucially, such terms were omitted in the Spring-STW contract, prompting Judge Jones to conclude that, in effect, there was no right of substitution – the third cited determinant of IR35.

Such an agreement would have been be impractical anyway, the judge suggested.

He said: "STW has an important and sensitive project and they contracted with the Appellant [ICL] for Mr Hough's services on the basis of his special skills.

"Another person would find it difficult to pick up the project in the middle and it might take a couple of months to do so unless Mr Hough were directing him."

Other factors, albeit lesser ones, cited by Judge Jones as explaining why ICL is caught by IR35 included the fact that Hough had a termination notice of four weeks.

In addition, although Hough was not privy to employee benefits, the freelance business/data analyst became "part and parcel" of STW, the judge said.

Issuing his verdict, Dr Jones explained: "Hough had a desk and computer terminal and had the same car-parking facilities and access to the canteen as normal employees."

Later, he added: "[But] he did not receive any of the fringe benefits received by normal employees.

"I assume that since he [Hough] was satisfied with the rate of payment, including the fact that it was not increased during several years, it must have made up for the loss of benefits."

Such wording from the Special Commissioners is almost unprecedented, according to Roger Sinclair, legal consultant at Egos Ltd, an advisory for IT contractors.

He told CUK: "Rarely have I read a judgment which was so clearly so wrong.

"I very much hope this will be appealed, and I have every expectation that it will be reversed when this happens.

"What this does illustrate is the vagaries of litigation; the ‘factual' findings seem to be based more on wishful thinking than on the evidence. The decision does not seem to me to be in accordance with the authorities."

Kate Cottrell, founder of Bauer & Cottrell, the IR35 specialists, agreed that a court's normal approach to consider whether the Intermediaries Legislation applies had not been pursued.

In a statement to CUK last night, she said: "Both the major issues and indeed most of the minor issues that need to be considered in all IR35 cases have effectively been dismissed by the Special Commissioner."

It added, that as it currently stands, "this case holds no comfort" for IT freelancers, as many contractors "will relate to Mr Hough's working arrangement and will be alarmed by this result."

However, there are lessons to be learned from the failure of the Spring-STW contract to include a contractor's right of substitution.

Ms Cottrell advised: "The main messages here are that the true terms and conditions of the relationship should be accurately reflected in all the contracts in the chain and that it is vital that the views of the end-client are established and confirmed ahead of any appeal hearing."

Adrian Marlow, managing director of Lawspeed, a recruitment law specialist, agreed.

He told CUK: "The fact that the Spring-STW contract did not contemplate proper project terms has added to the problem for Islands Consulting Ltd."

Yet he did offer some support for Judge Jones' verdict. Lawspeed, he said, has long-advised contractor clients that "notice periods," like the 4-week period of Hough's contract, "are evidence of potential employment."

Mr Marlowe, whose fuller analysis of ICL V HM Revenue & Customs will be published on Contractor UK on Wednesday, said the implications of the case for contractors appear to be "significant."

Meanwhile, John Kell, policy officer for the Professional Contractors Group, reflected on the first IR35 defeat for Accountax, a PCG approved supplier, which represented Hough.

He told CUK: "Our understanding is that this was a very long-running IR35 case that was lost due to the client presenting evidence at the hearing that did not tally with their previous written account of events.

"In other words, it went wrong unexpectedly on the day. It has no broader implications and PCG's record in fighting IR35 remains peerless."

Tuesday 24th July 2007