Contractors shouldn't rely on non-IR35 case law
On March 2nd 2010, HM Revenue & Customs announced a number of amendments to its Employment Status Manual, including case law updates in respect of the important High Court IR35 cases of Dragonfly Consultancy and Larkstar Data.
Both cases have caused HMRC to review its guidance in this manual which is for use by HMRC staff as well as the general public. The Employment Status Manual sets out HMRC's interpretation of particular case law and effectively gives us a clear view of the issues that HMRC will rely upon in the event of an IR35 investigation. HMRC won both Dragonfly and Larkstar which, with the cases of Synaptec and Usetech, gives HMRC a total of 4 out of 4 wins for IR35 cases at the highest courts that IR35 cases have been heard. Although there have been slightly different issues aired or points of law challenged, anyone relying upon non-IR35 case law precedent to decide IR35 status should do so at their peril.
The journey to the High Court
Dragonfly: Case first heard at the Special Commissioners - Taxpayer lost – Taxpayer appealed to High Court – HMRC won. Larkstar: Case first heard at the General Commissioners – Taxpayer won – HMRC appealed to High Court – HMRC won and case remitted to a different set of Commissioners (before the advent of the new Tribunals)- Taxpayer withdrew (this month) – HMRC effectively won again.
HMRC builds on all 3 status tests (Substitution, Mutuality of obligation and Control)
HMRC now states at ESM3345 "In the case of Dragonfly Consultancy Ltd v HMRC Henderson J found that Dragonfly was a one-man company, whose raison d'être was to supply Mr Bessell's services – therefore it was obvious that the intention of both parties was that it would be Mr Bessell who would provide the services. This provides the principle that, unless there is evidence to the contrary, the arrangement itself demonstrates the requirement for personal service in one person companies."
Looking at the Larkstar ruling, a finding of fact was that although the contract allowed a substitute to be provided for Mr Brill, the overriding security arrangements required substitutes to undergo procedures as rigorous as those for contractors and in practice that did not happen. Once again we have the situation of having a right to substitute counts for nothing if the right is not exercised and this finding in Larkstar will impact upon those contractors relying on a "reasonably fettered" right to substitute.
Mutuality of obligation
In Dragonfly, the MOO issue was not raised as a point of appeal and was only addressed in the context of the differences between the tax and NIC under IR35 legislation. Returning to the Special Commissioners decision for Dragonfly. it was found that the end client was paying for the availability of the worker irrespective of available work and that averaging of time worked took place so that extra hours worked one week could cancel out fewer hours worked another. The Special Commissioner concluded that MOO could be reduced to the need for personal service and to be paid for the work done.
In Larkstar, the General Commissioners found there was a lack of mutual obligation, which they saw as one of the most compelling factors indicating independent contracting. This was found to be a clear misdirection by the General Commissioners on the relevant law as they only considered the obligation to offer work outside the terms of the contracts, which is irrelevant to the question of whether there are mutual obligations during an engagement. In reaching their decision, the Commissioners ignored statements of principle by the Court of Appeal in Cornwall County Council v Prater. Sir Donald Rattee found a clear misdirection as to the law by the General Commissioners.
Control (What, Where, When, How)
Until Dragonfly, showing that there is a lack of control over "how" the services are performed was considered to be most important. However Dragonfly confirmed some previous decisions in that there is no expectation of control over how a skilled worker performs the services. Dragonfly has shifted the emphasis to the extent of control over "what" the worker is doing and how much of the "what" is "allocated", checked, monitored, subject to appraisal and/or supervised. There is significant control in the Dragonfly case both in the written contracts and in reality.
In Larkstar, Sir Donald Rattee upheld HMRC's ground of appeal in regard to the General Commissioner's finding of Control, due to 2 significant aspects. Firstly, the General Commissioners decided that as Mr Brill was a consultant, and there was no control by [client] MBDA as to how he did his work, indicated that he was independent, suggested to Sir Donald Rattee that the Commissioners took no proper account of the authorities referred to at the hearing by HMRC on this aspect.
Secondly, one of the General Commissioners' findings of fact was that Mr Brill was encouraged to work during MBDA's core hours. Mr Brill's own evidence was he was required to work 37 hours a week - adhering to core hours. As the General Commissioners' found Mr Brill's evidence to be convincing and to be preferred in all cases of apparent conflict, their finding of fact regarding hours of work was inconsistent. Had they found that Mr Brill was indeed required to work the hours they may have concluded this was a pointer towards employment.
IR35 - It's not just about the money
It is understood that there was very little tax at stake in the Larkstar case. It is almost 3 years now since HMRC published its Litigation and Settlement strategy which sets out principles for bringing tax disputes to a conclusion. HMRC states that cases which include an incorrect legal interpretation (which would apply to IR35 cases) the following – "Sometimes it will be necessary to take up issues where there is a relatively small amount of tax in the case itself, because of the wider implications of the point at issue."
The Larkstar case and the updates to the manuals illustrate that HMRC are on very strong ground with IR35 and that they are prepared to go to the High Court irrespective of amounts involved in order to protect the deterrent effect of the IR35 legislation which brings in hundreds of millions of pounds in tax and NIC. All the cases thus far have not been subject to HMRC's stringent penalty regime, effective from April 2009, so no doubt the amounts at stake in future cases will increase substantially where a contractor has not taken reasonable care over his/her IR35 status.
Contractors and their advisors should take heed of HMRC's IR35 track record. When deciding IR35 status, full account of the actual working practices should be taken and proper attention given to the case law that is wholly relevant to IR35. HMRC has won almost all the important cases including the IR35 Judicial Review, 4 High Court cases and 10 Special Commissioners cases. The taxpayer has won just 5 cases at the Special Commissioners. With this record, most onlookers would agree that the IR35 legislation is very far from ineffective.
Comment provided by Kate Cottrell, co-founder of Bauer & Cottrell, an employment status and IR35 specialist.