Dragonfly Consultancy loses IR35 appeal

The IR35 appeal of IT contractor firm Dragonfly Consultancy Ltd has been rejected, leaving its owner a £99,000 employment taxes bill for his contract being of, not for, service.

Agreeing with the Special Commissioner who heard the case, a High Court judge said it was "unassailable" that John Bessell had a relationship of employment with the AA.

Mr Justice Henderson's verdict validates the SC's ruling that Bessell's payment for his own equipment, training, and ISDN line to the AA amounted to only "weak" pointers to self-employment.

Explicitly, the verdict defeats Bessell's appeal, put by Andrew Stafford, QC, that the SC erred in law in four determinant areas: substitution, control, statement of intent and worker status.

Pointing to substitution, Mr Stafford said the upper contract between AA and DPP, Bessell's recruiter, could have stated that no substitutes would be acceptable, but did not do so.

Instead, it contained a promise by the agency it would supply staff competent to do the testing, together with a selection process, even if the first candidate offered was not suitable.

Alongside an "express" right of substitution in the lower contract, Mr Stafford argued that the notional contract would contain a clause allowing Bessell to supply a qualified replacement.

But it was "unrealistic" to suppose the AA would have agreed to an unqualified right of substitution, because the AA "did not want any competent tester, it wanted Mr Bessell."

Recalling this latter point, made by the SC Charles Hellier, Mr Justice Henderson also told the court that any substitution for Bessell would have "required the consent" of the AA.

"In order to displace such an inference," the judge added, "it would be necessary to find an express provision in the contract between DPP and the AA permitting substitution at the unfettered discretion of DPP; but any such provision is conspicuously absent."

IR35 advisors Bauer & Cottrell yesterday reflected how "case law has shown for some time" that a fettered right of substitution is not the "silver bullet" that some contractors, and seemingly lawyers, might hope.

The firm, which has never lost an IR35 case, said it would never advise an appeal under the legislation that a fettered right of substitution "should be relied upon in isolation."

Turning to control, Mr Stafford said SC Hellier wrongly concluded the notional contracts would contain provisions giving the AA a sufficient right of control to justify contracts of service.

Citing a clause in the contract between AA and DPP, he said while Bessel was "under the full control" of [the AA]" it was "on a day-to-day basis only regarding performance of duties."

But judge Henderson implied control was more dominant, evidenced in the first Dragonfly/DPP schedule, which says Bessell would be subject to the AA's "direct supervision and control."

Testimonials came from AA staff: as "part of his management checks," a Mr Alan Palmer could get Bessell to "run a specific test" to check his work was "acceptable". A project contractor confirmed she could "spot-check" Bessell's work.

The SC added that any "possible doubt" that the employment characteristic of control was present was "removed" by the second schedule in the series, which was headed:

"This Schedule sets out the principal terms upon which we shall engage you to provide a consultant to perform certain services for the Client under the Client's direction."

The "Client" was named in the second and third schedules as the AA, though in the remaining four schedules, the words "under the Client's direction" were removed.

Like another contractual tweak that ensued, the judge said the changes "owed more to anxiety about the possible impact of …IR35…than to any real change in the position on the ground."

Kate Cottrell of Bauer & Cottrell advised: "It is absolutely vital that any IR35 contract review looks at the working arrangements as well as the written contracts and that the contracts reflect the reality of the situation.

"Negotiation of changes to contracts should only be considered where the original contract does not reflect the true working practices."

Standing back from the detail, the former tax inspector said she believed the judgement showed there was "significant control in this case both in the written contracts and in reality."

Mr Justice Henderson agreed: "Bessell's performance of his duties was subject to a degree of supervision and quality control which went beyond merely directing him when and where to work. In the case of a skilled worker you do not expect to find control over how the work is done.

"Conversely, in the case of a self-employed worker in business on his own account," he said, you would not normally expect to find regular appraisal and monitoring of the kind attested to".

Designed to crush such hints that Bessell was akin to an employee from 2000 to 2003, when he worked at the AA, was a statement of intent, which Mr Stafford gave "much emphasis" to.

According to clause 12 of the contracts between Dragonfly and DPP, "nothing contained in or arising out of this Agreement is intended to create a contract of employment".

Mr Stafford argued that a notional contract between Bessell and the AA should have a similar clause, or that its terms should be seen against the background that neither party "wished to create an employment relationship."

The appeal elaborated that SC Hellier should have taken the parties' intentions into account, and had he done so, he would have concluded that neither the AA nor Bessell intended him to be an employee of the AA.

The judge rejected this: "It seems to me that Mr Hellier was right not to attempt to construct a hypothetical statement of intention as between Mr Bessell and the AA, because the material in question was at best inconclusive.

"Even if that is wrong, I would in any event not regard this as a case close enough to the borderline for the inclusion of such a term to have made any difference to the result."

However, the judge effectively overturned the Revenue's view that in IR35 cases the intention of the parties should never be considered when drawing up the hypothetical contract.

In the fourth area appealed, Mr Stafford said SC Hellier "wrongly directed himself" that the relevant dividing line between being in business of one's own account on the one side, and employment on the other side.

The QC argued the SC failed to allow for the fact that a person may be self-employed without necessarily being in business on their own account, given legal codes recognise 'worker' status.

Rubbishing the claims, judge Henderson said the general law of employment does not recognise any intermediate category between employment on the one hand, and self-employment on the other.

"I can see no reason why the Special Commissioner should have taken into account other possible categories of worker which exist only for the purposes of very specific and self-contained statutory codes," the judge said.

"I agree with counsel for HMRC that such categories only have meaning and relevance in the particular contexts in which they are found. In the context of IR35, the only distinction that matters is whether the notional contract would be a contract of service or not."

The judge said SC Hellier "clearly had that distinction well in mind, and for the reasons which I have given I consider that his conclusion that Mr Bessell fell on the employment side of the line is unassailable."

Before Dragonfly's hearing, the Professional Contractors Group, which funded the appeal, warned that defeat could "undermine much of the successful defence" against IR35 in past cases.

There was, then, some reassurance last night, as while the judgement does amend case law, such as with the statement of intent, the issues pertaining to IR35 have not "changed dramatically."

"The case is interesting," Ms Cottrell added, particularly "from the control angle, in that the emphasis has moved from not being controlled as to 'how' the services are performed but to 'what' services are being performed and how much of [those services] are allocated, checked and monitored."

Speaking after the judgment, the IT contractor said he was devasted by the news.

"Not only does it affect my family and me, but all the other freelance professional consultants who are trying to earn an honest living," Bessell said.

"I was never an employee of the AA and I simply cannot understand how the High Court has reached its decision. It's a travesty of justice."

Further Reading: Why Dragonfly got caught by IR35


Thursday 4th Sep 2008