IR35 defeat for Contractor
Despite having a right of substitution in his contracts, a freelance contractor recently lost an IR35 case in the Special Commissioners.
Background
Ian Hough, an expert in business and data analysis, supplied his services through his own personal service company, Island Consultants Ltd (ICL), via Spring Ltd (agency) to Severn Trent Water (STW). The contracts were typically three months in length, spanning over a five-year period.
HMRC assessed that IR35 applied and raised the additional taxes due for the three years ending 5th April 2003. ICL appealed to the Special Commissioners, but they concluded that Mr Hough, the director of ICL, would have been deemed an employee of STW under the IR35 legislation and so the additional demand for further taxes was valid.
Facts
Mr Carson of STW managed the 5-year project. The project involved STW employees, an external software company, and contractors such as Mr Hough who wore a badge that clearly indicated that he was a contractor.
Mr Hough did not manage and therefore was not responsible for any of the other workers on the project. He was required to work four days a week, but normally worked five and sometimes six or seven days a week. His daily hours also varied considerably from working five to twelve hours per day. He was not supervised, nor was his work checked, but he merely reported his progress to Mr Carson. Mr Hough was provided with a laptop when offsite including a dial-in from home, and a desk when he was on STW premises. He could use the canteen and parking facilities at STW, but no other benefits or employee rights were permitted to him.
A term within the contract stated that ICL had the right to send a substitute and any errors in Mr Hough’s work were corrected at the expense of ICL.
Decision
At the hearing before the Special Commissioners, HMRC called Mr Carson as a witness. The three main reasons stated by the Commissioners why they considered IR35 to apply in this case were:
Control: It was accepted that due to Mr Hough’s expertise, little control was expected over him as to how his services were performed. However, sufficient control existed which required Mr Hough to work at STW sites and when he was to work there. He was also required to comply with reasonable requests of STW for information and progress reports and to co-operate with other personnel on the project.
Substitution: In 2003 Mr Carson had signed a ‘Confirmation of Arrangements’, confirming that Mr Hough had a ‘right of substitution’ and was able to subcontract the services. However, in 2005 Mr Carson retracted this when he signed a statement at HMRC’s request that stated STW would be prepared to consider a proposed replacement. There was, however, no such substitution term within the Spring – STW contract. The commissioners therefore concluded that in reality, there was no right of substitution and this would have been highly impractical.
Mutuality of Obligation: This was a five-year project for which there was plenty of work requiring Mr Hough’s services. Whilst there was no obligation to renew the contract after each three-month period, there was sufficient obligation within each contract to provide work and pay the agreed rate. There was an obligation for four days work per week or more if requested.
Other factors were considered by the commissioners, but as they were minor, we have ignored them here.
All three terms above were deemed not to have been broken, and yet the Commissioners deemed ICL to be subject to IR35 as they considered these terms not to reflect the reality of the situation.
The control test requires sufficient control to exist to make one the master of the other. The Special Commissioner even commented that there was less control than one would expect for a normal employee. However, they ignored the fact that Mr Hough possessed an expertise that STW did not have in-house, and so STW could not have controlled how Mr Hough performed his services. The fact that he still had to report and provide details when requested, and had to provide these services at STW premises was enough for the commissioners to deem it within IR35.
There was no mutuality of obligation for STW to renew the contracts with ICL, but even if they were obliged due to the length of the project, ICL were not obliged to accept the renewed contracts. The Commissioners still deemed that in reality, STW would have offered and ICL would have accepted the new contract.
Unfortunately with regard to substitution, as no such term existed in the contract between the agency (Spring) and end client (STW), and with Mr Carson’s testimony, it was irrelevant to the commissioners that the right to substitute existed within the contract between ICL and Spring.
This case clearly demonstrates that, despite good professional representation and opinion, IR35 enquiries can sometimes hinge on interpretations of grey areas and factors beyond the control of the contractor, especially when it come to the terms of the contract between the agency and the end client.
Perhaps, regardless of whether your contracts have been confirmed as outside the remit of IR35, you should still consider obtaining IR35 insurance to protect yourself against such proceedings and the additional tax liability that will follow should you be defeated.
