Background
Keith Shepherd, a skilled IT consultant, is the sole director and shareholder for his company, Alternative Book Company Ltd, which was formed in 1997. From 2000-2002, his company was contracted to provide his services through his company to Gerling NCM (now known as Atradius) through a series of two connected contracts. The first was a contract between his company and Computer People Limited, a recruitment agency, to perform services for Gerling ("the lower level contract"). The second was a contract between Computer People Limited and Gerling NCM to supply the services of Alternative Book Company Ltd using Mr Shepherd ("the upper level contract"). Alternative Book Company Ltd had no written contract with Mr Shepherd and there was no issue taken about the interposition of Computer People Limited in the contractual sequence.
Mr Shepherd, supported by counsel John Antell instructed by Lawspeed, appealed against an HMRC determination that tax and NI was due on his income under IR35 for that period. The Special Commissioner, Michael Tildesley, explained that: "The determinations were made under what is commonly known as the IR35 legislation which was enacted for the purpose of curbing the tax advantages enjoyed by some individuals who supplied their services through a personal service company to a client. Under the IR35 legislation if it was found that the services provided by the person were given as an employee rather than genuinely as an independent contractor the fees paid to his personal service company would not be treated as company revenue upon which corporation tax was payable but rather as deemed salary to him. The company would then be responsible for the accounting of tax and national insurance contributions on the deemed salary.
The initial contract to provide services to Gerling NCM started in February 1998.
The substantive issue in dispute was whether Mr Shepherd would have been an employee of Gerling NCM if he had contracted direct with Gerling (NCM) under the hypothetical contract presupposed by the IR35 legislation.
The evidence
The Special Commissioner heard evidence from Mr Shepherd and four witnesses for HMRC, who were two HMRC staff, the manager to whom Mr Shepherd reported to at Gerling (Derek Gigg) and the Manager IT Services at Gerling, (Stephen Prentice) whom Mr Shepherd had nominated as the person to speak to HMRC about his working relationship at Gerling NCM.
The Commissioner's approach
The parties' submissions took the form of analysing the terms of the lower level and upper level contracts and the wider circumstances against a range of legal principles derived from case law on employment status, in order to arrive at their respective conclusions on whether the hypothetical contract was one of employment or not.
The Commissioner considered the parties' approach had the wrong emphasis and carried the risk that the dispute turned into one about employment status rather than on the construction of the hypothetical contract.
He adopted an approach of 'finding facts' to determine the terms of the hypothetical contract between Mr Shepherd and Gerling NCM followed by an assessment of the terms and contextual circumstances against case law principles on employment status to decide whether it was a contract of service.
The Commissioner's intention was to group the evidence and findings of fact against the indicators of employment and self employment as identified by the a number of previous case law cases.
The facts
Mr Shepherd had been contracting as a self employed person in a partnership or via a limited company since 1978 (with a six month break as an employee in 1985).
Since he formed Alternative Book Company Limited in 1997. His first engagement was with St Ivel which lasted six months. In February 1998 Mr Shepherd commenced work at Gerling NCM. From April 2003 Mr Shepherd supplied his services through a different personal service company, KES Computer Services Limited.
Mr Shepherd considered that working as a self employed contractor enabled him to broaden his expertise in business and computer systems, and the opportunity to meet new people. The disadvantages were the lack of job security, no pension scheme and holiday pay, and having responsibility for self development and running a business.
Relationship with Gerling
For six years (1998-2004) Mr Shepherd worked for Gerling NCM, averaging around 36 hours per week except for a break of four weeks. After that period, his hours were reduced at his own request until July 2005.
The contractual arrangements for Mr Shepherd's work at Gerling NCM were a series of term contracts generally ranging from three to six months between his company and the agency, and the agency and the end client.
Mr Shepherd gave evidence that there were no guarantees that Gerling NCM would offer a new contract when the previous one ended, nor whether he would accept it if it was offered.
However, he accepted in cross examination that he would not have other work lined up on expiry of the contract with Gerling NCM and indicated that he would await an offer of a new contract from Gerling NCM before seeking other work.
Mr Shepherd obtained the engagement with Gerling NCM after seeing an advert on the website of Computer People Limited which then arranged an interview for him. At the interview Gerling NCM assessed Mr Shepherd's technical expertise and interpersonal skills for working in a team not the capacity of his company's ability to supply the right personnel for the position.
Other engagements
The Commissioner heard that Mr Shepherd had no evidence of marketing his company's services or taking active steps to find alternative work during the period of his engagement with Gerling NCM. His accounts for the period showed that there was no investment or expenditure programme which developed and expanded the business, other than small amounts on computer equipment.
However, at various times during the periods of his engagement with Gerling NCM, Mr Shepherd had worked on three other assignments, including a previous client, the Tote, where he provided ongoing support for he systems he had created earlier. But the Commissioner ruled this was ' not significant'.
At the hearing there was a dispute between Mr Shepherd and the representatives of Gerling NCM about whether he was permitted to take phone calls at their premises from the Tote in respect of the support contract. Mr Gigg stated that Mr Shepherd's contract would have been terminated if he was found to be doing work for another organisation whilst working at Gerling's premises.
Around April 2000 he also completed a one-off project converting data files for which he received a VAT inclusive fee of £2,190.56 and later, together with a friend, developed a computer game, during the time he negotiated a reduction in his hours with Gerling NCM from 36 to 24 hours per week from May 2004 in order to concentrate on the computer game. me.
His company's total turnover for the period 2000- 2002 was an estimated £180,549, of which the "non-Gerling" work accounted for £6,803.
The contract the contractor's company and the agency restricted Alternative Book Company Ltd from accepting any other contract which might have created a conflict of interest.
Mutual Intention
The Gerling employees said that the company would prefer to take on employees but it was company policy to engage contractors to work on projects because of budgetary restrictions and limits on headcount. It also gave them flexibility, in that their contracts could be terminated at short notice if the workload fell. Further there were no overheads of employee indirect costs attached to contractors. The fees, however, paid to contractors were twice the annual salary of a member of staff doing equivalent work.
The lower and upper level contracts contained a clause to the effect that the respective agreements did not constitute an employment relationship between the parties. Under the contracts Mr Shepherd had no entitlement to holiday or sickness payments and ineligible to join the pension scheme of Gerling NCM. Mr Shepherd was responsible, via his company, for PAYE, income tax, corporation tax, national insurance contributions and VAT payments on the fees received.
Under the upper level contract the fee rate for Mr Shepherd's services was expressed as a weekly rate for 36 hours, with overtime calculated on a pro-rata basis. The fee in the lower level contract was altered to an hourly rate from the 8 May 2002.
A period of four weeks written notice was required to terminate both sets of contracts. The contracts did permit termination with immediate effect on the occurrence of specific events.
Personal service and substitution
The upper level contract named Mr Shepherd as the consultant whose services were being hired. No mention was made of his company, Alternative Book Company Ltd, in the upper level contract until 2002. The lower level contract identified Mr Shepherd as a consultant or personnel.
The Gerling staff confirmed that Mr Shepherd's appointment had been on the basis of his suitability to do the work.
The lower and upper level contracts beginning in April 2000 did not contain a substitution clause permitting the consultancy to supply the services through a consultant other than Mr Shepherd. From October 2000 the contracts included a clause for the right of substitution with 14 days notice, no disruption and Gerling had the right to veto.
Mr Shepherd produced a statement from Mr Gigg dated February 2005 which stated, among other terms, that Mr Shepherd had the right to provide a substitute who has the necessary skills to carry out the services and that Gerling would accept this.
However, in his evidence, Mr Gigg from Gerling, distanced himself from the statement, saying that the words were not his and that there would be no circumstances under which he would accept a substitute.
In February 2005 several contractors were asking Mr Gigg to sign similar worded statements as 'a way of getting round the IR35 legislation'.
He never sent a substitute during the seven years with Gerling.
Control
Mr Shepherd gave evidence that each contract with Gerling NCM was for work on a discrete individual project. Mr Prentice for Gerling, however, indicated that if Gerling's priorities changed Mr Shepherd would have been assigned to other projects.
Mr Shepherd gave the impression in his evidence that he had considerable freedom in how he carried out his work. He would use his skills and experience to determine the method and manner of performing the services. He worked mostly on his own. Mr Prentice confirmed that Mr Shepherd was required to make frequent informal progress reports and a formal report every month to the project manager. A team would carry out testing and acceptance checks on his work and he would be expected to rectify his errors. Further he could be over-ruled by a full time senior member of staff, and that Gerling NCM would have the final say on Mr Shepherd's standard of work. Mr Shepherd accepted that he could be overruled, although this never happened.
According to Mr Prentice, Mr Shepherd did not work on his own.
Mr Shepherd performed his services at the offices of Gerling NCM at Cardiff, which was stipulated by Gerling NCM in the lower and upper level contracts. Though Mr Shepherd stated stated that he was able to work at any time at his discretion provided the pre-agreed delivery dates for the projects were met, an examination of his time sheets showed that there were only only a few occasions when he was not working during the company's 'core hours'.
Provision of equipment
Gerling NCM provided Mr Shepherd with a computer terminal, desk, chair and phone on its premises. Mr Shepherd accepted that Gerling NCM provided him with the equipment to do the job. Mr Prentice on behalf of Gerling NCM accepted that Mr Shepherd was allowed to work from home out of choice. This happened relatively infrequently and was not a feature of the engagement.
Financial risk
Mr Shepherd was paid hourly and his earnings were fixed during the duration of each contract. He was not remunerated on a project or fixed fee basis. Neither he nor his company invested capital in the project. The payments under the contract were guaranteed on production of time sheets and made at regular pre-defined intervals.
The lower level and upper level contracts gave Mr Shepherd no job security, no entitlement to redundancy and no legal recourse in the event of unfair dismissal. He was required to provide his own training so that he could maintain his skills in a competitive environment. He took financial risks with the development of the computer game, which eventually was a loss making enterprise.
Part and parcel
Mr Shepherd stated that he worked largely on his own and that he would liaise occasionally with employees of Gerling NCM. In contrast Mr Prentice asserted that Mr Shepherd worked as part of a mixed team of employees and contractors. According to Mr Prentice, Mr Shepherd was the team leader for a particular project, although as team leader he did not have responsibilities for the personnel management of team members. Mr Shepherd disputed that he was ever a team leader at Gerling NCM.
Mr Shepherd was given a security pass with his photograph to gain access to the Cardiff premises of Gerling NCM. He was expected to observe the Staff Code of Conduct.
Mr Gigg considered that Mr Shepherd became part of the scenery at Gerling NCM. Mr Shepherd was invited to the company's Christmas dinner, which he declined. He took part in five a side football matches, which were informal social events organised by the participants rather than the company.
Mr Shepherd was not included in the staff appraisal scheme and had no career path within Gerling NCM.
The submissions
Counsel, John Ansell, for the contractor's company, contended that a hypothetical contract between Mr Shepherd and Gerling NCM would have included a substitution clause, in which case there was no requirement for Mr Shepherd to perform the services personally to Gerling NCM.
If his submission about the 'tie breaker 'nature of the substitution clause did not succeed, Mr Ansell contended that the facts of Mr Shepherd's engagement with Gerling NCM should be evaluated against the case law principles on employment status in the context of other "service providers" in the same kind of business. For example the fact that Mr Shepherd only made a modest investment in capital assets for his business was not necessarily a factor pointing towards employment as a computer software consultant in business was principally selling his IT skills which did not require the same capital investment as a road haulier running his business.
HMRC contended that the minimum obligation necessary for a contract of service was the obligation on the part of the engager to pay the worker remuneration and for the worker to provide his services in consideration of that remuneration. In this case, they argued that the question of mutuality of obligation posed no difficulty, as the evidence clearly demonstrated that Mr Shepherd would have provided services in return for remuneration under the terms of a hypothetical contract between Gerling NCM and Mr Shepherd.
HMRC considered that the evidence showed that the personal service of Mr Shepherd was required by Gerling NCM and that in reality the replacement of Mr Shepherd by a substitute would not have been practical.
According to HMRC the work undertaken by Mr Shepherd for the Tote during the contract with Gerling NCM was insufficient to satisfy business on own account.
HMRC also submitted that no weight should be attached to his activities developing the computer game, as these were not part of Alternative Book Company Ltd but of Mr Shepherd's other personal service companies.
HMRC said that the degree of control exercised by Gerling NCM over Mr Shepherd was sufficient to be consistent with a contract of service in a hypothetical relationship. The absence of financial risk, the provision of equipment, and the four weeks notice of termination were all pointers towards employment. Further the evidence indicated that Mr Shepherd had become an integral part of the Gerling organisation.
HMRC concluded that the picture painted by the facts of this case was one of a contract of service rather than a contract for services.
Findings of fact
On mutuality of obligation the Commissioner found that Mr Shepherd was required to perform services to complete IT projects for which Gerling NCM was obliged to pay a fee and that Gerling NCM was also obliged to provide work for Mr Shepherd.
The indications to the contrary were that Gerling NCM would only pay for the hours worked, and no specific term in the lower and upper level contracts requiring Gerling NCM to make work available. However, the Commissioner considered those contrary indications were outweighed by the period of notice; the contracts were short and for specific projects; the expectation was that Gerling would provide 36 hours work, and Mr Shepherd averaged 35.25 hours a week during the two years, which included holidays.
On control, there was a conflict between Mr Shepherd's and Gerling's evidence and the Commissioner preferred the evidence of the two Gerling employees.
He found that Gerling could - and did - move Mr Shepherd to other projects; Mr Shepherd took no steps to find alternative work but waited for the offer of a new contract suggesting he would accept any work from Gerling; allthough he did not have daily supervision he was required to report regularly and his work was assessed; he was a member of his team rather than working on his own; he was required to work from Gerling's premises; and he did not have the freedom to choose his hours of work or take leave without permission.
On substitution the Commissioner found Mr Shepherd's submission regarding the right of substitution 'without substance' and that Gerling had effectively contracted with Mr Shepherd to perform the required services. He reached that conclusion becausethe upper level contracts originally specified Mr Shepherd as the consultant supplying the services.; the lower level contracts also named Mr Shepherd as the consultant; Gerling recruited Mr Shepherd directly for his IT expertise, interviewing him as an individual not in his capacity as a director of a service company; the substitutuion clause which was added did not provide an unfettered right; in an interview in 2002 Mr Shepherd admitted that the substitution clause was of no practical effect and accepted that the substitution clause was inserted to meet any potential IR35 challenge; he ofered no substitute during the seven years he wourked for Gerling.
Overall the Commissioner concluded that the substitution clause was 'window dressing', and that Gerlingwould have replaced Mr Shepherd if he was unable to carry out the work.
The Comissioner found no compelling evidence that the Mr Shepherd was in business on his own account during his engagement with Gerling. He did not market his services and his work on other projects was considereed 'minimal' in the case of the Tote and 'too remote' in time period in the case of the computer game development.
Mr Shepherd was integrated within the IT department of Gerling NCM, working there for seven years, doing on average 36 hours a week generally as a member of team, which included employees. He was described as 'part of the scenery' by Gerling, which the Commissioner considered an accurate description.
The Commissioner found that the lower and upper level contracts specified that the agreements did not constitute or imply an employment relationship between the parties.The insertion of this clause in the hypothetical contract, however, would not be decisive about the nature of the working relationship between Mr Shepherd and Gerling NCM. The effect of the clause has to be considered in the context of the contract as a whole.
The hypothetical contract
In constructing a hypothetical contract between Gerling and Mr Shepherd, the Commissioner found it would include a requirement for Mr Shepherd to provide personally the services of an IT specialist; to report on progress; to work at Gerling's premises; fixed core hours; and no entitlement to sick pay or paid leave.
He concluded that the hypothetical contract would not include a substitution clause even though it appeared in both the lower and upper level contracts.
The Commissioner said: "I find that the hypothetical contract would have the necessary irreducible minimum to constitute an employment contract. When I stand back and consider the position as a whole I conclude that the picture painted of the relationship between Gerling NCM and Mr Shepherd was overwhelmingly one of employment."
Decision
The Commissioner said: "In the light of my findings I decide in principle that if the services were provided under a contract directly between Mr Shepherd and Gerling NCM, Mr Shepherd would be regarded for income tax purposes as an employee of the Gerling NCM for the tax years 2000/01 and 2001/02, and for the purposes of Parts I to V of the Contributions and Benefits Act as employed in employed earner's employment by Gerling NCM for the period 6 April 2000 to 5 April 2002. I therefore dismiss the Appeal."
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