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Tribunal case 'inside and outside' IR35
by Susie Hughes at 11:10 16/12/11 (News on IR35)
An unusual IR35 case has seen a partial victory and a partial loss for an IT contractor as a Tax Tribunal has ruled he was not under IR35 for the first few years of his contract but inside it for the later part.
As the case covered a seven year period, the Tribunal found that a few years into the contract the relationship changed between the contractor as he became more integrated and less project based which then placed him inside IR35. Nevertheless, the partial victory, covering the first three years of his contract, should see his tax bill reduced from the original claim by HM Revenue and Customs.

The case in question involved John Spencer an IT specialist who operated through his own company, JLJ Services Ltd; his client, Allianz Cornhill Management Services Ltd and agent Highams Recruitment Limited. It was heard at the Tax Tribunal in Bristol in front of Tribunal Judge, Howard Nolan in October 2011.

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The IR35 dispute covered the period from 2001 to 2008 and involved £91,443.48 in tax, £61,268.35 in NIC, and interest of £48,048.46 - a total of more than £200,000 - adjusted due to taxes paid and refunded corporation tax would have meant Mr Spencer was liable for £141,000 payment if HMRC had won the case.

The Tribunal said: "Our decision is that it is realistic to conclude that Mr. Spencer’s notional status, either as an independent contractor or an employee of Allianz, actually changed during the period. The precise point at which the change occurred is not easy to define, but at the end of December 2003 there were various indications that the relationship did then change. Our decision is accordingly that in the early period, prior to the end of 2003, Mr. Spencer would not have been regarded as an employee, but that from the start of 2004 onwards, he would have been regarded as an employee. We will of course explain the reasoning for our conclusions for the periods on each side of that dividing line."

This could prove to be an interesting case as it demonstrates a shift in position which could demonstrate the criteria which influences a tribunal's thinking and decision.

Evidence
Evidence was given by Mr Spencer and two employees of Allianz. There was general agreement on the facts with only minor differences of emphasis.

The sole question of principle for the Tribunal, therefore, is whether, had Mr. Spencer performed his services for Allianz under a direct contract between himself and Allianz, he would have been treated as an employee or as an independent contractor.

Background
At the date of the hearing, Mr. Spencer had been retired since 2007 after a long career in IT. He was made redundant in 1991 and after a two year period of unemployment, signed with agents Highams to undertake IT contract work. After a number of placements and periods without contracts he formed his company JLJ Services in 1994. Although there was no firm evidence of why Mr Spencer formed a company, the Tribunal alluded to the circumstances at the time in which agents Highams could have had a concern that they would have a potential financial liability for Mr Spencer's tax and NI without the insulation of a limited company. The Tribunal said: "It very much sounded as if Mr Spencer had found that he was unable to obtain full-time employment, similar to his original STC work, and unable to obtain work through agencies unless he formed the company that he did form."

For the next six years, Mr Spencer worked with a variety of clients, for differing periods of time, including gaps with no available work.

The work for Allianz
After a 3-month gap without work, Highams obtained a six-month engagement with Allianz in May 2000. The work involved a project geared to installing and writing programmes for Unix systems. The back-to-back contracts were virtually identical; including a qualified right to provide a substitute worker, the terms in relation to “control”, and the terms in relation to hours of work and termination.

From May 2000 to the end of December 2003, the pattern of engagements and agreed extensions was fairly similar with an indication of the particular project to be undertaken.

The Tribunal noted that the position after December 2003 changed with the contract extensions for longer periods, ie 12-month periods instead of a few months at a time, and no project descriptions were given. Also Allianz sought to engage Mr Spencer on an indefinite basis around that time, although there was some confusion as to the actual terms of the offer.

Contracts
To summarise the terms of the two contracts in relation to the points material to the dispute.

Substitution:JLJ's representative, ClearSky Accounting, placed considerable reliance on the clauses of each contract that entitled Mr Spencer to send a substitute worker. The relevant wording of the contract between JLJ and Highams was that:
"The services shall be performed by the Contractor. However, the Company may send a substitute of equal experience and ability to perform the Services as set out in the Schedule. In the event of a change, the Company and/or the Contractor shall submit to Highams the names of suitably qualified substitutes and shall permit the Client an opportunity to interview such proposed substitutes.”

The Tribunal queried some of the terms and conditions in the wording, for example what happened if the proposed substitute was not acceptable, the definition of 'contractor', the fact that not even Mr Spencer was named.

Control:Two clauses of JLJ contract with Highams related to 'rights of control', though their emphasis was principally on regulations and health and safety matters.

The general evidence in relation to Allianz’s right of control over Mr Spencer was mainly that Allianz would decide on the next project to which Mr Spencer would be assigned, and there would then be discussion as to how long that project would be likely to take and what further support was needed. Mr Spencer was regarded as the expert in his field and there was little day-to-day intervention.
from Allianz’s employees Mr. Spencer would need in order to complete the project.

There was a slight difference in the evidence as to whether Mr Spencer’s performance was assessed, and whether he was subjected to 'quality control'. Mr.

Working hours, etc The contracts themselves were silent about working hours, though the renewal schedules generally indicated the hours to be worked by Mr Spencer. In reality the position was reasonably flexible. JLJ billed Highams, and Highams billed Allianz for hours actually worked.

He was not required to “clock-in” as employees were required to do though he generally worked for normal working hours. He was not given paid holidays or sick pay, he had no pensions rights, fringe benefits and paid for his meals, even, it was mentioned, the Christmas lunch. Either party could terminate the contract with four week’s notice.

The parties’ intentions: Both contracts contained an identical clause, indicating that “any Contractor supplied by [the Appellant] shall not be deemed to be an employee, agent or partner of Highams or the Client.”

Other relevant evidence: Other matters revealed in evidence that were not directly related to any terms of the contracts included:

  • Allianz itself had an extraneous reason, ie headcount, for preferring to engage Mr Spencer as a contract worker, rather than as an employee, particularly after 2003, when Mr. Spencer dropped down to working on a part-time basis.
  • Allianz still has a number of contract workers and it was not aware of any other IR35 challenges.
  • 'Own business'. In terms of financial risk and provision of tools, it was accepted that Mr Spencer
    worked almost entirely with tools provided by Allianz and had little financial risk.

The decision
The Tribunal commented on the relevance of a number of tests.

  • the feature of personal service;
  • the degree of control;
  • the consistency of other terms;
  • the issue of whether the provider of services has his own business, and
  • the slightly nebulous issue of “mutuality of undertakings”.

On personal service the Tribunal stopped short of saying that the substitution clause in this case was a complete 'sham' claimed that 'it is perfectly obvious that, as with all similar contracts drafted to seek to sustain non-employee status, the clause was inserted to achieve the desired tax purpose, and it has virtually no bearing on our approach to the decision in this case'. The Tribunal considered it to be irrelevant because it was ambiguous, conditional and improbable in reality.
In seven years, no substitute was ever offered.

On control, the Tribunal accepted there was limited control over Mr Spencer's work. However, the Tribunal said: "At the end of 2003, if not before, it became clear that Allianz wanted Mr Spencer’s services permanently. It no longer engaged him for projects. It either offered him employment, or permanent engagement, and even if he rejected that, he was thereafter engaged on an annual basis. In other words he became one of Allianz’s key computer experts, available for work that was likely to be available indefinitely. He certainly ceased to be engaged just for identified projects. By breaking the link with projects, and indicating that Mr. Spencer would work generally within the organization, we consider that from 2004 onwards, there was more reality to control."

On his own business, it was considered he failed on the financial side, ie he had no opportunity to make more or less profit by his efficiency (he was paid for hours worked) and little financial risk. However, it did acknowledge the niche speciality skill he had which would be mainly required on a project rather than full-time basis.

On mutuality of undertakings, the Tribunal felt that the case law is progressively indicating that the test is of diminished importance, or that it is indeed nearly meaningless. There is a feature in this case where the phrase 'mutuality of undertakings' has some resonance. They recognised that contract workers will be dispensed with first and have no real benefits.

The distinctions
The decision whether Mr Spencer would or would not have ranked as an employee at the point in mid-2000 based on a notional contract, the Tribunal said that he would have been a contract worker, and not an employee.

The type of situation, where the Tribunal considered the contract worker analysis to be realistic is the one where:

  • an individual has a particular area of expertise;
  • that area of expertise is one that he has found has not enabled him to gain full time employment;
  • the explanation for not gaining full-time employment is that the area of expertise is likely to be one that various companies might need, but not on an indefinite basis, but rather simply to complete a particular project;
  • the type of work for which the worker is engaged is likely to be work outside the core work of the business.
  • the individual has only been able to gain work through rendering his specialist expertise available through placement agents;
  • the past pattern of work has confirmed all the above points of short engagements with different companies, and many unwanted gaps between engagements;
  • the area of expertise is likely to be one where the client would indicate the project to be done, and the hoped-for time frame for completion of the project, but would not expect to be able to supervise or “control” the worker in any way, simply because the expert would be engaged to do something outside the expertise or competence of the company; and
  • the company engaging the individual, engaging him for a project, would consider it quite inappropriate to provide holiday pay, pension benefit, and the other normal incidents of employment because they would all be inappropriate for such contract workers.

The Tribunal found that when Mr Spencer first entered into contracts with Allianz, all the above criteria were satisfied.However, the situation altogether changes, by the point in late 2003, when Allianz offered Mr Spencer either employment, or indefinite engagement, and when the parties moved to a pattern of annual renewals on a non-project basis.

The Tribunal said: "It seems perfectly evident to us that from that date onwards, Allianz regarded Mr Spencer as someone who they wished to engage and retain indefinitely, and when Mr Spencer continued to work for Allianz, and accepted yearly contract extensions, it seems realistic to say that his status must have changed. He would by then plainly not satisfy many of the tests ....above. He was engaged on an entirely personal basis. The substitution argument was basically irrelevant 'window-dressing'. If he was to be engaged indefinitely on a non-project basis, it seems likely that he was proving useful in numerous respects in relation to computers and IT, and no longer just undertaking his defined projects. So the 'control' argument becomes stronger. And fundamentally Allianz wants to engage him as a permanent member of the team.

"Our decision is accordingly that initially it would not have been appropriate to classify the notional relationship as one of employment. Certainly from January 2004, it would have been appropriate to regard the notional relationship as one of employment. We put the dividing line at December 31 2003 because it was at that time that he was offered indefinite work, and it was from that date that renewals were agreed on an annual basis, and from which no further reference was made to particular projects.

"We consider that it is possible that we have put the dividing-line in the wrong place, and that if we have done, the change-over to notional employee status would in fact have taken place well before 31 December 2003. We still consider, however, that the reason underlying the point in the last sentence of paragraph 59 is cogent, and we confirm that as the date when the status changed."

The Appeal was accordingly allowed in part.

For more information about IR35 and other cases, see Shout99's News on IR35.

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Susie Hughes © Shout99 2011


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