You will probably have heard me sounding off at fairly regular intervals about how inconsistent and impossible to judge the average IR35 case is. I’ve looked at many appeal judgements over the years and each one has been supportable, given the vague nature of that which is being judged. You can usually kind of see where the judge was coming from.

Now, however, we have a case that fails even a generous stab at understanding the logic.

How else do you describe a judgement that puts the contractor outside IR35 and then inside IR35, within the same contract…?

The case was JLJ Services Ltd vs. HMRC, heard by Howard Nowlan. On the face of it this was one of those cases where a contractor, a Mr Spencer, working through his own limited company and an agency for an end client had been challenged under IR35 and found wanting. He appealed the case and it went to the First Tier tribunal.

So far, so good. Well, not good for Mr Spencer, but you know what I mean.

Then life starts to get a little strange. JLJ had started off as a Unix-based technical expert for the client, Allianz in Bristol, working on a succession of projects. After a few years of presumably valuable and acceptable work, Allianz’s requirements changed and Mr Spencer moved to a more part-time role, on a series of rolling contracts, picking up whatever needed doing.

Now this is the key point, as far as the judge was concerned; the first part, being deliverables based, did not exhibit a degree of control, the second, however, did. Accordingly Mr Nowlan rules that the first part was outside and the second part inside. This despite everything working to the same overarching contract – only the schedule of deliverables had changed – and I’m guessing it never crossed Mr Spencer’s mind that the game had changed underneath him. He simply kept on doing what he was clearly very good at for a client with whom he had a good and mutually beneficial relationship.

That said, by screwing up your eyes and squinting, you could just about see where Nowlan was coming from; the increased level of Control moved the IR35 goalposts in the wrong direction.

Ah but, I hear you cry, having been paying attention over the years, Control is not the only test. What about Substitution, Mutuality and that most recent phenomenon, “being in business”? Which is where I rather part company with the judiciary.

Substitution? The contract had a right of substitution and, as near as I can tell from the judgement, Allianz could reject a substitute with reasonable grounds but were not actually averse to considering taking one on if Mr Spencer was unable to work. Nowlan, however, after a bit of verbal gymnastics – including allowing an Allianz representative rather too much latitude in the accuracy of his evidence giving – said that he “ took it to exhibit a realistic businessman’s contempt for a clause that he probably found irrelevant”, a position he agreed with.

So, Mr Nowlan, how many employees do you know who are allowed to submit a substitute worker?

Mutuality? A mere bagatelle. Mr Nowlan’s words: “There is considerable case law in relation to this test, progressively indicating that the test is of diminished importance or that it is indeed nearly meaningless”. Really? Can’t say I’d noticed any diminution in its importance. Cases have recently hinged on someone being sent home without pay when the systems failed and they could no longer work, while the permies sat and waited for normal service to be resumed. On full pay. Heigh ho.

So there went the RMC judgement on what constitutes employment then.

In business? It’s clear from various comments that Nowlan considered JLJ Services to be irrelevant and queried why it had been set up. So a judge trying a contactor case involving an agency who hasn’t heard of S44-47 ITEPA 2003 then. But hey, it was Nowlan’s first IR35 case.

So in conclusion, at a very long stretch, the judgement may be supportable. But we should not lightly dismiss the ability of a judge to take a fairly cavalier attitude to the key IR35 tests on some fairly flimsy grounds.

In fact the only good thing to come out of the whole case is that we should be grateful that First Tier cases do not set precedents. Luckily for us…

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Image: 1996 UK Royal Mail Cartoon Stamp Card by andertoons

Last week I got into one of those elliptical conversations you sometimes have on the internet. It started off with one of those all-to-frequent questions, “My new contract hasn’t got a notice period! What am I going to do?” Silly question: “Earn a lot of money while you finish the gig” was my response.

This, apparently, was the wrong answer. Heigh ho…

And this is where it started to get confusing. The main thrust was that if I have a notice period and the contract is terminated early, I’ll get paid for not having to do any work. Which is a good thing, yes?

No, I said, it isn’t.

Then someone else chimed in with a tale of being terminated early and having to threaten legal action to get his notice period paid. Unsuccessfully, it transpired, but let’s not spoil the argument with reality.

OK, so let’s explore this a little more deeply.

One of the three major planks of a solid IR35 defence is to have the minimum level of Mutuality of Obligation between you and the client, the other two being a lack of Direction and Control and a Right of Substitution. Which we all know already of course.

But a minimum of mutuality, put simply, means that they don’t have to offer you work, you don’t have to take it and they don’t have to pay you if there’s no work to do. Like, for example, when the job is done and they don’t need you any more. At which point they would rather like you to go away and stop costing them money because you are a contractor and that’s why they hired you/

So if you insist on being paid for working when there is no work to do, aren’t you now demonstrating something rather more than the irreducible minimum set by case law? This rather blows a hole in your IR35 defence, unless you can demonstrate an absolute lack of Direction and Control and even then your case is seriously weakened.

There is, needless to say, a second thread to this debate. What if you want to leave the contract early? Something I’ve never done myself, but there can be good reasons for it (and, let it be said, some very pathetically amateurish ones) If you have a notice period, then you can exit gracefully stage left simply by giving the stated notice. You probably won’t be that popular, but it’s not wrong to exercise your contractual rights. However, if you haven’t got a notice period, then you are stuck there for life, or something, with no hope of escape. At which point I might ask why the hell you signed the contract in the first place, if it’s that important, but I digress.

You can always leave a contract. The process is called “negotiation” or, if you’ve really been paying attention, “Substitution”. Either will work, it will be a very strange manager who wants to force someone to stay who clearly doesn’t want to be there.

So argument settled. You don’t need or want a notice period. Ermm, no, apparently. “I got terminated early and I have a four week notice period so I want paying for it” was the refrain. Isn’t this where we came in…?

OK, so even if we ignore the Mutuality argument, you’re still missing a couple of key details. Firstly, your contract will almost certainly have something along the lines of payment being conditional on a signed timesheet or some other authorised evidence of work done. If you’re not working, you won’t have one, so no payment is owed.

Secondly the contract will also contain a clause to the effect that the client or the agency can terminate the contract with no notice at their absolute discretion. And that rather buggers the whole debate, doesn’t it?

The net result of all this is that while it’s a nice to have, and it’s an even nicer to have honoured, notice periods in freelance contracts are not only pointless, they may well be expensive. So let’s leave them for the permies. We don’t need them.

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Image: pointless first iPad/iPhone test app by mac morrison

At one point it seemed as though HMRC’s radar was focused solely on the Construction Industry, but now their gaze has fallen hard and fast on limited company contractors (yet again).  In the last month Accountax have seen a 162 % increase in the number of IR35 enquiries instigated by HMRC.

These enquiries, spurred as usual, off the back of Compliance visits and HMRC’s new powers of inspection see HMRC firing on all cylinders, and doubling their resources for compliance.

It is now more important than ever to ensure your company is fully compliant and know what the law says.  Fundamentally though you must get it into your head that as soon as HMRC write to you or your accountant requesting a Compliance visit they will look at IR35.  Do NOT be lulled into a false sense of security that IR35 is not in their mind.  It is.

Secondly you must not be swayed from your arguments.  It comes down to three fundamental criteria:

Personal Service

Are you obliged to do the work yourself?  If not, then IR35 cannot apply.  Do you have a right to send a substitute?  Is the substitute only vetted to check skills, qualifications or experience?  If this is the case you are not obliged to provide personal service and as such IR35 does not apply – you do not have to SEND a substitute, the right to send one is sufficient.

Control

Are you told how to do the work?  If not, then IR35 cannot apply.  If the manner in which you provide the services is your own (ie you determine how you will design, approach, develop and actually carry them out) this is sufficient.

Mutuality of Obligations

Are you obliged to do the work, and is there an obligation to provide you with work.  If no such obligation exists IR35 cannot apply.

HMRC must establish that all 3 criteria exist before IR35 can apply.

In Business factors

the final consideration is the “in business” test.  Do you invoice?  Do you have insurances? Do you have company equipment and materials?  Are you identified separately as a contractor?  These factors will all help to demonstrate you are in business on your own account, but they do not determine IR35 on their own.

Obviously these factors, on the face of it, are fairly straightforward.  The problem arises due to badly drafted contracts which do not contain clearly how the contractor provides the services.  Most limited company contractors I have dealt with would not tolerate, nor adhere to, being treated like an employee by the end client.  The problem is the contract does not reflect this.

Agencies are slowly realising the dangers of IR35 (which has taken long enough), and now is the time for contractors to strike and ensure they get their contracts reviewed properly and negotiate with the agencies to implement the terms they want!  It can be done – persistence is not futile!

What contractors must not do is jump ship to umbrella companies merely because they are scared of IR35 – you may simply be jumping out of the frying pan into the fire!  Umbrellas received a mention in the Pre Budget Report, yet again, warning of a consultation process.  While I do not practically see how HMRC could possibly legislate against umbrella companies, HMRC have increased their efforts in targeting umbrella companies and Accountax are now dealing with double the amount of umbrella company investigations.

Not all umbrella companies will fall foul of HMRC, and not all should be avoided, however there are still a great many who exploit the expenses legislation and play on a contractors fears of IR35.  Umbrella companies work well for a number of individuals but they do not work for everyone!

Things contractors should beware of:

“fully IR35 compliant”. IR35 does not, and can not, apply to umbrella companies.

“approval”.  Third party “approval” or “accreditation” does not mean the umbrella is compliant, it simply means someone has checked them for MSC implications, and not for basic compliance.  This is of little benefit to a contractor.  Accountax have seen a number of umbrellas with third party approval for MSC implications fall foul of HMRC because they have not operated expenses, employers’ obligations etc properly.  If an umbrella company has not paid your tax across, or processed your expenses correctly HMRC can pursue you for the liability.

“option”, “solution”, “scheme”.  Be wary of companies offering a variety of options or solutions and various tack on services such as recommending accountants etc.  Any company stating on a website they offer “solutions” are sure to be high up on HMRC’s radar and attract unwanted attention.  If they are offering a “one stop shop” it is likely they will be considered a scheme by HMRC and caught by the MSC legislation.

“dispensation”.  Any company promoting the fact they have a dispensation as part of their marketing strategy should be viewed with caution.  A dispensation does nothing more than “dispense” with the umbrella company’s need to produce a P11D.  It does not allow you to claim expenses you have not actually incurred, if a company is telling you this you could find yourself personally liable.

These are just a few things to be wary of, unfortunately for contractors for every one umbrella which operates correctly there are a dozen who do not.  Umbrellas can work well for contractors, but likely if a limited company is suitable for you an umbrella would not be. Your best bet is to get your IR35 position checked thoroughly by a professional adviser who can back up their claims (do they represent at tribunal level for example).  One golden rule – DO NOT JUMP FROM YOUR LIMITED COMPANY WITHOUT ADVICE.

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Image:  danger for baby 2 by efilpera

The intention of IR35 is very simply expressed: if you are working as an employee of your client then you should pay the same taxes as an employee of that client. You can’t avoid paying those taxes simply by saying you are a freelance contractor, you have to be able to prove it.

Proving it, though, is not that simple. IR35 does not set hard and fast rules that would allow a clear-cut decision.

Let’s start with the contract. The basis of any IR35 judgement centres on the three key employment indicators, Direction and Control, an irreducible minimum of Mutuality of Obligation and a reasonably unfettered Right of Substitution. In theory, the clear presence of any of those three in a contract would take that contract outside IR35. In practice, they are never that clearly defined unless the contract has been very carefully drafted. Therefore any contract you use must be checked for these factors and if necessary changes made to define them correctly. This requires expert opinion from someone with demonstrable expertise in this field. What you should never do is use HMRC’s own free contract assessment service; that is a guaranteed loser.

However the contract is only part of the story. The final judgement will take account of the totality of the arrangements and the intent of all the parties involved. So you may have a safe Right of Substitution in the contract, but if the client is never going to allow you to invoke it then it has no value as a defence. This was the major conclusion of the Dragonfly case, that the working arrangements and the contract have to be fully aligned.

It is therefore very hard to state categorically that a contract will pass or fail IR35. You should take great care to ensure the contract is properly assessed and amended and you must fully understand the nature of the engagement. Then, if you are challenged by HMRC, you have the tools to mount a decent defence. And because you have taken steps to assure yourself of your IR35 status, if you do lose there won’t be any additional penalties.

That defence, however, requires expert support and guidance. Most if not all of the lost IR35 cases have been where the contractor represented themselves. Make sure you have effective insurance to cover the cost of expert advice and representation. A few hundred pounds will protect you from the average £15,000 costs of a defence. And, more importantly, it will buy a great deal of peace of mind.

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Image: yes!_no? by Fernando Takai

This is not and does not claim to be a definitive guide to IR35 and how to avoid its clutches. That is something that has defeated many experts over the last ten years. However, I hope to provide a summary of what we do know about IR35, what all the arcane acronyms really mean, and which bits are the important ones.

There is a lot of detailed discussion out there; too much to be easily read these days. Much of it has been written by people with their own agenda which is why some advice seems to conflict with other versions. So I thought a simple and pragmatic overview from an informed freelancer’s side is probably overdue.

What is IR35?

IR35, or the ”Intermediaries Legislation” as it is more properly called, was announced in the Budget of 1999 and came into force in April 2000. Its aim was to stop people using dividend payments instead of salary in order avoid paying a large percentage of their National Insurance contributions. It didn’t try to make that practice illegal, since that would be rather difficult, but it attempted to define a set of conditions that would make you pay those “missing” NI contributions.

Its real genius was to fail to define what those conditions are. Instead it said that if you look like an employee, you will pay tax as an employee on all your earnings, except we’ll give you 5% to cover your working costs since you are not an employee. You can see why there might be a degree of confusion.

The definition of an employee has been set by case law over many years. At its simplest, it comes down to three key concepts: Direction and Control, Mutuality of Obligation and Right of Substitution. Each needs to be defined in the contract and, obviously, the contract has to match reality pretty closely if it is to stand up in court.

Direction & Control

Direction and Control means that the client can tell you what to do. If however, he can tell you to do things that are not directly relevant to delivering what it is you are there to do, then that is excessive. A quick check is “Do the permanent staff have to do this to do the job?” If they do, then fine, if not it is excessive. This needs to be managed with a degree of care and sympathy, of course: no point staying outside the client’s rules on hours of work and then simply not turning up because you fancy a day off. Equally, most freelancers are given an objective, a set of quality constraints and a time scale; those are not Direction and Control, since you are free to deliver the objective in the best way you see fit.

Mutuality of Obligation

Mutuality is a bit complex but at its simplest, does the client have to offer you work, do you have to accept it if offered, and can you charge when there is no work to do. There will be an irreducible minimum of Mutuality in any contract, but for our purposes the simple maxim of “No work, no pay” will work as the basic key test.

Right of Substitution

Right of Substitution is fairly clear cut: can you send someone else to do the work. Employees can’t do that, so if you can, you are not an employee. However, the client has to have some say in the matter. The usual formula is along the lines of “you may send a substitute subject to the approval of the client, such approval not to be unreasonably withheld”.

Any one of the above should be enough to take you outside IR35, but the ideal would be all three. And let’s be clear, the above three conditions genuinely have to exist in reality as well as in the contract. A case (Dragonfly) was lost recently in part because the client denied they would ever accept a substitute for the worker, despite there being a clear clause in the contract that substitution was possible (a clause that was added some time after the engagement began, incidentally).

There are some other myths around IR35 that may be worth noting. Using your own kit is good, but if you have to use the client’s kit, it’s not that much of an issue. Having to work on site is not an issue if you have to be able to interact with other workers to do the job (although exactly when you are on site is up to you, as we have said earlier). Having multiple contracts is not a defence, since IR35 is applied on a per contract basis. Multiple clients may show you are genuinely in business but that seems not to be a major criterion in determining IR35 status despite, it being said very clearly that people in business on their own account would be outside the rules (Dawn Primarola, Paymaster General in 2000, is on record as having said precisely that).

Incidentally, Umbrella users are not and cannot be subject to IR35. They are employees in law and pay employee’s taxes (as well as employer’s taxes, come to that) so are out of scope.
The real trick is to think like an independent business, not as a temporary employee of the client. If you look at the engagement on those terms, much of the distinction between inside and outside IR35 becomes, if not clear, at least a little clearer.

IR35 Investigations

Finally, if you lose an IR35 case it does not currently mean that you are therefore an employee. The tests they use to determine status are the same but it’s only about taxation, not rights of employment. One day someone may press the nuclear button and claim employee rights because IR35 says they are one, but that hasn’t happened yet.

Losing a case means all relevant tax declarations, personal and corporate, will need to be recalculated and the balances paid over, with interest. As long as you have tried to determine your IR35 status, penalties will not be applied: that is about the only good thing about the whole sorry mess.

And to close, let me offer the comforting thought that the vast majority – well over 98% – of IR35 cases challenged in court to date have found in favour of the freelance being outside.

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Image: Relax by Neil Cummings