Are your contractors really in business on their own account?

IR35 advice for Businesses

Written By David Evans

July 5, 2022

The consequences of getting your assessment wrong.

 

Faced with tight labour market conditions, hiring a specialist contractor is an attractive option for many businesses. The technology consultancy market, in particular, is booming and we have seen a marked increase in the use of contractor agreements over the past months.  This is in stark contrast to the blanket ban approach to off payroll arrangements that became a typical response of those medium and large businesses caught by the changes to IR35 last year. However, hiring individual contractors in any field of expertise and in any size of business requires a detailed assessment of whether the arrangement is in fact a form of disguised employment. Failure to do so can leave you and the contractor exposed to significant tax and national insurance consequences and, if the consultant is engaging with you directly, to uncosted worker and employment liabilities. Just ask Uber or Pimlico Plumbers!

 

Employment and worker status in a state of flux.

 

Despite its importance there is still no clear definition of what amounts to employment or self-employment and any assessment is still heavily dependent on case law. Throw into this mix an extension of statutory rights to an ever-growing category of workers, who fall in the gap between employment and genuine self-employment and it’s easy to underestimate the risks involved.

 

A quick recap on IR35

 

Individual contractors typically fall into two categories: (1) those contracting directly and (2) those operating through an intermediary, such as a personal service company. The latter category requires some further explanation. The imposition of an intermediary between the client and the contractor prevents a direct employment relationship between the parties and so in theory the contractor can then be paid via dividends from profits from his or her company rather than through PAYE. As this has considerable tax advantages, the intermediaries’ legislation, more commonly known as IR35, operates to determine whether a direct contract exists between the client and the individual and if that hypothetical contract is one of employment, income tax and NICs are applied to circumvent tax avoidance.

 

Court of Appeal decisions in Kickabout and Atholl House*

 

The Court of Appeal has recently considered that final element of employment status within the context of IR35 in respect of two separate cases involving broadcasters who provided their services via a personal service company.  The Court of Appeal reaffirmed that the most authoritative test for employment status remains the three-stage process set out in the Ready Mixed Concrete *case, but provided clarification and commentary about the application of each stage, namely (i) mutuality of obligation, (ii) control and (iii) whether the other provisions of the contract are consistent with a contract of employment. While the facts of both cases are quite unusual, there are some really important observations from the judgments that will have broad applicability and should be considered when drafting any agreements.

 

Incorporating the lessons from Kickabout and Atholl House into your consultancy agreements

 

  1. The contract remains the starting point in any determination on tax status. This is not necessarily the case for assessments relating to employment and worker status, discussed below. Therefore careful thought needs to be given to the terms at the outset to ensure that the clauses reflect the reality of the situation. Substitution clauses need to be realistic and effective, and if they are used, evidence of such should be retained.
  2. Time commitment/exclusivity. If there are obligations to work a significant number of hours/days, a first call on the contractor’s services and a restriction on taking on other work for third parties, then these will all be relevant and persuasive indicators of an employment relationship.
  3. The broadcaster’s right to control the content of their programmes was considered “highly material”. If you are engaging a highly skilled individual to provide something new to your business, consider whether it is necessary to control how that service is provided. Further, if it is a project or end product that is being provided rather than a daily service, clearly reference that in the deliverables.
  4. Adherence to client policies. Asserting editorial control was considered a relevant factor in these cases. By analogy to more common commercial arrangements, overzealous adherence to company policies that may not be relevant are best avoided.
  5. Suspension and notice provisions imply an obligation to make work available and point towards mutuality of obligation.
  6. The third stage of the test is now a broader exercise and will involve a multi-factorial assessment of whether an employment contract exists. The courts have reaffirmed that this should not be a mechanical exercise but to “paint a picture from the accumulation of detail”. As such, it will be difficult to determine what weight will be given to each relevant factor in respect of each engagement. However, if a party is genuinely in business on their own account they should be treated as such, even if personal service and a level of control point towards an employment relationship. If the consultant has a recognised history of being in business on their own account and is set up as such and this is a continuation of this, it would be very sensible to record those details in the recitals to your agreement.

 

In summary, while greater precision is required to define the relationship, the principal test remains whether the contractor is in business on their own account. Some assistance in this analysis can be provided by HMRC’s CEST tool. However this tool has been criticised as unreliable and therefore clients would be advised to carry out their own more rigorous and detailed assessment.

 

Additional factors relating to those being engaged directly.

While the Court of Appeal’s approach will also be relevant to determining tax status for those engaged directly, there are two additional factors that need to be considered for clients in these circumstances:

 

  1. While IR35 creates a hypothetical contract of employment for tax avoidance purposes, the fact that there is an intermediary does still provide practical protection from an actual employment relationship. This barrier does not exist with those engaged directly.
  2. Tax classification is only interested in the distinction between employment and self-employment, but as set out above there is an intermediary statutory definition of worker that carries with it important statutory rights. If an individual is unable to establish an employment relationship, he or she may still be able to assert worker status if the determination of self-employment does not represent the true agreement between the parties. Recent decisions relating both to vulnerable workers in the gig economy and extending now into the broader economy, require tribunals to take a more purposive and less contractual approach to determining whether an employment or worker relationship exists. If established, workers will be able to assert claims for holiday pay, minimum wage, failure to meet pension auto enrolment obligations as well as pursuing discrimination claims in the tribunal.

 

If you are interested in finding out more on tax and employment status issues, please sign up to our latest podcasts, where this and other business related topics will be covered with guest speakers over the coming months.

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