HMRC have recently made some amendments to their Employment Status Manual. These amendments include updates on case law following their wins in the IR35 cases of Dragonfly Consultancy and Larkstar Data.
The purpose of the Employment Status Manual is to provide guidance to both HMRC staff and the general public. It provides information on how HMRC will conduct an IR35 investigation and the issues which they will rely upon in such circumstances. To date, four IR35 cases have been heard at the highest courts: Dragonfly, Larkstar, Synaptec and Usetech – all of which have been won by HMRC. These cases had their differences with regards to the points of law challenged and the issues aired. Kate Cottrell, IR35 expert with Bauer & Cottrell, advises that anyone wishing to challenge an IR35 investigation using non-IR35 case law precedent should be very wary.
The Dragonfly and Larkstar cases took two different routes to the High Court. With regards to Dragonfly, the case was initially heard at the Special Commissioners where the taxpayer lost the case and subsequently appealed to the High Court. HMRC won. By contrast, Larkstar was originally heard at the General Commissioners and the taxpayer won the case. HMRC then appealed to the High Court and won this appeal resulting in the case being remitted to a new set of Commissioners. The taxpayer then withdrew resulting in a win for HMRC.
HMRC have a four out of four success rate which they have built on all three status tests: substitution, control and mutuality of obligation. Speaking to Contractor UK, Cottrell looked at all three in further detail.
Regarding substitution she cited ESM3345 as is quoted in the HMRC Employment Status Manual: “In the case of Dragonfly Consultancy Ltd v HMRC Henderson J found that Dragonfly was a one-man company, whose raison d’être was to supply Mr Bessell’s services – therefore it was obvious that the intention of both parties was that it would be Mr Bessell who would provide the services. This provides the principle that, unless there is evidence to the contrary, the arrangement itself demonstrates the requirement for personal service in one person companies.”
With regards to the Larkstar case, a right of substitution existed but was not exercised since any substitute was required to undergo such strict procedures as the contractor themselves. HMRC successfully arguing this case will set a precedent for any future contractors arguing a “reasonably fettered” right of substitution.
In terms of mutuality of obligation, this issue was not actually raised as a point of appeal. Instead it was discussed purely to highlight the differences in tax and NICs with regards to IR35. When the Special Commissioners made their decision they stated that the end client was paying the worker to ensure his availability even when there was no work available. They also found that the worker was able to average out hours, working more some week and less the following. This means that the need for personal service and payment for work done was able to reduce the mutuality of obligation.
Larkstar was different in that the lack of mutuality of obligation was one of the most relevant factors which saw the Commissioners determine independent contracting. Sir Donald Rattee found that this was misdirection as to the law on the part of the Commissioners who failed to take into account the mutual obligations during an engagement as well as the work offered outwith the contract. He cited the statements of principle by the Court of Appeal in Cornwall County Council v Prater which he felt were ignored by the Commissioners.
Previously, IR35 investigations related solely to ‘how’ services were performed when examining the principle of control. However, this changed with Dragonfly when there was no expectation of how the skilled worker would perform his duties but there were question marks regarding ‘what’ the worker was doing and moreover ‘what’ was actually subject to supervision, direction and appraisal. This means the principle of control now pertains to ‘how’, ‘what’, ‘when’ and ‘where’. The Dragonfly case showed control in both written contracts and in the reality of daily work.
The General Commissioners determined control on 2 aspects in the Larkstar case but HMRC’s appeal was upheld by Sir Donald Rattee. They believed that as Mr Brill was a consultant the end client had no control over how he did his work but HMRC stated that no account was taken of the authorities which were stated at the hearing. Secondly, the General Commissioners stated control in relation to Mr Brill stating that he was expected to work 37 hours – core hours. However, the findings actually showed that his hours of work differed and he was subject to averaging of hours meaning he worked more some weeks and less on others.
With regards to cases relating to an incorrect legal interpretation, including IR35, it is often not about the sum of money involved. HMRC say: “Sometimes it will be necessary to take up issues where there is a relatively small amount of tax in the case itself, because of the wider implications of the point at issue.”
HMRC published their Litigation and Settlement strategy three years ago which details their principles for concluding tax disputes. The subsequent updates to the Employment Status Manual serve to strengthen the IR35 rule. The rule has long been a contentious issue with contractors but the success rate of HMRC in these cases cannot be ignored. Besides, the rule is responsible for millions of pounds in taxation and NICs annually.
The cases tried so far, and won by HMRC, have not been subject to the new stricter penalties available to HMRC. However, they will from now on which means that a contractor must ensure that he is in no doubt over his IR35 status.
As it stands, HMRC has won the IR35 Judicial Review, 10 Special Commissioners cases and 4 High Court cases. Only 5 Special Commissioners cases have been won by the taxpayer. IR35 expert, Kate Cottrell, advises that all contractors must ensure they take full account of their actual working practices and all relevant case law in order to determine IR35 status. After all, the HMRC track record speaks for itself.