IR35 and a Six Figure Tax Bill

The latest IR35 case to be publicised is that of an IT contractor who has been left with a bill for unpaid taxes, national insurance contributions and penalties totalling £141,000, following a four year battle with HMR&C. The case has really set the cat amongst the pigeons because previously significant factors, which were relied on in all previous IR35 cases, were considered to have little or no impact in this case.

John Spencer, 66 and now retired, was operating through his own limited company, JLJ Services Ltd, for the end client Allianz. Clearsky Accounting provided the accountancy services for Spencer's limited company and had originally deemed that his working practices fell outside of IR35. HMR&C disagreed and ruled that the contracts between 2000 and 2007 were all caught by IR35, and therefore, Spencer was liable for the outstanding tax and NI contributions across the whole 7 years. In a recent appeal, however, it was accepted that IR35 did not apply for the first 3 years, until 2003, when Spencer became integrated into the client's business and 'regarded as an employee'.

The main points of the case were:

  • The Right of Substitution (RoS) clause in the contract was added, in the words of the tribunal judge, to achieve the desired tax purpose and that it had 'virtually no bearing on their approach to deciding the case'. As a one man limited company, Spencer had no other employees to send in his place, in the event that he was unable to do the work himself and Allianz would have had to interview any substitute to confirm suitability. The judge stopped short of calling it 'a complete shame' but intimated that the clause was added purely as 'window-dressing'.
  • Control - Spencer changed from being on a series of different contracts for specific projects to having a rolling one year contract that was extended repeatedly over four years. During this period the client could ask him to work on any tasks, rather than have him undertake specific projects. This change in control was considered 'breaking the link with projects, and indicating that Mr. Spencer would work generally within the organization' and therefore placed him inside IR35 from 2003.
  • Financial risk – The judges disagreed that suffering financial loss if the agency went bankrupt was an indicator towards being in business on one's own account. It was further clarified that 'the sort of financial risk that sustains the 'own business' status is the loss, or the diminished profit that results from costs not being controlled' e.g. rectifying mistakes at your own cost and/or time.
  • Own Business - Mr Spencer failed the own business test because he was working under the direction, supervision and control of Allianz, ergo displayed characteristics of being an employee of the company. The judge stated that 'no opportunity to make more or less profit according to how efficiently he worked, how he managed to minimise and control costs and manage the cost of tools, assistants etc that would be involved if he was conducting a business in the ordinary sense. Mr Spencer was simply paid for hours worked.'
  • Mutuality of Obligation (MoO) – Allianz offered either employment or indefinite engagement in late 2003 and moved to a pattern of annual renewals on a non-project basis, which Mr Spencer continued to accept. The judge commented '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 seem realistic to say that his status must have changed.'  

Significantly the judge commented about the MoO test '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'. MoO was previously a major consideration when determining ones status under IR35 so this latest revelation will really affect people's tax planning arrangements going forward.

  • The parties' intentions, which were that Mr Spencer was not to be considered an employee of the company, were reflected in the contract but were dismissed as having 'little or no importance' as the clause did not actually reflect the reality of the arrangements.

This unprecedented verdict means that if you are a limited company contractor, or considering setting up your own company, it is now more important than ever to review your working arrangements. Failure to do so could result in a similar lengthy legal battle where the consequences are life changing.

Inside IR35?

If you are working under the direction, supervision and control of the end client, your working practices will fall inside IR35. The legislation is a great deal more involved than this though, as this latest case shows, so please do not hesitate to contact one of our expert advisors on 01206 713 680 or info@contractorumbrella.com to discuss how ContractorUmbrella can help you avoid the potential pitfalls.