IR35 detailed comment

The legal question to be answered

Statute

'IR35' is now reflected in Schedule 12 to the Finance Act 2000.  The basic legal test is set out in paragraph 1 of that Schedule:

' 1. - (1) This Schedule applies where-

(a)           an individual ("the worker") personally performs, or is under an obligation personally to perform, services for the purposes of a business carried on by another person ("the client"),

(b)          the services are provided not under a contract directly between the client and the worker but under arrangements involving a third party ("the intermediary"), and

(c)           the circumstances are such that, if the services were provided under a contract directly between the client and the worker, the worker would be regarded for income tax purposes as an employee of the client.

…

(4)           The circumstances referred to in sub-paragraph (1)(c) include the terms on which the services are provided, having regard to the terms of the contracts forming part of the arrangements under which the services are provided.'  ^[1]

The decision in the PCG Judicial Review case has emphasized that the reference to the contracts in subparagraph (4) is not exhaustive;  rather, that other circumstances must also be taken into account. 

It is, as Dr Plender QC accepts, essential to any consideration of the common law test as to whether an individual is trading as an employee or as an independent contractor, that consideration should be given to whether he is in business on his own account: see for example Market Investigations Ltd v Minister of Social Security [1969 2 QB 173].

The legislation requires consideration on an engagement by engagement basis; the tax and NIC payments are required to be calculated by reference to each separate engagement, and the circumstances to be considered

"include the terms on which the services are provided, having regard to the terms of the contracts forming part of the arrangements under which the services are provided".

Notwithstanding this however, the question of whether the service contractor himself has, prior to that engagement, performed or is, simultaneously with that engagement, performing [an important contrast to the duty of fidelity ordinarily owed by an employee], or will subsequently, after the termination of that engagement, perform, services for others, and is to be construed as carrying on business on his own account, is and must be a central consideration.

That this is in fact accepted by the Revenue is clear from the Examples given by the Inland Revenue in the February Guidance referred to in paragraph 18 above. The fact, as analysed in that document, that

"Charlotte and her company have a business organisation - including an office and associated equipment based at Charlottes home ... a variety of clients and all her contracts have been, fairly short term"

is said to be a

"strong pointer to self-employment ". 

Of course, whether such pointer is determinative may depend upon the nature of a particular assignment.  She may be self-employed for much of the year, and yet, in relation to a particular assignment, perhaps by virtue of its length or its specific arrangements, she may be considered as an employee for the purposes of IR35. There must he careful consideration of this by the inspector; and sufficient information must be given to the inspector by the service contractor and his accountant in order for him to reach the appropriate conclusion.

Note that in particular, notwithstanding the terms of the contracts themselves, the question of whether the individual performs services for other clients (before, or during, or after the contract in question - and particularly, during):, ,

' and is to be construed as carrying on business on his own account, is and must be a central consideration' [2]

Note also that Dr Plender (the Revenue's own barrister) accepted that consideration of that fact - being in business on one's own account - was an 'essential' consideration when considering the status of any individual contract.

The fundamental question to be answered is whether the individual ('the worker') would (hypothetically) have been an employee of the Client or not, were it not for the fact that there are limited companies in between.  If so, then given certain other facts (which I have said I will assume  for the purposes of this opinion to be present here), the contract will be a 'relevant engagement' within the meaning of the legislation, and so the income from the contract will taxable under its provisions.  If not, then the rules will not apply, and the contract will be outside the scope of the Service Companies Legislation.

This in turn is a question to be answered by imposing the hypothetical relationship specified by the Act onto the framework of the existing body of case law.

Revenue guidelines - generally

On this subject (imposing the hypothetical relationship specified by the Act onto the framework of the existing body of case law) the Revenue say:

The Approach to be adopted

Whether a worker would have been an employee if engaged directly by the client depends on a range of factors, set out in this article.  But the final decision is not reached by adding up the number of factors pointing towards employment and comparing that result with the number pointing towards self-employment. The Courts have specifically rejected that approach. In Hall v Lorimer  ^[3] Mummery J made the following comment which was quoted with approval by Nolan LJ in the Court of Appeal:

"In order to decide whether a person carries on business on his own account it is necessary to consider many different aspects of that person's work activity. 

This is not a mechanical exercise of running through items on a check list to see whether they are present in, or absent from, a given situation. 

The object of the exercise is to paint a picture from the accumulation of detail. 

The overall effect can only be appreciated by standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative appreciation of the whole. 

It is a matter of evaluation of the overall effect of the detail, which is not necessarily the same as the sum total of the individual details.  Not all details are of equal weight or importance in any given situation. 

The details may also vary in importance from one situation to another.' [4]

When the detailed facts have been established the right approach is to stand back and look at the picture as a whole, to see if the overall effect is that of a person in business on his own account or a person working as an employee in somebody else's business. If the evidence is evenly balanced the intention of the parties may then decide the issue (Massey v Crown Life Insurance Co  ^[5]).'  ^[6]

These notes must now be read against the background of the comments referred to above in the PCG Judicial Review case, in which the significance of performing services for other clients (before, during and after) was emphasized, and even acknowledged by the Revenue's own barrister. [7]

In relation to agency contracts, the Revenue say:

'The terms of contracts used by service company workers who obtain engagements through agencies tend to be of a standard form. Such contracts typically require the worker to work on the client’s premises, use the client’s equipment, work standard hours, be paid at an hourly rate and be subject to a high level of control. In such cases, the opinion of the IR about the engagement is likely to be that it would be employment.

Where a worker is engaged on this type of contract for a period of one month or more, and cannot demonstrate a recent history of work including engagements which have the characteristics of self-employment (see the third example below) then we will say that the engagement would have been employment and therefore be covered by the new rules. Where the contract is for less than a month, then, although the engagement may still have been one of employment, the status position will be considered on a case by case basis.'  [8]

These comments have been criticized scathingly by the Judge in the PCG Judicial Review case as 'inflexible', and their consequences described as 'inappropriate';  the Judge made clear that, standard agency contract or not, it is still necessary to consider all relevant factors. 

It is, in my judgment, inappropriate that there should be in the February Guidance, which contains the helpful assessment of the positions of Henry, Gordon and Charlotte, the apparently inflexible stance that it is only where a contract in the agency's standard terms is for less than a month that the

"status position will be considered on a case by case basis".

Although it is right to say that the same Guidance makes it clear that in respect of such contracts for more than one month the Revenue will not automatically assume that it is to be treated as employment where the service contractor can

"demonstrate a recent history of working including engagements which have the characteristics of self-employment',

there may still be other factors to consider. Clearly some uncertainty could be resolved by the drafting, agreement and approval of a series of acceptable new standard forms.

The Judge's comments suggest that his view is that the IR35 status of each engagement should be considered on its own merits, and that the Revenue's statement of their position in this guidance on agency standard contracts is unsupportable.  This would certainly be consistent  with legal authority.  [9]

Case law - the 'irreducible minimum' - is the relationship capable of amounting to 'employment' (contract of service)?

In Ready Mixed Concrete South East Limited v Minister of Pensions and National Insurance  , MacKenna J said:

"A contract of service exists if these three conditions are fulfilled.

(i)       The servant agrees that, in consideration of a wage or other remuneration, he will provide his own work and skill in the performance of some service for his master.

He agrees, expressly or impliedly, that in the performance of that service he will be subject to the other's control in a sufficient degree to make that other master.

(ii)              The other provisions of the contract are consistent with its being a contract of service.'  ^[10]

This was recently approved by the Court of Appeal in Clarke v Oxfordshire Health Authority 1998  ^[11], in which it was said, referring to the above:

"There must, in my judgment, be an irreducible minimum of obligation on each side to create a contract of service. I doubt if it can be reduced any lower than in the sentences I have just quoted"

It was again even more recently approved in Express and Echo Publications Limited v Tanton 1999  (Court of Appeal)  ^[12].

Returning to Ready Mixed Concrete South East Limited v Minister of Pensions and National Insurance [13], on the issue of control, McKenna J. continued explaining that in order to find where the right of control resides

"…one must look first to the express terms of the contract, if they deal fully with the matter one may look no further. If the contract does not expressly provide which party shall have the right, the question must be answered in the ordinary way by implication."

Again, on the issue of whether or not the provisions were consistent with it being a contract of service: This condition, the Judge felt, was the important one and he gave five examples to explain what he meant by provisions inconsistent with the nature of a contract of service.

'A contract obliges one party to build for the other, providing at his own expense the necessary plant and materials. This is not a contract of service, even though the builder may be obliged to use his own labour only and to accept a high degree of control, it is a building contract. It is not a contract to serve another for a wage, but a contract to produce a thing (or a result) for a price.

A contract obliges one party to carry another's goods, providing at his own expense everything needed for performance. This is not a contract of service it is a contract of carriage.

A contract obliges a labourer to work for a builder, providing some simple tools, and to accept the builder's control. Notwithstanding the obligation to provide the tools, the contract is one of service. That obligation is not inconsistent with the nature of a contract of service. It is not a sufficiently important matter to affect the substance of the contract.

A contract obliges one party to work for the other, accepting his control, and to provide his own transport. This is still a contract of service. Transport, in this example is incidental to the main purpose of the contract.

A contract provides both that one party shall work for the other subject to the other's control, and also that he shall sell him his land. The first part of the instrument is no less a contract of service because the second part imposes obligations of a different kind.

In other words, while an obligation to do work subject to the other party's control is a necessary, though not always a sufficient, condition of a contract of service, if the provisions of the contract as a whole are inconsistent with its being a contract of service, it will be some other kind of contract.'

(emphasis added)

These cases suggest three preconditions, all of which must be satisfied, before one can move on to consider the 'factors' extracted by the Revenue -

·         personal service;  and

·         submission to a sufficient degree of control;  and

·         nothing else inconsistent with an employment relationship.

 - and that if even one of those preconditions is not satisfied, then the relationship cannot as a matter of law be employment - however the other factors may point.  The 'irreducible minimum'.

In a recent case (Express and Echo Publications Limited v Tanton 1999  (Court of Appeal))  ^[14] it was said:

‘…the correct approach is as follows:

(1) The tribunal should establish what were the terms of the agreement between the parties. That is a question of fact.

(2) The tribunal should then consider whether any of the terms of the contract are inherently inconsistent with the existence of a contract of employment. That is plainly a question of law…

(3) If there are no such inherently inconsistent terms the Tribunal should determine whether the contract is a contract of service or a contract for services, having regard to all the terms. That is a mixed question of law and fact.’

So again we have the proposition that if any of the terms are inherently inconsistent with employment, then the relationship cannot be employment.

The significance of that last point (mixed question of law and fact) emerged in the Synaptek case;  this was an appeal from General Commissioners, and the High Court held that it could only therefore interfere with the decision if the Commissioners could be shown to have misdirected themselves and that the conclusion they reached was an impossible one – in that case it was not possible to say that the commissioners were wrong in their decision.

The importance of these preconditions has been emphasized by the Court of Appeal as recently as 9^th March 2001.[15]

For my part, I regard the quoted passage from Ready Mixed Concrete as still the best guide and as containing the irreducible minimum by way of legal requirement for a contract of employment to exist. It permits Tribunals appropriate latitude in considering the nature and extent of "mutual obligations' in respect of the work in question and the "control" an employer has over the individual. It does not permit those concepts to be dispensed with altogether. As several recent cases have illustrated, it directs Tribunals to consider the whole picture to see whether a contract of employment emerges. It is though important that "mutual obligation" and "control" to a sufficient extent are first identified before looking at the whole.

Case law - where the relationship is potentially capable of amounting to 'employment' (contract of service)

Is the individual in business on his / her own account?

"The fundamental test to be applied is this: "Is the person who has engaged himself to perform these services performing them as a person in business on his own account?" If the answer to that question is "yes," then the contract is a contract for services.  If the answer is "no," then the contract is a contract of service.'  [16]

Consider 'many different aspects' - do not run 'through items on a checklist'

"In order to decide whether a person carries on business on his own account it is necessary to consider many different aspects of that person's work activity.  This is not a mechanical exercise of running through items on a check list to see whether they are present in, or absent from, a given situation.'  [17]

There is no exhaustive list of aspects to be considered - or of the relative weight to be given to those considerations

'No exhaustive list has been compiled and perhaps no exhaustive list can be compiled of the considerations which are relevant in determining that question, nor can strict rules be laid down as to the relative weight which the various considerations should carry in particular cases.'  [18] 

Beware the dangers of assuming that just because one factor may have pointed one way in one case, it will carry the same weight (or even that it will always point in the same direction) in another case;  it may do - or it may not.

"It is in my judgment, quite impossible in a field where a very large number of factors have to be weighed to gain any real assistance by looking at the facts of another case and comparing them one by one to see what facts are common, what are different and what particular weight is given by another tribunal to the common facts.  The facts as a whole must be looked at, and what may be compelling in one case in the light of all the facts may not be compelling in the context of another case."  [19]

Then step back and view the detailed picture

'The object of the exercise is to paint a picture from the accumulation of detail.  The overall effect can only be appreciated by standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative appreciation of the whole.  It is a matter of evaluation of the overall effect of the detail, which is not necessarily the same as the sum total of the individual details.  Not all details are of equal weight or importance in any given situation.  The details may also vary in importance from one situation to another.'  [20]

All of the above quotes either came from, or were specifically approved in, the leading case of Hall v Lorimer 1994.  None of the above comments have been contradicted in any later case.  This case effectively drew the threads together, and may be taken to represent the law as it stands today, in relation to circumstances which are potentially capable of being 'employment'. 

Overall, the difficulties of defining universal rules to find the dividing line between employment and self-employment were neatly (though perhaps simplistically) summarised by Lord Denning in an old case as follows  ^[21]:

'it is often easy to recognise a contract of service when you see it but difficult to say where the difference lies. A ship's master, a chauffeur and a reporter on the staff of a newspaper are all employed under a contract of service; but a ship's pilot, a taxi-man and a newspaper contributor are employed under a contract for services.'

The decision in the PCG Judicial Review case has emphasized that it is always necessary to consider all potentially relevant factors. [22]

Relationship between case law, and the Revenue's guidelines

It is important to remember that the 'bottom line' is that it is the body of existing case law, together with the Courts deciding new cases, that is decisive - and not the Revenue's opinion.  Here (as in many other areas of their material), whilst what the Revenue say may appear to be largely accurate, it is not necessarily a complete statement of the law as it presently stands - and it is, to an extent, misleading - for example, it implies that the only factors which are to be taken into account are those mentioned in their guidelines, which is certainly not what the case law shows.

A proposition by the Revenue which appears to have no legal authority as its basis remains no more than a proposition, and does not acquire the status of legal authority, however many times it may be repeated, until and unless approved by a Court, thereby becoming embodied in case law.  The fact that the proposition may come from the Revenue (as opposed to anyone else) gives it no greater status in the eyes of the Courts.

It would appear that what the Revenue have done in their guidelines (which themselves are a simplification of the content of their own Employment Status Manual[23]) is to seek to present a series of 'factors' (some of which have featured in past cases, although not always in the way the Revenue have presented them in their guidelines). 

·         It must be remembered however that each of these (and indeed any other factor) will only be helpful, to the extent that in the circumstances of the particular case in question, it helps towards a conclusion as to the nature of the relationship in that case - beyond that, the factors themselves have no intrinsic importance - whether because they have been embodied in the Revenue's guidance, or otherwise. 

·         Furthermore, the Revenue's list of 'indicia' cannot be said to be exhaustive;  any 'indicium' which tends to show that a given set of facts is more likely to be consistent with either employment or self employment is helpful and may validly be taken into account, before taking the step back to view the whole picture. 

·         Given that the case law specifically says it is not a matter of running through a checklist, but instead involves that mental act of stepping back and viewing the whole picture, it follows from simple application of logic that if, viewed against the background of a particular situation, a factor points towards either particular conclusion, then it is helpful  - and if it is not, then it should be disregarded. 

The 'indicia' covered by the Revenue's own materials do however give an indication of what the Revenue's position is likely to be, and of how the Revenue are likely to view the matter themselves - but that does not necessarily mean that a Court would support that position;  their position must stand on its own two feet before a Court would support it.

Thus the Revenue are likely to seek to identify the position in relation to each of the 'indicia', to relate that to their own guidelines, and form a view as to whether that 'indicium' is an indicator towards employment or self-employment.  Indications so far suggest that in practice if a factor supports employment they will rely on it, whilst if it supports self-employment they are likely to ignore it.

The more one examines the Revenue Guidelines on these 'indicia', the more one feels lead to the view that despite the existing and clear case law, which makes clear that the decision is emphatically not  one to be reached by running through a checklist, their interpretation of the indicia they include (and the importance they place on them) is in many cases so simplistic as to be positively unhelpful in addressing the real question - imposing the hypothetical relationship specified by the Act onto the framework of the existing body of case law, and forming a view as to whether or not the real relationship here is or is not of the employment type, and therefore fails or passes the test.  Further, the 'indicia' the Revenue include appear to be focused around the unskilled or semi-skilled worker, or the exploiter of physical equipment, and in many places are unhelpful (and indeed misleading) when considering the position of the professional who brings with him his own blend of specialised knowledge, and hard-won experience and expertise.

In relation to agency contracts, the point can be put more forcefully:  there is absolutely no legal authority which might justify the Revenue's position;  their declaration that provided only a handful of conditions are satisfied, they will treat the relationship as one of employment, flies in the face of all existing case law and of the principles which the Courts have laid down for deciding such issues. 

It has to be said that the overall impression is given of the Revenue quoting from such issues as have been covered in the Courts - and then seeking to nullify them where they lead towards a non-employment conclusion - whether misleading by half-statements of the position, or by repeating positions and arguments which have already been rejected by the Courts.

The real point is that the issues are nothing like as simple or as clear-cut as the Revenue would seek to present.  Or, perhaps, as they might wish them to be.

The above comments are reinforced by the comments of the Judge in the PCG Judicial review case.  [24]

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