The First Tier Tribunal has ruled against HMRC in the latest case concerning the IR35 rules – assessing employment status for tax purposes (RALC Consulting Ltd v HMRC).
RALC Consulting Ltd (RALC) was the personal services company of an IT contractor, who was the sole director and shareholder of the company. During the tax years in question, 2010/11 until 2014/15, RALC contracted largely with two main end clients, Accenture and the Department for Work and Pensions (DWP).
The First Tier Tribunal agreed with RALC’s argument that the contracts with Accenture and DWP were both outside of IR35. Key indicators of being outside IR35 were:
- insufficient Mutuality of Obligations (MOO) to establish employment status; and
- taxpayer had significant control over his own work.
What is IR35?
The aim of the IR35 rules was, as stated by HMRC in a press release when the rules were first introduced back in 1999, to prevent the situation where a person could 'leave work as an employee on a Friday only to return the following Monday to do exactly the same job as an indirectly engaged ‘consultant’ paying substantially reduced tax and national insurance'.
The IR35 rules have seen increased relevance lately due to technology advances enabling a shift towards a more flexible working environment. This led to the introduction of a new set of ‘off-payroll working’ rules, which were introduced for the public sector in 2017 and are due to be extended to the private sector (medium and large) with effect from 6 April 2021.
From 6 April 2021, in a significant change to the current position, it will be the end-user engagers of contractors who provide their services via personal service companies (rather than the contractor themselves), who will be required to:
- assess whether the IR35 rules apply to each contract; and
- where IR35 is deemed to apply to a contract following a status determination, comply with various tax compliance requirements, including withholding PAYE from any payments made to the contractor and accounting for the income tax, National Insurance contributions and Apprenticeship Levy to HMRC via monthly payroll.
What’s the significance of this case?
In preparation for the extension to the private sector of the off-payroll working rules, HMRC have updated their online guidance to employers on this complex area and have also updated their Check Employment Status for Tax (CEST) tool. The CEST tool is designed to assist employers to assess the status of any contractors they engage with, to determine whether PAYE should be applied to any payments made to them. Importantly, HMRC have stated that they will stand by any assessments made by the CEST tool where accurate information has been fed into it.
Over the years, the courts have referred to Mutuality of Obligations (MOO) as being one of the key indicators of an employment relationship. Where an employment relationship exists, there will be an obligation on the employer to provide paid work to the employee, and an obligation on the employee to perform that work.
One of the criticisms of HMRC’s CEST tool is that it does not consider MOO. This is in line with HMRC’s stated position, that MOO is essentially a pre-condition of all contracts ie, all contracts, whether employment or self-employment, will include an obligation to provide, pay for and perform services, so it is not necessary to consider this further in the CEST tool.
This judgement adds further weight to the argument that MOO remains a critical consideration. It’s entirely possible that any MOO that does exist as part of a contract may be insufficient to create an employment relationship. In the tribunal, the judge was 'not satisfied on balance that sufficient mutuality of obligations did exist between Alcock and the end clients in the notional contracts to establish an employment relationship……... Although there was some mutuality of obligations in respect of the requirement for payment if work was done, it did not extend beyond the irreducible minimum in any contract to provide services nor demonstrate the relationship was one of a contract of service'.
Although it was acknowledged that there was a degree of control over “when and where” Alcock provided his services, 'this was necessary to provide a quality of service for his clients”, and “Mr Alcock’s substantial level of control over how he provided his services was provided for as a matter of right in his contracts and exercised in practice.'
As with all cases the tribunal had to weigh up all the factors and decide whether a hypothetical contract between Alcock and the end client, would have the qualities of an employment contract or not. Taking into account not only on the contractual terms, but also on the working practice. Some other factors considered included:
- no notice was required to be given by DWP and 30-days’ notice by Accenture. Notice could be given without reason. One programme was stopped and the contract terminated early;
- there was a fettered substitution clause, such that each client had the ability to consider and decide whether to accept substitutes offered based on suitability, qualifications and expertise;
- he was not required to attend internal meetings at his clients, which were not specific to the delivery of his specific projects;
- he was permitted to work for other clients;
- he had no HR or wider management responsibilities than those necessary to collaborate on projects he was working; and
- he had to remedy any errors at his own cost and was liable in certain circumstances for negligence/ errors committed.
The judgement is also significant as during it HMRC said the outcome of the CEST tool in this case was irrelevant, because they disagreed that the questions had been accurately answered. Furthermore, HMRC also asserted RALC had been ‘careless’ in its assessment and therefore increased penalties would apply, despite the fact RALC had engaged professional advisers to advise it on the assessment. It goes to show it is very important that when using CEST those completing it are in possession of the full facts, understand the significance of using it and answer the questions accurately, because the result could be subject to challenge at a later date.
Finally, this case again demonstrates how crucial it is to ensure there is a detailed contract in place that clearly states the agreement under which both parties are engaging. The contract should be clear as to the extent of the key principles of MOO and ‘control’ and should accurately reflect the reality of the working arrangement.
Employers will be understandably nervous about HMRC’s stance, both in terms of the incorrect application of the IR35 rules and the CEST tool assessments. Employers should make their own determination as to how much reliance can be placed upon any assessments obtained from the tool.