Court ruling against dragonfly consulting limited:
NES seeks to understand the implications for IR35...
The contracting press went into overdrive following the recent High Court decision regarding ‘Dragonfly’ and, as often happens on these occasions, contractors can be confused about the messages that are being sent out. NES Group commercial director, Stephen Rookes said “to ensure that our own contractors are fully briefed on the impact of the case and the steps that they need to take to reduce any exposure to tax/NIC or penalties, we asked a leading IR35 expert (and ex-HMRC tax inspector) John Hill of John Hill & Associates to provide an overview of the relevant issues and to give practical advice on what our contractors need to consider going forward.”
Response provided by John Hill
“Starting with the basics first, this was an IR35 decision affecting those contractors who operate through a personal service company and have part of their income paid in dividends. It does not affect those contractors who are paid through an employment umbrella company (and whose fees are all subject to PAYE) or individuals who have a limited company (including companies treated as managed service companies) where the whole of the fee income, less eligible expenses, is also subject to PAYE.
The case is of considerable importance to other individuals who offer their services through a limited company and treats one or more of their assignments as being outside of IR35 whereby part of the fee income is paid out in dividends. It reverses a growing trend by contractors, and some advisers, to regard IR35 as something of the ‘forgotten’ tax following the introduction of the MSC legislation in April of 2007, but more than that, it has placed a new emphasis on those factors that give rise to an individual being regarded as an independent freelance contractor outside of IR35.
Individuals who may previously have regarded themselves as outside of IR35, or have received an opinion that they are likely to be outside of IR35 will need to consider the effects of this decision on their own circumstances.
To put this into context, the contractor in Dragonfly had the usual trappings of being in business, including a website and adverts in Yellow Pages etc., and generally worked under his own initiative in carrying out the work under a non-exclusive contract which gave him a qualified right to send a substitute. He also incurred some costs on equipment and training, and was obliged to pay for a dedicated ISDN line in view of the client’s security requirements. However, notwithstanding these factors, which the judge ruled were only minor pointers away from employment, the contractor was considered to be subject to IR35 and now faces arrears of just under £100,000 over a period of six years. In explaining their decision, which supported an earlier ruling by the Special Commissioners, the judges pointed to four key factors:
(a) the level of control exercised by the client,
(b) the lack of any real likelihood of the contractor being able to send a replacement whenever he wished,
(c) the extent to which contracts with one client had simply been extended, and was not project based,
(d) the extent to which the contractor was seen as part of the client’s organisation.
The Control test
It was accepted that the client did not tell the contractor how to do the work because he had the skills himself but this was not considered to be a sufficient test of control for a skilled professional worker. What was of more importance was the fact that the client told him what work to do and when to do it, and he was generally subject to the guidance of his team and team manager who carried out periodic reviews of the contractor’s work. These were considered to be sufficient right of control by the client.
The Substitution test
Although the contract between the contractor and the agency provided for the worker to send a substitute with the reasonable approval of the client, the judge concluded, on the evidence, that the named contractor was the individual the client wanted as he was the one that had been interviewed for the work. The client supported this by confirming that it was unlikely a replacement would have been acceptable to them in practice.
The extension of contracts and lack of project based work
The contractor was an extremely experienced IT tester who had worked on a series of contracts for the one client over a number of years. The judges found that his work was not project based and he was simply allocated work as and when it was required. There was no evidence that he performed any significant work for other clients during this period. He was engaged in relation to the work to be done on a specific project but not to deliver anything other than his services in providing testing in relation to that project. In that respect he had a role similar to a professional employee. Doing whatever work the end client finds necessary, and billing for it under a contract is considered to be a strong indicator of IR35.
Part & Parcel test
The contractor was considered to be integrated into the client’s business. He attended all the weekly employee meetings, he ate in the staff canteen and had a dedicated ISDN line that ran to the client’s offices. In those respects he was acting in a similar way to the client’s own employees. In general, because of the time he had spent on the client’s premises over the years, working generally to a 37.5 hour week, he was seen as part and parcel of the organisation rather than as a freelance self-employed worker.
Conclusion
Although perhaps not welcomed by the contracting industry, the Dragonfly case has gone some way to focussing attention on those factors that are regarded as important indicators of IR35 status. In particular, it is now more likely that a contractor in the following circumstances will be subject to IR35:
- simply undertakes the work allocated to him or her by the client and/or is available for many different assignments irrespective of the contractual project,
- is part of a client team subject to the client’s guidance and review,
- is generally told when the work is to be performed,
- has no significant financial risk or expenditure in the assignment (the cost of basic training courses, minor equipment including laptop PCs etc, are not considered to be significant),
- is simply paid by the hour for the hours required by the client.
Genuinely operating outside IR35
For a contractor to genuinely be outside of IR35, it is important that the four tests above (or as many as possible) are not shown to apply. In particular this means for limited company contractors:
- working only on specific projects and not simply being available to have tasks allocated by the client,
- having a say in when the work is undertaken,
- not being seen as integrated within the client’s organisation (ie not having a job title, not being included in internal directories, not being seen as part of a client team or receiving newsletters etc designed for employees etc.),
- not working exclusively for one client over an extended period,
- not having work routinely reviewed or supervised by the client (apart from a progress report),
- having a right to send a substitute and maintaining an employers liability insurance to enable the limited company to ‘employ’ a substitute,
- there is a significant financial risk in the assignment (eg. rectify work at your own cost and invest in your company),
- insurance is maintained by the limited company in respect of its services (professional indemnity) and liability to third parties (public liability insurance),
- the contractor provides a whole service and not simply personal labour.”
Finally, John notes that “following the Dragonfly ruling, all contractors with a limited company are urged to take professional advice on whether their own current assignments are caught by IR35. HMRC can seek recovery of taxes and NIC over the previous six years where applicable as well as imposing interest and penalties, so contractors cannot rely on the fact that they have not yet had an enquiry from HMRC. However, under the new penalty rules which come into effect on 6 April 2009, HMRC have confirmed that a contractor who has sought a professional opinion on his or her IR35 status is unlikely to face a penalty unless key factors were suppressed in requesting that opinion. This makes it even more important that IR35 reviews are routinely carried out in future.”
Stephen adds “for those contractors who may be concerned about their IR35 position, NES has agreed with John Hill & Associates that they may have an IR35 review carried out a discounted rate of £50 plus VAT per contract/assignment (normal price £75 plus VAT).” To find out more about this valuable service, visit our website at www.nesgroup.com/Group-IR35-Contract-Review, or send an email to enquiries@johnhillassociates.co.uk or visit their website at www.johnhillassociates.co.uk
