Contractor avoids £141,000 tax bill with partial victory in IR35 tribunal ruling

IT contractor John Spencer’s company JLJ Services has won a partial victory in its four-year battle against HMRC. It is likely to significantly reduce the contractor’s original £141,000 tax bill, as Tribunal Judge Howard Nowlan ruled that only the last four of the seven-year contract with client Allianz were inside IR35.

Spencer’s representative, accountant Neil Awbery of ClearSky Accounting, said that the ruling came as no surprise following the evidence of Spencer’s client project manager from Allianz: “When asked by the Judge if there was anything to distinguish the contractor in the latter years of his contract from an employee, apart from the mechanism by which he was paid, John’s client answered ‘no’.”

But according to Awbery, the Judge was right to rule the first three years were outside IR35, thus reducing Spencer’s original £141,000 tax bill significantly. “We are waiting for the final settlement figures from HMRC,” adds Awbery.

Key facts of the case

• IT contractor John Spencer, contracting via his own company JLJ Services, worked on contracts for client Allianz from 2000 to 2007
• HMRC claimed he was inside IR35 for all seven years of the contract and insisted on a settlement of unpaid income tax and National Insurance Contributions (NICs), interest and penalties of £141,000
• Judge Howard Nolan ruled in a Bristol Tax Tribunal heard on 24 and 25 October 2011 that IR35 did not apply for the first three years of the contract, but after that Spencer had then taken on all of the characteristics of an employee
• Spencer moved from being on a series of contracts for specific projects to having a one-year contract that was extended repeatedly over four years; and during this time his client could ask him to work on any tasks, not specific projects. In other words, he had become a ‘tail-end charlie’
• The contract had a mirrored substitution clause, which the Judge said stopped short of being ‘a complete sham’; indeed, the client claimed any substitute would have to be interviewed and hired independently
• Control was limited up until the end of 2003, when Spencer “ceased to be engaged for identified projects” and was in reality more controlled by the client
• Spencer failed the ‘in-business’ tests as there was, in the Judge’s view, no opportunity to profit and Spencer was “simply paid for hours worked”
• Mutuality of obligation (MOO) was dismissed by the Judge as irrelevant: “...the [MOO] test is of diminished importance,” he said
• The parties’ intentions were also dismissed by the Judge as having “very little or no importance”. He said: “Their [Spencer and his client] opinion on what is a matter of realistic construction of the overall facts is of very minor significance.”

The client, as well as telling the Judge that Spencer was an employee in all but name, also said that using contractors was a convenient ruse to circumvent the German parent company’s rules on headcounts, when in fact the affected people should have been employees.

In his ruling, Judge Nolan also provided a bullet point summary of where he considered “the contract worker analysis to be realistic”. However, the summary includes several criteria that are simply not the case in the UK’s contracting sector and should be challenged, so that they are not applied in future cases.

Employer’s compliance review into full blown IR35 investigation

According to Awbery, Spencer, who has been a client of ClearSky since 1995, underwent a standard employer’s compliance review by HMRC in 2005. Whilst investigating general compliance issues, HMRC escalated the investigation into a status inquiry and asked to see Spencer’s contracts.

“The status inquiry started in 2007. HMRC determined that John was inside IR35 for the entire seven years of his time at Allianz, calculating a settlement of £141,000 in unpaid income tax and National Insurance Contributions (NICs), plus interest and penalties.

“We contested the proposed settlement, proposing a compromise, but HMRC refused to back down,” continues Awbery. “We then requested that HMRC conduct an internal review of the case before proceeding to tribunal. The result, which HMRC shared with us, supported the status inspector’s view, so a tribunal was inevitable.”

Personal reasons in both HMRC’s and Spencer’s camp were responsible for the two adjournments that followed, before the case was finally heard in October 2011.

Lessons for contractors

Awbery urges contractors to learn from Spencer’s experience in this case, particularly those who work on long-term projects. His advice is:

• Avoid long-term contracts. If contracts are extended, ensure that each one is a new contract and that it is for a specific project. Beware of morphing into the behaviours of an employee and becoming ‘part and parcel’
• Get the story straight with the client. Spencer’s client provided evidence that put him clearly inside IR35 in the latter years of his contract. By agreeing in writing with the client the nature of the client-contractor relationship from the outset, HMRC can be halted in its tracks.

“All the elements of an IR35 employment status case came into play in this ruling, with the added complication that John’s status changed over time,” said Awbery. “We did well to get the settlement reduced.”