IR35: Financial risk and payment
Another indicator as to the employment status of a worker is whether any personal financial risk is incurred as a result of the performance of the work duties, or by the way that payment is made for the services provided.
In general terms, if self-employed, a person will incur more financial risk in that they may need to incur personal capital expenditure on certain items (such as marketing, tools and equipment). Flexibility to choose any charge-out rates or costs for the job is illustrative of self-employed status which can allow for more profit, but also carries the risk of incurring a loss if the job takes longer than anticipated.
In contrast, employment provides more certainty as to payment to an individual and minimises liability as the employer is ultimately responsible for incurring costs and receiving payment from the client or customer.
It is not always clear and the most up-to-date HMRC Employment Status Manual still refers to the case of Market Investigations Ltd v Minister of Social Security [1969], which states that the degree of financial risk and the way in which a person is paid can be a determining factor when considering employment status.
Likewise, more recent case law endorses that this issue still can be a determining factor:
Ashton v Revenue and Customs Commissioners First-tier Tribunal (Tax Chamber) - October 2016 was an appeal against the decision by HMRC to treat the appellant as a self-employed partner of Karate World, a martial arts instruction business, rather than as an employee.
Karate World is a martial arts instruction business; it began an unspecified number of years ago as a sole trader business with, eventually, a number of employees including the appellant. In October 2003, the proprietor of the business considered options for growing the business and set up a partnership with a number of the employees as partners, including the appellant.
The appellant explained that he took no financial risk in the business; he had no access to partnership bank accounts. He accepted that he was a signatory on a partnership savings account, which he believed had been set up to take the profits split from the various schools. A percentage of profits from each school was paid into the account in order to pay bonuses to the chief instructor in a school if that school met its targets. The appellant explained that he had nothing to do with the account and that he didn't know why he was a signatory. On balance, considering all the factors, it was found that the appellant was an employee of Karate World.
A more recent case is a good illustration of the sort of issues to consider. This is the case of Tomlinson v Revenue and Customs Commissioners First-tier Tribunal (Tax Chamber) - June 2017.
This relates to the employment status of a glazing salesman who had worked in the industry for more than 35 years selling mainly conservatories and double glazing. Following a tax investigation into his affairs in 2013, the issue of employment status was closely considered by the adviser he appointed to deal with the investigation who thought he should be considered as an employee rather than self- employed.
After two years of significant discussion and representations, agreement could not be reached with HMRC as to his employment status. HMRC then issued a decision that he was self- employed and this was appealed to the First Tier Tribunal. It was submitted on behalf of Mr Tomlinson that he should be considered as an employed person as opposed to self- employed.
In support of the argument that he was employed, representations were made that: Mr Tomlinson had no real financial risk. Although it was accepted that if Mr Tomlinson did not turn up for work, he would not make a sale and would therefore not earn any money. However, this was likened to an employee on a zero-hours contract who would also not earn any money if he did not do any work.
It was also accepted that there were circumstances in which Mr Tomlinson's commission could be cancelled, reduced or clawed back. In addition, it was accepted that Mr Tomlinson would incur some expenses in running his car and paying for his mobile phone. However, it was submitted on behalf of Mr Tomlinson that these amounts were trivial.
To support the fact he was employed, it was also submitted that Mr Tomlinson could not profit from sound management in the performance of his task; that he was dependent on leads allocated by the company and in any event, was subject to the parameters imposed by the company in his negotiations with potential customers.
The submissions referred to the decision in Hall v Lorimer where Nolan LJ's conclusion was that the expenses incurred by Mr Lorimer were "quite different in nature and scale from those likely to be incurred by an employee". (In that case, the expenses in 1985/86 were approximately £10,000, whereas Mr Tomlinson's expenses would have been significantly less than this).
It was also submitted that, in circumstances where Mr Tomlinson's commission was reduced (for example, as a result of giving a discount of more than 25%), the reduction in the price paid by the customer was borne partly by the company and partly by Mr Tomlinson which again reduced any financial risk taken by Mr Tomlinson. There were also periods when Mt Tomlinson received regular payments which it was said pointed towards employment rather than self-employment.
Mr Tomlinson did not submit formal invoices for his work but just a commission claim. If Mr Tomlinson was truly self-employed, it was submitted that he should have issued proper invoices.
Now let’s look at what was submitted in support of self- employed status. In setting out its rather different view, HMRC drew on the fact that Mr Tomlinson only received commission and only became entitled to the commission when there was a completed order and was at risk of a reduction or claw back of commission if something went wrong, saying it shows that he was in fact taking a significant financial risk.
In the view of HMRC, financial risk does not mean that there has to be a possibility of a meaningful loss and HMRC also referred to further comments by Nolan LJ in
124. She also referred to Nolan LJ's comment in Hall v Lorimer [at 217] that:
"The risk of bad debts and outstanding invoices is certainly not one which is normally associated with employment."
HMRC said that the fact that Mr Tomlinson was paid only on the basis of commission was significant. He could work as many hours as he liked but if he failed to achieve any sales, he would not earn anything. This therefore was a very great financial risk compared to an employee who would normally be paid for the work which he does.
The Tribunal’s finding was as follows: “Whilst it would not be impossible for someone who is paid only on the basis of commission to be an employee, our view is that in this case that Mr Tomlinson was taking a significant financial risk in being paid only on the basis of a commission for successful sales. He did have the opportunity to increase his profits by generating his own leads and negotiating better deals and he did incur expenses which would reduce his profits and could in theory result in a loss. In this particular case, we think this is a fairly strong indicator of self-employment rather than employment.”
Written by Jonathan Wright, tax investigation solicitor and partner at Richard Nelson LLP.
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