IT contractor loses IR35 appeal

An IT contractor whose company was listed on his stationery, on his website and in Yellow Pages was akin to an employee and owes £27,000 in employment taxes under IR35.

Ruling in favour of HMRC, the Special Commissioners said Martin Ellwood, director of MKM Computing Ltd, became "part and parcel" of his client's firm between 1998 and 2002.

During this time, working as a contract analyst programmer for insurer London General Holdings, Mr Ellwood went without sick pay, holiday pay or employee appraisals.

Another aspect of his work that might have pointed away from employment was the right of substitution in MKM's contract with Proactive, a Birmingham-based recruitment agency.

Mr Ellwood believed it was his "implicit right" to send another person in place of himself, for example if he fell ill, and he thought this was clear to Paul Jarrett, LGL's IT director.

But reflecting on the commissioner's judgement, experts say the lower contract between Proactive and MKM "did not mirror" the upper contract between Proactive and LGL.

"On the issue of substitution, the Special Commissioners found that the contract was for the specific services of [only] the named contractor," said Kate Cottrell, founder of Bauer & Cottrell, the IR35 advisory.

"The upper contract contained a limited right of substitution where the worker was unable to perform the services. The lower contract allowed the worker to propose a substitute but any substitution was always subject to the approval of the client and the agency."

Speaking to CUK last night, Ms Cottrell said that case law shows that the right of substitution is therefore effectively "fettered, limited and not inconsistent with an employment relationship."

Trouncing the likelihood of substitution even further, Mr Jarrett was asked to envisage the conversation that would follow if Mr Ellwood said he would take leave and send a substitute.

Though the question was posed by investigating tax officers in June 2004, Mr Jarrett's reply to the commissioners was telling as he said, "that that conversation just would not happen."

IR35 case law shows that the presence of a substitution clause is an indicator which points towards self-employment - and if far-reaching may itself determine self-employment

In deciding whether a contractor is caught by IR35, substitution is as big a factor as 'control', and in Mr Ellwood's day-to-day relations with LGL there was ample evidence of control.

Firstly, both the lower and upper contracts stipulated that "supervision", "instruction" or "control" would be exerted on the part of LGL over Mr Ellwood.

Secondly while he "did not get instructions" on how to perform, his tasks were always allocated, his work on an international project was "monitored" and he worked among a team.

Special Commissioner Charles Hellier added: "He reported his progress to Mr Jarrett or other project managers and discussed what he was doing with other members of the team.

"Although these interchanges did not consist of giving orders it was clear to me that they would have affected what he did, when he did it, and how he did it."

Thirdly, employee-style controls were implied by Mr Ellwood himself when he told the commissioners that LGL "was sympathetic to traffic difficulties and would let me go early."

Similarly, Mr Ellwood's request to LGL to take a day-off was refused outright and moreover, he did not, and was not expected to, "wander in and out as he pleased," the SC ruled.

When on the client's premises, Mr Ellwood also failed to keep within the confines of his role, which he committed to for exactly 37.5 hours each week, regardless of his progress.

The SC said he was "called upon for help in emergencies and worked along with them [ LGL's members of staff] on the projects as would a permanent employee."

In their judgement, the commissioners also found mutuality of obligation to be present: not only was Mr Ellwood obliged to work and the client was obliged to pay, but the client also paid when there was no work to do.

"If a project were to finish early or looked likely to do so Mr Jarrett would have contacted the agency and told it that he would find something else for the contractor to work on," the SC said.

The commissioners also accepted Mr Ellwood's "candid" evidence about times when systems were down – illustrating the extent to which he regarded his arrangement as providing for continuing payment.

Special Commissioner Hellier said: "If Mr Ellwood was in a good mood on such an occasion he said he would not count the downtime as hours to be billed; if he was in a bad mood he said he would charge".

Such working arrangements do little to strengthen Mr Ellwood's claim he was outside IR35 and in fact appear to support the findings of the written contracts.

These contracts were for a fixed term and contained a notice period, which included the right to make a Payment In Lieu of Notice.

Moreover, the contracts required work on - as opposed to having to deliver - projects as part of a team which included LGL's employees.

Ms Cottrell, a former inspector for HMRC summed up: "It appears that this case failed on all the fundamental tests - personal service was required and provided, there was sufficient control, mutuality of obligation was present during the contractual periods and there was little of any weight that was inconsistent with an employment relationship.

"The Special Commissioners likened this case to an employee on a fixed term contract and by doing so concluded that the business risks were the same."

In a message to contractors, she advised: "This case once again highlights the need to review contracts and working arrangements.

"From the clauses quoted in the judgment the lower contract in this case would fail the IR35 tests and the working arrangements appear to support the same conclusion."

Concluding the case, Mr Hellier wrote: " While he was working at LGL Mr Ellwood was part and parcel of the organisation.

"I accept that he was recognised as a contractor rather than as a permanent member of staff, but he sat alongside other members of staff discussed future projects, and was called upon for help in emergencies and worked along with them on the projects as would a permanent employee.

"Standing back and looking at the whole picture I am left with the distinct impression that under the notional contract Mr Ellwood would have been an employee. He would have been providing his own work to do those tasks allocated to him and would have been paid broadly for a 37½ hour week. To me it appears that his job was working for LGL, not that he made his money by providing something to LGL."