IR35: Court of Appeal provides clarification

The off-payroll working rules, also known as IR35, are designed to ensure that individuals who provide their services via an intermediary – typically, a personal services company (PSC) – but who work in a similar way to employees, pay broadly the same income tax and national insurance contributions as employees.

Legislative reforms introduced for the public sector in 2017 and the private sector in 2021 have made in-scope organisations engaging workers through an intermediary, directly or indirectly, more accountable for IR35 compliance. In particular, they are responsible for determining whether a worker would be an employee if they had contracted directly, and must exercise reasonable care in reaching this decision. Non-compliance risks liability for deducting and paying a worker’s employment taxes to HMRC and a financial penalty.

Determining employment status for tax purposes involves a fact-specific application of principles derived from case law, together with HMRC guidance and tools. Two recent Court of Appeal judgements have provided much-needed guidance. However, they also illustrate the significant challenges involved for organisations in applying the complex and multi-factorial tests in practice.

Background

Section 49, Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003), applies IR35 where:

• a worker personally performs, or is under an obligation personally to perform, services for the client;
• the services are provided under a contract involving a third-party intermediary; and
• the circumstances are such that, if the services were provided under a contract directly between the client and the worker, the worker would be regarded for income tax purposes as an employee of the client or the holder of an office under the client. Those circumstances include the terms on which the services are provided, having regard to the terms of the contracts forming part of the arrangements under which the services are provided.

In both of the Court of Appeal (CA) cases below, there was no dispute that the workers’ services were provided personally under a contract involving their PSCs. Therefore, the CA was concerned with the final part of the test, involving an analysis of the circumstances of each case and whether hypothetical employer status, for tax purposes, existed.

The hypothetical employment status test

In HMRC v Atholl House Productions Limited [2022] EWCA Civ 501, the CA noted that, when assessing whether an employment relationship exists under a hypothetical contract, the following three-stage process provides a helpful structure:

• find the terms of the actual contractual arrangements (for example, between the personal service company and the client on the one hand, and between the worker and the personal service company on the other) and relevant circumstances within which the individual worked;
• ascertain the terms of the hypothetical contract (between the worker and the client);
• consider whether the hypothetical contract would be a contract of employment.

In determining whether the hypothetical contract would be a contract of employment, the
three-stage test set out in Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968] 2 QB 497 should be applied. The three stages are:

• the contract involves mutual obligations on the parties to each other (mutuality of obligation);
• the worker is subject to a sufficient degree of control by the ‘employer’; and
• the other provisions of the contract are consistent with it being a contract of employment.

HMRC v Atholl House Productions Ltd

Kaye Adams (KA), a radio presenter, used her personal service company, Atholl House Productions Limited (Atholl House), to contract annually with the BBC to present a radio show. After HMRC determined that IR35 applied to these arrangements, Atholl House appealed successfully.

The CA allowed HMRC’s appeal and remitted the case back to the Upper Tribunal (UT), giving significant guidance on the correct approach to determining employment status, including:

• The test in Ready Mixed Concrete does not lay down an exhaustive and immutable test and it should not be afforded legislative status. This was in response to arguments from both parties seeking to interpret it in a rigid or binary way – for example, providing that one factor was decisive over another. The CA preferred a multi-factorial approach.
• Mutuality of obligation and a right of control are pre-conditions to a finding of employment; however, they do not create a presumption of employment. This provides helpful clarity.
• Mutuality of obligation and a right of control must be present to a sufficient extent before ‘other factors’ are considered. These other factors are: the terms or circumstances of the engagement that existed at the time that the contract was made and which were known or reasonably available to the parties.
• An example given was whether it was known that the worker was self-employed and carrying on a business in their own account. However, an individual can in the same tax year perform similar services both as an employee and as an independent contractor. It is a relevant fact, but it goes no further than that (the UT had set too much emphasis, the CA decided, on KA’s career as an independent contractor).
• The relative strength of control and mutuality of obligation could be taken into account as part of the multi-factorial process (contrary to HMRC’s position). For example, control may be so pervasive as to make it very difficult to conclude that there was not a contract of employment.
• The approach in Autoclenz Ltd v Belcher and others [2011] UKSC 41 (that contractual terms may be disregarded if they do not accurately reflect the genuine agreement of the parties) applies to certain statutory employment rights, according to Uber BV v Aslam [2021] UKSC 5. Section 49, ITEPA 2003 has a different purpose and it is not legitimate to apply the Autoclenz

The CA confirmed the lower tribunal’s findings that mutuality and control existed. In remitting the case, it stated that the next step required an overall assessment to be made as to whether, under the hypothetical contract, an employment relationship existed, taking into account the terms of the contracts, their effects and the circumstances in which they would have been made.

Kickabout Productions Ltd v HMRC

Unlike Atholl House, the decision in Kickabout Productions Ltd v Commissioners for Her Majesty’s Revenue and Customs [2022] EWCA Civ 502 entailed less guidance and focused more on the facts.

Paul Hawksbee (PH) provided his services via his PSC, Kickabout Productions Limited (Kickabout), under contracts with Talksport as a radio presenter. HMRC determined that IR35 applied to these arrangements and the resulting appeals led to the Court’s decision in HMRC’s favour.

The CA agreed with the UT’s analysis of the terms of the engagement as entailing an obligation to offer 222 programmes per year. In relation to control, the CA found no error in the UT’s decision that Talksport could control ‘where’ and ‘when’ PH performed his duties and that it had material rights of control over ‘what’ tasks he performed because it had the ultimate right to decide on the form and content of a particular programme. The fact that, in practice, Talksport was content to give him a high degree of autonomy did not alter that conclusion as the control test focuses on the right of control and not how, or if, that right is exercised. The UT also noted that the fact that Talksport had little control over how PH presented the programmes put him in the same category as other highly skilled people, such as a surgeon or a footballer, but did not prevent the existence of a sufficient framework of control for these purposes.

The CA rejected the grounds of appeal raised by Kickabout in relation to the UT’s application of the multi-factorial test. In particular, it confirmed that given the wide range of factors that may be relevant in determining whether an employment relationship has been created, it is right that the relevance of any particular factor should be tested against the individual circumstances of the case. Factors that are relevant, even highly relevant, in some cases may well be of little or no relevance in other cases. Here, the UT held that the ‘part and parcel’ of the organisation test added little to this case.

Conclusions

Atholl House provides authority on the appropriate application of the employment status test. Its rejection of the applicability of Autoclenz results in a difference of approach when determining status for tax and statutory rights purposes.

The cases illustrate the multiple factors that organisations must apply, to each case, when hiring the services of contractors and freelancers through third parties. To mitigate resulting tax liability risks, organisations should ensure that those making status determinations are trained in exercising reasonable care, reflecting HMRC’s guidance. Even if the determination is later judged to be wrong, taking reasonable care (and fulfilling other IR35 duties) will mean that responsibility for employment taxes will not rest with the organisation.

About the author

Mark Hammerton, Partner, Eversheds Sutherland