The contract that never was – IR35 victory for HMRC re-draws battle lines over personal service companies
HMRC has been successful in the first case since 2011 on the intermediaries legislation (known as the IR35 rules) in a case which brings back into the limelight a commonly-used freelancing structure.
The decision issued on 10 February concerned Christa Ackroyd, a journalist and television presenter for over 40 years (particularly relevant if you have ever watched “Look North”). Her personal service company, Christa Ackroyd Media Limited (“CAM”), entered into two fixed term contracts with the BBC to provide her services. Ms Ackroyd and her husband were both directors and shareholders of CAM. CAM paid Ms Ackroyd a salary on which it operated PAYE but also made dividend payments to its shareholders out of its receipts from the BBC to which more favourable tax treatment was obviously applied.
HMRC issued determinations to CAM for more than £400,000 of income tax and social security contributions on the basis of IR35 and equivalent social security regulations. In essence, HMRC argued that CAM should have operated PAYE on all amounts received from the BBC, not just the sums paid on to Ms Ackroyd as salary.
It was accepted that the actual contractual arrangements involved CAM contracting to provide services to the BBC for which it used the services of Ms Ackroyd. It was not suggested that Ms Ackroyd was, in reality, an employee of the BBC. But that is not how IR35 works.
The key question facing the First Tier Tax Tribunal was whether the nature of the relationship between Ms Ackroyd, the BBC and CAM was such that, if the services provided by Ms Ackroyd were provided under a contract directly between the BBC and Ms Ackroyd, she would be regarded for tax purposes as an employee of the BBC. This so-called “hypothetical contract” analysis switches on IR35 and requires that the personal service company (i.e. CAM) accounts to HMRC for, broadly, the income tax and NICs that the contracting company, here the BBC, would have paid had the individual been an employee. The Tribunal found that even though Ms Ackroyd was treated very differently in many respects from actual employees of the BBC, there were sufficient factors in the hypothetical direct contract that would have pointed to employee status for it to conclude that IR35 applied.
The decision attached most weight to the fact that contractually the BBC could control what work Ms Ackroyd did, even though the BBC did not on the evidence apply many restrictions to her, and that the second of the two contracts was a 7 year term for what was effectively a full time job: “We do not consider that Ms Ackroyd could fairly be described as being in business on her own account. She was economically dependent on the hypothetical contract with the BBC which took up most if not all of her working time”. The lack of financial risk for Ms Ackroyd and the fact that CAM made little (sub 5%) other income were also important factors.
We understand that this is the first of a number of similar cases being pushed through the courts by HMRC. Recent legislative changes have made personal service companies less common for public sector contracts. It may be that, bolstered by this case, HMRC will look to pursue personal service companies more rigorously or that (as is regularly rumoured) the Chancellor may seek to replicate the public sector changes for the private sector. Any individuals using personal service companies would do well to seek advice on whether their structures are sufficiently robust to resist challenge.
Key factors will include:
(i) the degree of control exercisable by the end-user. Cunningly, HMRC can use the written terms of the contract to establish a right of control even it isn’t exercised in practice, but can also use the practical exercise of control even if it isn’t in the contract. Put shortly, however, the more flexibility the individual has on what he does and how he does it, the safer he will be;
(ii) duration – multiple short-term assignments, ideally with gaps, look more like a business operation than one or two very extended arrangements. Seven years doing pretty much the same thing throughout just looks like a job, no question;
(iiii) non-exclusivity – the more different “customers” your service company has, the better for the appearance of a free-standing business. Conversely, clauses preventing it from supplying you to anyone else will be bad news tax-wise;
(iv) rights of substitution – if Ms Ackroyd were sick she could presumably not just send along her husband to do the show instead, but if possible in other cases, reserve the right to do so and then actually do it from time to time, to show the right to be a real one;
(v) economic dependency – this is a relatively new concept also appearing in the Taylor Report Taylor Review of Modern Working Practices. Its value in this sort of assessment is still unclear because it is obviously possible for small businesses to be economically dependent on one or more big clients without thereby becoming employees, even just for tax purposes;
(vi) keep up the trappings of a business – a website, an accountant, branded materials, a logo, your own terms of business, insurance, offices, etc. – all things a direct employee wouldn’t actually have.