IR35: Right Result, Wrong Conclusions

Judge Howard M Nowlan presided over the recent First Tier Tax Tribunal hearing that left John Spencer, director of JLJ Services Ltd, with a bitter-sweet taste as his company part won, part lost, its IR35 appeal.

For the period May 2000 – 31st December 2003 the Tribunal ruled that JLJ Services Ltd's contract to supply services to Allianz was outside of IR35 but caught by IR35 thereafter. In ruling that the services were within the IR35 legislation as from 1st January 2004, the change to the length of engagement and an absence of a description of the work to be performed was key to the decision. Prior to 31st December 2003, JLJ Services had worked under a number of defined contracts for short periods, the longest of which was 10 months. From 1st January 2004, however, contract extensions were for 12 month periods and contained no project descriptions. This was because Allianz wished to retain the services of Mr Spencer on an indefinite basis and he became integrated into their business as one of their key computer experts. It was therefore more likely that Allianz would have had a sufficient degree of control over Mr Spencer.

Judge Nowlan is a part time judge in the First Tier Tax Tribunal and former tax partner in Slaugher & May, a leading international law firm. With such a reliable background in both tax and law, it would be reasonable to expect such a judge to reach decisions on a sound and objective basis. Whilst he may have reached the right conclusion however, he did make some strange remarks and reasoning on the subjects of right of substitution and mutuality of obligation (MOO).

Right of substitution
JLJ Services contract with the agency contained a substitution clause that stated, “ The services shall be performed by the Contractor. However, the Company may send a substitute of equal experience and ability to perform the Services as set out in the Schedule. In the event of a change, the Company and/or the Contractor shall submit to Highams (ageny) the names of suitably qualified substitutes and shall permit the Client an opportunity to interview such proposed substitutes.”

The Tribunal concluded that a substitute could only realistically be used in circumstances where Mr Spencer was likely to suffer long absences from his work but even then this seemed unlikely to the Tribunal. Four reasons were cited for the Tribunal's dismissive decision in respect of this employment status test, namely:

It was not clear whether Allianz could reject an offered substitute of equal experience and ability. The end client was, however, able to interview any proposed replacement and there would be little point in providing for an interview if Allianz could not reject an offered substitute.

Substitution should be considered in two contexts, ie short and long term. Where substitution is a reality, it was reasoned that a replacement worker might be offered on one isolated day. In JLJ Services case this was inconceivable.

John Spencer knew of two potential substitutes but it was reckoned that there was no way of knowing whether either of them might have been available and in all probability they would be either otherwise engaged or living too far away. Furthermore, in the event that one might have been free to accept such an appointment it was unclear whether that person could or would have wished to provide their services via JLJ Services.

In seven years no substitute was ever offered because it was never relevant and it was clear that Allianz was interested in the qualifications and the individual suitability of John Spencer. The end client would also have been equally interested in the personal suitability of any replacement.

For a judge to make such a supposition as made in point (3) above is  both baffling and exasperating. Without firm evidence to support his theory how could Judge Nowlan draw such a conclusion? In the vast majority of cases a right of substitution is almost always hypothetical because contractors never need to call upon a replacement but where a genuine right exists how can a renegade judge seek to undermine that right with unreasonable supposition? Unless Judge Nowlan possesses hitherto untold psychic abilities he could not possibly know whether or not either of the two substitutes would be in a position to accept an engagement offered by JLJ Services. The judge was not in a position to stand in their shoes and, in the writer's opinion, he was wrong to attempt to do so.

MOO
In respect of this test  Judge Nowlan considered it to be “nebulous” and commented, “ There is considerable case law in relation to this test, progressively indicating that the test is of diminished importance, or that is indeed nearly meaningless. “  It is interesting that in cases over recent years his counterparts have never sort to reason in the same manner and have acknowledged the importance of this test because it remains a fundamental aspect of a contract of employment.

Although MOO has become distorted and is a tricky concept to fathom and really needs another court case to redefine its true meaning, it simply cannot be ignored in the manner Judge Nowlan sought to cast it aside. Indeed, his rationale would be that which one would expect from HMRC.

The judge described a touchstone of being an employee as the hope and expectation of some relationship of faithfulness between employer and employee, ie an employer commits to providing continuous work for their staff even in slack times. Where there is a shortage of work, then contractors will be the first to go. In general terms that is a reasonable yardstick and was a feature in the First Tier Tax Tribunal ruling in Marlen Ltd v HMRC in July of this year.

In the earlier years, where JLJ Services Ltd worked under a series of short term contracts with defined projects, it was accepted that Mr Spencer neither knew or could be confident whether the various contracts would be renewed.

The Tribunal probably reached the correct decision in ruling that IR35 applied from 1st January 2004 as a right of control, MOO and personal service all appeared to exist together with other factors being consistent with a contract of employment. In getting to that point however, Judge Nowlan did throw in some curve balls. Maybe it is just as well that First Tier Tax Tribunal decisions, although they can be referred to, do not create legally binding precedents. Such decisions do, however, take on more relevance if no appeal is made to a higher Court or tribunal against their decision. Hopefully, this judge has not given anything for the Revenue to hang their hat on.