In a landmark court case, HM Revenue and Customs (HMRC) have lost an appeal over an alleged IR35 violation after a contractor successfully had their ruling overturned.

HMRC lose IR35 case – what is IR35?

IR35 is tax law also known as the Intermediaries Legislation or the ‘off-payroll working rules’.

These rules were put in place to make sure contractors pay roughly the same tax and National Insurance contributions as an ordinary employee would:

• if they provide services through their own intermediary (e.g. a limited company), and
• if they would be an employee had an intermediary vehicle not been used.

Essentially, the law is used to make sure employees don’t work through their own company in order to pay less tax. This kind of workers are often called ‘disguised employees’ by HMRC and, if caught by IR35, they’ll need to pay all of the same income tax and NICs as they would’ve had they been an employee going back to the start of their contract.

Despite having been in force since 1999, the legislation is highly unpopular among tax experts and business owners; with many believing IR35 to be poorly conceived, badly implemented, and that its sole purpose is to rack up unnecessary costs for genuine small business owners.

IR35 can reduce a contractor’s post-tax income by as much as 25% – costing the average limited company contractor thousands of pounds in additional income tax and NICs.

HMRC lose IR35 case – HMRC’s investigation

Mr Daniels set up his business MDCM Ltd in 2004, providing construction management services to various construction companies. Mr Daniels and his wife are both the directors and only employees of the company.

In an investigation into the company in 2016, HMRC decided that a contract between MDCM Ltd and one of its clients to provide services between 2012 and 2014 was within the scope of IR35.

In cases such as this, IR35 essentially aims to turn one person small businesses into employees for the purposes of tax. When under investigation, a HMRC inspector will ignore all written contracts between the contractor and the client and work to create a ‘notional’ or hypothetical contract based on the actual nature of their working relationship.

A judge will then review the notional contract to determine whether it is one of employment or one for B2B services to work out whether IR35 applies. This is based on the three principle ‘tests of employment’:

• Control – How much control does the client have over what, how, when and where the worker completes their work?
• Substitution – Must the worker carry out their service personally, or could they potentially send a substitute in their place?
• Mutuality of obligation – Is the client obliged to offer work and is the worker required to accept it?

In the case of Mr Daniels, HMRC laid out a hypothetical contract from the findings of their investigation. This stated that, whilst Mr Daniels was controlled by the client no more than any other contractor by the client, there was a contract for his personal services; meaning he could not provide a substitute to carry out the work.

In addition to this, Mr Daniels took no other financial risks than paying for his own travel and expenses, and the client provided Mr Daniels with his safety equipment.

HMRC ruled that the relationship between Mr Daniels and the client was that of an employee and employer; meaning IR35 applied and that he would need to pay tax the due as such.

HMRC lose IR35 case – the landmark appeal

Mr Daniels chose to appeal HMRC’s ruling, taking the case to the First Tier Tribunal. The court looked over copies of contract between MDCM and six different construction company clients against HMRC’s hypothetical contract.

The Tribunal Judge ruling the case said that whilst the court did not agree with HMRC’s arguments over the client having control over Mr Daniels, they agreed that the requirement for personal services and lack of financial risk did point towards more of an employment relationship.

“However,” they added, “we find that the nature of the payment arrangements, a flat rate per day with no notice period and no entitlement to any employee benefits are inconsistent with employment. Further, Mr Daniels was not treated as an employee.”

They ruled that the hypothetical contract required by IR35 showed that Mr Daniels was not in an employment contract; allowing his appeal and overruling HMRC’s decision.

Deputy Director of Policy and Public Affairs at the association for self-employed workers IPSE, Andrew Chamberlain, said that the court’s decision only goes to show that the IR35 rules are too complex and are extremely difficult to apply with complete certainty.

“HMRC looked at the relevant factors and decided that IR35 should apply. The Tribunal looked at those same factors and decided that it shouldn’t. If HMRC, with all its expertise seemingly cannot make a correct determination, how are public authorities and individual businesses supposed to get it right?”

Chamberlain added: “If the Government extends the ill-judged IR35 changes it made to the public sector last year to the private sector, the chaos and uncertainty is only going to intensify.”

HMRC lose IR35 case – are you a contractor?

If you’re a sole trader operating through your own intermediary, it is possible that IR35 may apply to you. For professional advice and guidance regarding you’re your employment status and investigations from HMRC, call the Burton Beavan team today on 01606 333900 or email hello@burtonbeavan.co.uk