Do you see an employee or a contractor?

Employees iStock 000005305116XSmall 146x219Responsibility for determination of employment status under IR35 shifts from off-payroll workers to public bodies this week. Azhar Ghose analyses what is a significant shift for legal services.

First let me explain what IR35 is and its significance.

‘IR35’ is the shorthand name for the intermediary legislation that regulates whether a deduction needs to be made at source for tax purposes arising from a worker’s employment status. It requires the determination of the employment status of an off-payroll worker who provides services personally to an employer via intermediaries. The intermediaries may be part of a supply chain, or a chain of entities, which includes the limited company owned by a worker, a recruitment agency and usually another provider to the employer as the end user in the chain.

To date, the responsibility of making the determination under IR35 was that of the worker. However, from 6 April 2017, there will be a reform to the law that shrewdly shifts the responsibility to the public body and the final payer of the worker in the supply chain; the reason for this shift is to account for tax where the worker provides services to that public body. The reforms apply to the same broad range of public bodies as those that are subject to the Freedom of Information Act. This will, as before, require a determination of the underlying employment status of an off-payroll worker.

It has been reported that there has been an ‘exodus’ of IT contractors to the private sector, the very same high earning primary target group of the reforms. However, for the purposes of this article, I will focus on legal services within local government. Legal services will need to pay close attention to these changes as, thus far, they have relied on this ‘invisible workforce’ to bolster their service delivery.

A worker’s employment status

The IR35 status check will be required for every engagement of a worker intending to provide services to a public body via an intermediary; HMRC have introduced an online Employment Status (IR35) Calculator to assist the responsible body for this very purpose.

Essentially the question to be resolved is whether the worker is engaged under a contract of services (employment) as opposed to a contract for services (self-employed) as performed by a business or a contractor.

If there is a finding that the worker is a ‘deemed employee’ or a ‘disguised employee’ rather than a contractor arising from the manner in which the worker provides services to the public body then they will have their tax and National Insurance contributions deducted at source like any other employee.

The title to this article alludes to the judgment by Mummery J. in the High Court case of Hall v Lorimer approved by the Court of Appeal and cited by HMRC in its Employment Status Manual:

‘This is not a mechanical exercise of running through items on a check list to see whether they are present in, or absent from, a given situation. The object of the exercise is to paint a picture from the accumulation of detail. The overall effect can only be appreciated by standing back’.

It was Cooke J in Market Investigations who said that there can be no exhaustive list of the considerations nor can there be strict rules on the relative weight of such considerations in any particular case. HMRC also warns of the danger of categorising workers without consideration of each individual case.

The invention of the HMRC IR35 calculator, standard questionnaires and any carte blanche policy on determining whether a group, profession or sector comes within the IR35 remit therefore seems flawed at the outset as well as running contrary to the very spirit of case law and HMRC’s Employment Status Manual. Where the IR35 calculator, which by its very existence negates a blanket approach, produces a result contrary to the public body’s stated policy, how will this be resolved?

Another questionable approach is to automatically classify ‘locum’ roles to be within IR35 where these provide cover for an existing employee role such as maternity leave cover or as an interim pending the recruitment of a role. This may be one of many factors in assessing whether this falls within IR35, however, this approach does not allow for the parties to negotiate how a genuine contractor may provide services differently from a contract of services thus taking this, on balance, outside of IR35.

The procedure

As the substantive law on IR35 remains unaltered, it is perhaps worth revisiting the HMRC Employment Status Manual that has been used by HMRC as its best practice guidance for determining the employment status of a worker. It states that: ‘It is only after the facts are established that the principles of general law can be applied and an opinion given on the person’s status.’

An investigation is advocated for the purposes of establishing the relevant surrounding facts of the worker’s engagement and how they provide services to the employer, including evidence of whether they run a business on their own account.

Fundamental to the enquiry is the need to establish the original contract terms offered to the worker by the employer or, in its absence, the implied terms from the working practices between the two. Where there is a supply chain, each of the contracts in the chain should be consistent with the terms agreed between the employer and the worker.

If a written contract appears to be comprehensive it should not normally be challenged except where there is evidence that the parties are not acting in accordance with it.

Other information that would assist the enquiry includes understanding the nature of the employer’s business and the way that business operates. It will be important to establish the nature of the worker’s job and whether employees are doing similar work under similar terms and conditions.

These facts then need to be considered in light of the different factors that the Courts have identified as being relevant in determining whether a particular contract is a contract of service or a contract for services.

The legal tests

Despite what you may read on the internet, the pursuit of an authoritative legal test to distinguish between a contract of services and a contract for services has been as varied and fluctuating as the shifting sands in a desert.

Identifying the constituent elements of a contract of service may seem easy enough, such as recognising the intention of the parties, the mutuality of obligations, personal service/ substitution and control, but these must be balanced by the circumstances that may justify the worker operating as a business on their own account.

The inevitable conclusion of the courts is that there is no sole determining factor, such as control of the worker, which can resolve the issue. In recognition of this, Cooke J in Market Investigations stated that other factors may be of importance, for example, whether the worker provides his own equipment, helpers, the degree of financial risk, the degree of profit from the investment and management of their business.

If the person performing these services does so as a person in business on their own account then the answer could be that this is a contract for services.

Some of the factors may be personal to the worker which lie outside the terms of the direct contractual relationship that the worker has with the employer. Such factors still need to be considered in the context of the case as a whole, and the weight to be attached to them will vary from case to case.

It is worth noting that office holders, such as the statutory Monitoring Officer or the officers of a company such as directors and the company secretary, are automatically deemed to be within the IR35 legislation.

The likely impact of these reforms for legal services depends on the value of the contractors and how they themselves will respond to the IR35 reforms.

Painting a portrait of the worker

Temporary off-payroll workers supporting legal services are often inappropriately referred to as ‘locums’ in the sector. This misnomer is particularly true in the cases of project work or where there is no specific employee role being assumed by the contractor. Although job titles are disregarded for the purposes of IR35, which looks at the actualities, adopting the correct language will help to shape the right behaviours in the relationship of the employer to the worker, given that this relationship is the subject of the employment status assessment. It may be more apt and consistent with a determination outside of IR35 if they were referred to as ‘Independent Consultants’ or contractors.

Take the everyday example of a contract of employment; an employee must provide their services personally to their employer without any substitution by another. They report to a line manager who will have a degree of control over them on such matters as when, where and how to do the work, including conducting their appraisals. There is a mutuality of obligation where they can expect their employer to provide them with fixed hours of work in return for their services for which they receive payment. If there is no work, they can still be expected to be paid.

A contractor may act on his/her own behalf or elect to use a substitute as the focus is on completing or progressing the task rather than the requirement to have the personal services of that individual. This is not as contrived as it sounds as so called ‘locums’ are sometimes recruited without the formalities of a face-to-face interview unlike employees indicating the potential for substitution.

Consultants are not managed or integrated with the existing workforce by such control methods as appraisals, team meetings and the employee’s routine one-to-ones. The quality control for a contractor may be by a review of performance in line with a contract for services. Any below standard work would be remedied by the contractor in their own time and at their own expense. In reality, a legal service may be more confident in this approach with senior and experienced consultants.

An independent consultant can be expected to determine when, where and how many hours they need to work to perform the task. They would not necessarily be entitled to, or expect, a minimum number of hours of work like an employee. The contract could identify the work or services to be performed, such as on a project, or scope the work that could be assigned for the worker to perform. Any work outside of the scope should be subject to agreement between the parties, albeit on the same terms and conditions. A contractor may also serve a number of clients and provide their own equipment, training and insurance.

Engaging in a series of assignments, by moving from one to another rather than remaining in one post over a long period, would also be indicative of contractor status.

The business risk of investment and management for a contractor could include marketing via a website or publishing articles, tendering for work and absorbing the loss of income from gaps in assignments or the early termination of contracts due to short notices.

The value of ‘the locum’ and their response    

‘Locums’ tend to be much maligned and sometimes viewed as ‘mercenaries’, nevertheless, they provide a cost effective solution to the business needs of the employer. Up to this point in time, one of the reasons why employers have been happy to recruit consultants has been to avoid taking on ‘employees’ with all their associated costs and it has helped to minimise the ‘head count’ of employees on the payroll in line with corporate targets.

Many consultants choose this path because they wish to have autonomy and adopt an entrepreneurial approach in providing their specialist skills. They do not wish to be treated as ‘employees’ of any one employer or to be integrated with that employer’s workforce.

There is sometimes a gap in the meeting of minds between employer and worker, perhaps for a number of reasons, including a lack of appreciation and/or understanding of the manner in which the ‘worker’ has set up in business, or the different relationship of the worker from other employees and the lack of direct negotiation which is often conducted by a recruitment agency.

Impact and options

Most local authorities and recruitment agencies have assumed a ‘one size fits all’ approach and that all agency workers are inside IR35. This approach could be deemed to be unreasonable if the facts of each contract, and the law, are ignored.

The impact on independent consultants falling within IR35, along with the deduction of tax and National Insurance contributions, also means that they can no longer off-set their away from home expenses as a business expense such as accommodation, subsistence and travel.

This partially explains the latest response of consultants to the imminent changes by seeking opportunities closer to home, asking for an increase to their hourly rates to compensate for their pay reduction and, in some cases, to ask for a review of the IR35 assessment.

Other options include: leaving the public sector altogether or consider taking on a mix of private or public sector assignments. However, the private sector may also be a short-lived sanctuary given that the government is contemplating rolling out these reforms to the private sector at a future date.

Rural and town-based local authorities may struggle to find the experienced skill and support for their services that they seek, especially if they maintain the same hourly rates being paid prior to the reforms.

The reforms could therefore lead to an increased cost to the local authority in these straitened times. The financial ‘number crunchers’ will have to assess whether engaging contractors is still financially preferable over the cost of recruiting permanent staff, and paying employee associated costs, such as long term pensions, holidays and redundancy. If there was a proper application of the IR35 rules, they may not need to increase costs or face such risks.

The use of external law firms provides an accessible and specialist alternative to meet the public body’s business needs, however, it can become a more expensive option and delivers a very different kind of ‘formal’ legal service to clients.

Other options for ‘plugging the gaps’ for legal services include accessing the services of shared legal services, the recent entrants to the legal services market in the form of local authority owned Alternative Business Structures and other public body legal service providers that are seeking new sources of work.

Local authorities could also design future procurements for legal services in such a way as to make these more accessible for micro, small and medium enterprises (SME).

Risks

The liabilities for an incorrect assessment rest with those entities that are responsible to account for the tax to HMRC. Thus, a public body will have such a risk on a direct engagement of the worker or the closest recruitment agency making payments to the worker where there is a supply chain. Interest and penalties can be charged on the tax and National Insurance contributions where this should have been paid. HMRC warns that penalties can be more severe if it can be proved that IR35 legislation has been deliberately avoided.

The risks to the responsible body from the worker could be a challenge of the IR35 status assessment where they are operating as a genuine contractor.

Further mitigation of risk can come from applying the IR35 criteria in each case and obtaining an assessment from the IR35 calculator. As the tool can be used by all parties, in order to avoid obtaining conflicting results of the worker’s employment status, all the key terms and circumstances of the assignment should be negotiated and agreed in advance between the parties in written form. This will be an important part of the evidence and audit trail to defend any claim for lost revenue from HMRC.

Where the parties have been free to negotiate their terms of business, risk can also be mitigated by requiring indemnities from the worker should there be any losses, claims and penalties made against them.

A reminder of the risks that the public sector has been exposed to for many years (prior to the reforms) came from the recent case against Pimlico Plumbers. The purported ‘contractor’ was successful in arguing that he was an employee of Pimlico and therefore had an entitlement to employment rights such as sick pay and holidays. By extension, could contractors who are found to be ‘disguised employees’ seek other attractive employee benefits such as pensions and the protection afforded to employees for continuous service?

A case by case approach

A proper application of the law as it suits the individual circumstances and context of each case should be applied rather than taking a blanket policy approach. The IR35 calculator is not conclusive of the employment status, although HMRC appear to be standing by its results provided that accurate information has been entered. Since its introduction in March of this year, the tool has already been revised and it is likely to undergo further revisions.

The key IR35 cases have involved IT contractors and therefore the differences relating to legal services provision would need to be teased out and advanced as part of a proper assessment.

Take, for example, the recruitment of an employee lawyer versus that of a legal consultant. Typically, the standard local government recruitment of a permanent employee involves the completion of an extensive job application form, attendance at a first interview, giving a presentation, some psychometric testing and a final interview.

By contrast, a legal consultant may be selected on the basis of their CV alone and without a formal interview as compared to employees carrying out similar work. This would be an argument indicating that the selection is not specific to that individual and that a substitute of a worker with a comparable or competent skill set would be just as acceptable. This obvious point of substitution may be lost as, in most cases, the employer usually reverts back to the recruitment agency rather than negotiating directly with the contractor should they require a substitute.

Consultants operating as a business on their own account providing legal services are in a position to substitute their services, especially where this involves simply drafting a legal agreement.

Conclusion

At present, it seems that IR35 reforms are being implemented in order to mitigate corporate risk for the accountable bodies rather than having proper regard to the individual circumstances of each worker and the application of the substantive law. The approach will, no doubt, be welcomed by the Government and HMRC as it will produce greater revenue than that which could be expected where responsibility previously lay with the worker.

There may, however, be some unintended consequences to watch out for, such as an increased cost to the public sector as a whole because of a rise in consultant rates or, indeed, a challenge from one or more of the hundreds of thousands workers affected by these reforms.

Azhar Ghose ACIS is an Independent Consultant of Arcadia Business Intelligence Ltd offering consultancy services to the public and private sector; providing a cost effective solution for commercial and company secretarial requirements. He can be contacted at This email address is being protected from spambots. You need JavaScript enabled to view it. or via Linkedin.

© 26th March 2017 Azhar Ghose