Atholl House v HMRC – Navigating the Complexities of IR35 Legislation

Tax Tribunal decides against HMRC on IR35 Intermediary Legislation Appeal

Problem: In Atholl House Productions Ltd v HMRC TC/2018/2263 (29 November 2023), a case that our expert tax lawyers had advised the successful appellant, the First-tier Tribunal once again considered the problematic IR35 legislation and the complex questions: When should a freelancer, operating through their own company, be considered an employee for tax purposes?

The case, which spanned nearly 9 years, involved multiple tribunal hearings (from the First-tier Tribunal to the Court of Appeal, and then back to the First-tier Tribunal) and focused on the interpretation of IR35 legislation in the context of the BBC’s engagement with Kaye Adams, a journalist and broadcaster, through her service company, Atholl House Productions Ltd (AHP).

The primary concern was whether the contractual arrangements between AHP and BBC Radio Scotland for the 2015/16 and 2016/17 tax years placed Ms Adams in the category of an ’employee’ under IR35.

Outcome: After a series of legal challenges, the First Tier Tribunal ruled against HMRC. The tribunal found that the factors indicating self-employment outweighed those suggesting employment. Thus, they concluded that IR35 legislation did not apply, upholding AHPL’s appeal.

The tribunal applied a three-stage process: identifying the actual contract terms, determining the terms of a hypothetical contract, and then deciding if this hypothetical contract implied employment. Key considerations in the decision included the lack of BBC’s control over Ms Adams’ other engagements, the absence of treatment as an employee by the BBC, her economic independence, and the explicit statement in each agreement negating an employment relationship.

Our expert tax lawyers and in-house consultant accountants can help with any tax concerns and IR35 legislation, call us today for a Free Consultation on 0207 459 4037.

What is IR35 Legislation?

IR35 is a set of tax laws in the United Kingdom, formally known as the Intermediaries Legislation in accordance with Sections 48 to 61 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA 2003”) and the related provisions of the Social Security Contributions (Intermediaries) Regulations 2000 (the “2000 Regulations”).

IR35 aims to address tax avoidance by workers, and the companies hiring them, who use intermediaries such as personal service companies or partnerships but are otherwise indistinguishable from regular employees.

Under IR35, if an individual provides their services to a client through an intermediary, but would be an employee if they were providing their services directly, they are deemed to be a ‘disguised employee.’ This designation means they are subject to Pay As You Earn (PAYE) and National Insurance contributions as employees.

The legislation focuses on two key concepts: the hypothetical contract and the nature of the working relationship. The hypothetical contract imagines what the contract terms would be if the worker were engaged directly by the client. The nature of the working relationship assesses factors like control, substitution, and mutuality of obligation to determine employment status.

How IR35 Works – The Tests of Employment

IR35 legislation determines employment status through several key tests. These tests assess if a worker is an employee in the context of their work engagement or a self-employed contractor. Understanding these tests is crucial for accurately applying IR35 rules.

1. Control: This test examines the degree of control the client has over what, how, when, and where the worker completes their work. In an employment relationship, the employer typically exercises a significant level of control over these aspects. For example, if the client has the right to dictate specific working hours or how tasks should be executed, this may indicate employment.
2. Substitution: The substitution test checks whether the worker can send a substitute in their place. If the contract specifically requires the personal service of the worker and does not allow for substitution, or if any substitution requires the client’s approval, this points towards an employment relationship. Conversely, the freedom to send a substitute without needing approval suggests self-employment.
3. Mutuality of Obligation: This test looks at the obligations between the client and the worker. In an employment relationship, there is an ongoing obligation for the employer to provide work and for the employee to accept it. If the worker is obliged to accept work when offered and the client is obliged to provide ongoing work, this suggests an employment relationship.

The Atholl House tax appeal highlighted the importance of these tests in determining employment status under IR35. The tribunal’s analysis focused on these factors, particularly considering Ms Adams’ degree of control, ability to substitute, and the mutual obligations in her contract with the BBC.

These tests are not exhaustive and must be applied in the context of the overall working arrangement. Other factors, such as the contract’s wording, the worker’s financial risk, and their integration into the client’s organization, may also be relevant.

What to Do if IR35 Applies – Calculating the Deemed Payment

When it is determined that IR35 applies to a particular working arrangement, it is essential to calculate the ‘deemed payment.’ The deemed payment refers to the amount that is treated as employment income for tax purposes. The calculation involves several steps:

1. Determine the Income: First, identify the total income from the engagement subject to IR35. This includes all payments made to the intermediary (such as a personal service company) for the worker’s services.
2. Deduct Allowable Expenses: Certain expenses can be deducted from this income. These include the actual expenses incurred in doing the job, a fixed 5% allowance for business expenses allowed by HMRC, pension contributions, and any employer’s National Insurance contributions.
3. Calculate the Deemed Payment: After deducting these expenses, the remaining amount is considered the ‘deemed payment.’ This is the amount subject to PAYE and National Insurance contributions as if it were a salary.
4. Tax and National Insurance Contributions: The employer (the intermediary) then needs to calculate and deduct the appropriate tax and National Insurance contributions from the deemed payment. The net amount after these deductions is what the worker receives.

The deemed payment calculation ensures that workers inside IR35 are taxed similarly to employees, paying roughly the same amount of Income Tax and National Insurance contributions as if they were employed directly.

What are the consequences if IR35 Does Apply?

When IR35 legislation applies to a working arrangement, it brings several significant consequences:

1. Increased Tax Liability: The most immediate impact is the increased tax liability. The deemed payment, as calculated under IR35, is subject to regular Income Tax and National Insurance contributions as if the worker were an employee. This often results in a higher tax bill compared to what would be paid if the worker were considered self-employed.
2. Reduced Net Income for Contractors: For contractors caught by IR35, the increase in tax and National Insurance contributions typically leads to a reduction in their take-home pay. This is because they lose the tax efficiencies of working through an intermediary, like a personal service company.
3. Administrative Burden: Companies engaging contractors must carefully assess whether IR35 applies to each contract. If it does, there is an administrative burden of ensuring compliance with PAYE and National Insurance contributions, similar to regular employment.
4. Legal and Financial Risks: Both the contractor and the client face legal and financial risks if they incorrectly determine the IR35 status of a contract. If HMRC challenges the status and finds it to be incorrect, there can be backdated tax demands, penalties, and interest charges.
5. Impact on Contract Negotiations and Rates: The determination of IR35 status can affect contract negotiations. Contractors may seek higher rates to offset the higher tax liabilities, while clients may adjust their approach to contracting to mitigate risks associated with IR35.
6. Reputational Risk: For businesses, there is also a reputational risk in case of non-compliance with IR35. It can affect their relationship with contractors and their standing in the industry.

Understanding the consequences of IR35 is crucial for both contractors and businesses. It not only affects financial planning but also plays a significant role in how work engagements are structured and negotiated.

Atholl House Productions Ltd v HMRC

The Issues

The matter in dispute was whether the arrangements between the Appellant and the BBC fell under the IR35 rules. If so, the Appellant would be liable for income tax and national insurance contributions as if Ms Adams had been employed by the BBC, for the tax years ending 5 April 2016 and 5 April 2017. The amounts involved for those tax years were significant, with income tax of £81,150.60 and national insurance contributions of £43,290.98 at stake​​.

As set out by the tax judge in the claim:

“In order for there to be a relationship of employer and employee: (1) there must be mutuality of obligations; (2) the putative employer must enjoy a degree of control over the putative employee; and (3) the other terms of the contract must be consistent with its being an employment contract“.

The Arguments by the Parties

The parties’ respective positions had been consistent throughout the matter:

1. Appellant’s Argument: The Appellant, represented by Kaye Adams, argued that the working relationship and contract terms did not fit the employment status under IR35. They highlighted the autonomy and flexibility in her working relationship with the BBC, suggesting an independent contractor status.
2. HMRC’s Argument: HMRC contended that the nature of the relationship and contractual terms between Ms Adams and the BBC, especially the control and obligation aspects, placed her under the employment category, thus falling within the IR35 legislation.

Decision

The tax tribunal’s decision-making process involved a detailed analysis of the contractual arrangements, evidence presented, and legal interpretations of IR35. The tribunal considered three stages in its analysis:

1. Stage 1: Understanding the actual contractual terms between the Appellant and the BBC and the relevant circumstances of Ms Adams’s work.
2. Stage 2: Establishing the terms of the hypothetical contract, what it would have been between Ms Adams and the BBC directly.
3. Stage 3: Assessing whether the hypothetical contract amounted to a contract of employment under the established legal tests.

The tribunal allowed the appeal, concluding that the contracts in question, if made directly between the end user (BBC) and the individual (Ms Adams), would have been contracts for services and not contracts of employment.

This decision was significant as it determined that IR35 did not apply to the specific arrangements, thereby relieving the Appellant of the substantial tax and NIC liabilities (in total over £120,000).

Reform for IR35 Legislation

The potential scrapping of IR35 legislation has been a topic of much debate over recent years; the legislation is inadequate and causes a lot of uncertainty as it is open to interpretation.

Parliament should provide clearer guidelines and objective criteria to determine employment status. In a recent notable policy shift, Chancellor Kwasi Kwarteng announced plans in September 2022 to repeal IR35 reforms extended to the private sector to stimulate economic activity and address the burdens on businesses.

However, amidst economic concerns and stakeholder feedback, the decision to remove IR35 legislation was reversed in October 2022. Jeremy Hunt, the new Chancellor of the Exchequer, has indicated a reform of IR35 will follow however no specific details have been provided.

Given the contentious nature of IR35 cases and the ongoing lack of clarity on IR35, we may see further high-profile appeals.

Expert IR35 Tax Appeal Lawyers

The Kaye Adams IR35 appeal once again demonstrates the complexities and problems with IR35 legislation, highlighting the need for precise analysis of both written contracts and actual work practices.

The appeal has now been remitted for additional evidence and clarification of contractual and working terms, leading to a reassessment of employment status.

We understand that tax disputes can have serious consequences for you. You can face large penalty payments or even criminal charges if you do not cooperate with HMRC tax investigations. It is therefore vital to get legal advice from our specialist tax lawyers and consultant accountants as soon as possible.

Some of our lawyers are trained mediators and can provide a unique insight into HMRC’s tactics and mindset which can be crucial in negotiations and appeals. Our team of established tax lawyers and mediators have a proven track record of delivering solutions for our high net worth individual and corporate clients. Uniquely, we also have tax consultants that work with our lawyers in-house to ensure that the voluntary disclosure is accurate, and any returns are prepared for you.

Our tax lawyers and accountants have an excellent track record of negotiating on behalf of our clients to ensure that their voluntary disclosure is not only accepted by HMRC based on our calculations, but HMRC have also agreed to waive penalties and interest thereby avoiding any criminal liability for clients.

If you have any concerns about IR35 legislation, please do not hesitate to call our expert tax lawyers today for a Free Consultation on 0207 459 4037 or complete our booking form to discuss your tax issue.