Employment status of individuals working through personal service companies

Employment status of individuals working through personal service companies

Thu 29 Mar 2018

The potential application of IR35 legislation to deem the receipts of personal service companies to be employment income of the individuals operating through them, has been high profile news recently.   Applying the IR35 legislation may not always be straight forward where the circumstances of a contract have some, but not all of the characteristics of employment.

The recent case of MDCM Ltd is an example where the First tier Tribunal (FTT) found that while some factors indicated employment, other factors inconsistent with employment were more dominant and the relationship was not one that would be characterised as employment.

In the MDCM case, factors that pointed towards employment were the requirement for personal services and lack of financial risk. Factors pointing away from employment included the nature of the payment arrangements, a flat rate per day with no notice period and no entitlement to any employee benefits.

Requirement to apply IR35 legislation

Particular requirements need to be met in respect of the contract for services in order for the IR35 legislation to apply. These are:

  • The individual is under an obligation to personally perform services for the client (who is not a public authority, as different rules apply to this sector);
  • The services are not under a contract of employment directly between the client and the individual worker, but through an intermediary; and
  • If the contract had been directly between the client and the worker, the worker would have: (i) been regarded for income tax purposes as an employee of, or office holder under, the client; or (ii) been the holder of an office for the client and the services related to that office.

The particular facts of the MDCM case:

Mr Daniels worked as a quantity surveyor in the construction sector through MDCM Ltd, a company of which he and his wife were directors. Through a recruitment business MDCM was engaged to provide Mr Daniel’s services as a night-shift manager at a construction site in London.  He had to work established shift times from 5:30pm to 7am, Monday to Friday and reported to the client’s project manager.  During his work he was the client’s site representative.  The work lasted initially from 26 October 2012 to May 2013.  The client offered Mr Daniels and MDCM work at another site, which he accepted and his engagement with the client ended in July 2013.  Mr Daniels/MDCM was paid a daily rate by the client, who was not responsible for Mr Daniel’s travel, subsistence and hotel expenses.

On the facts of this case, the FTT found that the client exercised no more control over Mr Daniel than they would over an independent contractor. The case summary does not go into great detail on mutuality of obligation, but despite the standard contract term providing for a right of substitution, the FTT, considered there was in fact no right of substitution and on this basis seem to have concluded there was mutuality of obligation.  The FTT found that Mr Daniels was not required to provide equipment or accept any significant financial risk in relation to the work.  Mr Daniels was not considered by the FTT as part of the client’s organisation as he was not invited to functions or events run for employees.  Neither party was required to give notice to terminate the contract.

Discussion of factors indicating a contract of employment

As the MDCM case illustrates, the decision as to whether someone is employed under a contract of service is highly fact sensitive. It is the case that if certain critical facts are not present, a contract cannot be regarded as one of employment.  These include:

  • A right to substitute personnel;
  • The lack of control over how the service is to be performed;
  • There is a lack of mutuality of obligation.  Mutuality of obligation exists where the engager is obliged to offer on-going work and the provider is obliged to undertake the work.  A well-known case discussing this is the House of Lords decision in Carmichael and others v National power plc (1999 UKHL47) where it was held on the facts that ‘employment on a casual as required basis’ did not satisfy the requirement for mutuality of obligation.

HMRC’s employment status manual at ESM0515 lists the relevant factors that are considered in assessing whether a contract is one of employment (a contract of service) or self-employment (a contract for services).  Where the client is not a public authority, if IR35 legislation applies, the intermediary through which the individual works is responsible for operating PAYE.  Where the client is a public authority, it may be necessary to identify the ‘fee payer’ (which could be the public authority, who is then required to operate PAYE where the IR35 legislation would otherwise apply (‘off payroll workers in the public sector’).

This is a complex area and engagers, whether within the public authority sector or not, need to have appropriate procedures to ensure their employment tax obligations with respect to engaging individuals are properly managed. In addition to employment tax obligations, larger corporate organisations may need to consider the implications for the senior accounting officer regime, and all businesses will now need to consider whether their procedures protect them from being charged with facilitating a tax evasion offence under the Criminal Finances Act.

For a further discussion of these areas, please get in touch with a member of the Mazars employment tax team.

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