£17K bad debt defeats an IR35 challenge

Freelancer David 'S' had suffered a double blow from contracting and IR35. An agency he was working through had gone bust owing him £17,000. Furthermore, as a result of this insolvency, he suffered a further loss when the bank Lloyds TSB entered into a deal with a new agency under which freelancers like David were forced to accept lower rates for their un-submitted timesheets or face even greater losses.

Coupled with this, when IR35 was introduced, David's accountant had advised him that he was probably caught and he had submitted P35s on this basis. So, although his contracts had never been reviewed, the Revenue had issued demands for tax, NIC and interest totalling £60K that David was unable to pay.

By September 2003 the Revenue was about to send in the bailiffs and David contacted me to see if I could help him. I was unable to deal with his case myself at that time so I advised him to go to Qdos or to Sarah Bauer and Kate Cottrell of Bauer and Cottrell. David decided to go to the latter firm and Kate Cottrell took up his case.

She established that he had had five contracts that she conceded were "not very good". These contracts were at two end clients. However, David had reasonable 'in business' characteristics with an office at home, computers networked on a wireless network, laptop, furniture, company logo, business cards etc.

Most importantly, Kate identified the loss of £17K of fees and the subsequent reduction in fee rate as evidence of risk and business operations. She opened the debate with the Revenue and submitted details of David's business operations.

The Revenue's response was to say that "I am unable to agree that the contracts would fall outwith IR35, on the basis of the information provided." The Revenue went on to argue that factors such as daily rates, potential for overtime, requirement to assign IPR to the Client were evidence of a disguised employee relationship.

The Revenue also cited what Kate describes as a "gem" of an argument and certainly one I've never seen used before. David was a disguised employee because he "cannot receive any financial or other benefit out of recommending any third party product or service to the client."!

The Inspector also quoted Synaptek re. MOO and substitution and added that the contract where the loss occurred, "may" be outside as it only lasted a few months but he needed confirmation of the terms. He also said that he wanted to talk to the end clients.

Further debate ensued. Kate confirms that her main point was the bad debt, which she thought was enough to put everything outside IR35. She continued to put the pressure on with reminders and telephone calls. In her final conversation Kate reports that:

"I said that there was not a Commissioner in the land who would say that someone who had a bad debt of in excess of £17K was a "disguised employee" This resulted in "much spluttering and he repeatedly said that it was the contracts he was concerned with and that the debt related only to one "relevant engagement".

In his final letter the Inspector spent three paragraphs confirming his differences of opinion with Bauer and Cottrell and complaining about the lack of additional information. However, in what proved to be the perfect Easter present for David he then conceded that "the loss would be difficult to counter before the Commissioners and in the circumstances I would accept that this would take the matter outwith IR35".

The Revenue's constant argument that freelancers, who are paid by the hour or the day, run little financial risk should never be accepted without a struggle. While cases of losses as high as £17K are, hopefully, fairly rare many freelancers have had some experiences of losses due to agency failure or client default. Many others also have examples of delays in payment – which was an argument that LimeIT used successfully in its case at the Special Commissioners.

This is an area that UKTECH's 'Freelancers Outside IR35' (FO35) recommends that freelancers keep detailed records on, to be able to demonstrate that the financial risks they run are different from and greater than those run by an employee.

So David's £17K bad debt cloud has proved to have a £60K silver lining. A delighted David has shown his gratitude to Kate and Sarah by filling their office with flowers!

Kevin Miller, MA FCA

Kevin Miller Consulting Limited