Borderline IR35 win for IT contractor
An IT analyst has won his IR35 case against HM Revenue and Customs, who began an investigation after the contractor asked them for advice as to whether IR35 would apply in his circumstances.
A Manchester tax tribunal ruled that Novak Brajkovic of Novasoft Ltd was not 'part and parcel' of his client, Avecia's organisation, during the two years under review from 2000 to 2002.
During the early years of operation of the IR35 legislation there was a procedure whereby a taxpayer could seek the views of HMRC as to whether the IR35 legislation might apply to its circumstances. Novasoft did that in January 2002. HMRC undertook various enquiries including interviews of managers at Avecia. The parties could not agree the position and this led eventually to the issue of claims for tax and NI from Mr Brajkovic, who appealed the decision to the tax tribunal.
Background
Novasoft is owned 75 per cent by Mr Novak Brajkovic and 25 per cent by his wife. During the period in dispute, Novasoft provided the services of Mr Brajkovic through an agency, Lorien Holdings Limited. In July 1998 Novasoft entered into a contract - the Lower Contract - with Lorien, which was extended on several occasions up to December 2002.
Among the clauses in the contract were
- Clause 8 stated "The personnel shown in the schedule hereto shall be the only persons whose services may be supplied by [Novasoft] to the client otherwise [sic] agreed by Lorien in writing."
- Clause 12 stated "[Novasoft] and personnel supplied hereunder shall be under the direct supervision of Lorien's client and shall perform their duties hereunder subject to the client's reasonable requests."
- Clause 20 stated "For the duration of this agreement [Novasoft] hereby agrees that the personnel supplied hereunder shall not undertake any other work of a similar nature except with the express consent in writing of Lorien."
In October 1998 Lorien entered into a contract - 'the Upper Contract' - with the end-client Zeneca Limited. In June 1999 Avecia Limited was spun out of Zeneca and it was agreed that for the purposes of the IR35 legislation, Avecia was the client.
IR35 came into effect in April 2000. The Tribunal accepted that it was to hypothesise a notional contract between Mr Brajkovic and the client, Avecia, and then to consider whether under that notional contract the worker would have been an employee of the client. It noted that that should be done by applying normal principles of contract and employment law and that the IR35 legislation provides no special code in that regard. It relied on a 'very considerable body of case law on the topic'.
HMRC, represented by Alan Hall, proposed the following list of factors for consideration, and the Tribunal agrees these are the relevant factors:
(1) Extent and degree of control exercised by the client over the worker.
(2) The worker's right to engage helpers or substitutes.
(3) Mutuality of obligations between the worker and the client.
(4) Financial risk of the worker.
(5) Provision of equipment.
(6) Basis of payment of the worker.
(7) Personal factors
(8) The existence of employee rights.
(9) Termination of the contract.
(10) Whether the worker was part and parcel of the client's organisation.
(11) Exclusive services.
(12) Mutual intention.
The Tribunal said that it would bear in mind the admonishment in a previous case not to treat this as a checklist to run through mechanically. Instead they are the factors that go towards painting the picture whose overall effect must be evaluated.
Mr Brajkovic gave no formal evidence but made his submissions as advocate, which did not allow HMRC the opportunity to cross examine. For HMRC, two representatives of the client gave evidence.
Extent and degree of control
The client confirmed that Mr Brajkovic worked a 36 hour week, with fixed core hours and flexible start and finish times. He was expected to follow the team standards and procedures and would work on projects as and when allocated to him, which were appropriate to his skills.
Mr Brajkovic pointed out the differences between himself and employees, for example, he started and finished work early and usually took two to three months holiday each year.
The Tribunal concluded that the notional contract between Avecia and Mr Brajkovic would have required Mr Brajkovic to undertake his work in accordance with standards and protocols necessary to make the project work-product fit for purpose and maintainable in the future by other IT experts; also to commit sufficient time to that work in order for deadlines and budgets to be met; also to ensure any significant absences fitted with the staffing of the projects overall. Otherwise, the notional contract would not have been prescriptive as to exact hours of attendance, or the exact manner in which Mr Brajkovic implemented the skilled tasks assigned to him.
Substitutes
The Lower Contract provided that only Mr Brajkovic may be provided and no substitution is allowed. This was supported by the client's evidence. It was noted that if Mr Brajkovic nominated a substitute then that person could not have gained access to the department because of security issues, and would not have been allowed to work on the project software because his/her technical competence had not been established by the project leader and manager.
The Tribunal said that although a right of substitution would generally be inconsistent with a contract of employment, its absence does not point definitely to such a contract and concluded that the notional contract between Avecia and Mr Brajkovic would not have permitted substitution.
Mutuality of obligations
HMRC submitted that the irreducible minimum of mutuality of obligation was clearly satisfied. HMRC accepted that there was no obligation on Lorien to offer further work on expiry of the contract – nor on Novasoft to accept it – but while the contract was in place mutual obligations did exist.
Mr Brajkovic for Novasoft submitted that the formal expiry date of the contract was 27 December 2002 but it was terminated on 13 December 2002 with no offer or expectation of any rights in respect of the final fortnight. There was no right or expectation to be offered any contracts on future phases of the projects. All parties agreed that Mr Brajkovic would not have been paid for 'down-time' outside his control such as a power failure.
The Tribunal concluded that the notional contract between Avecia and Mr Brajkovic would have established mutuality of obligations during the term of the contract but, (for the reason put forward by Park J in Usetech), considered that that is appropriate to a self-employment contract as well as one of employment.
Financial risk
The client's evidence showed that if some of Mr Brajkovic's work had been unsatisfactory then the time spent by Mr Brajkovic in correcting that work would have been remunerated, so that Novasoft would have received fees for that extra work. Mr Brajkovic stated that there had not been any such occasions but if there had then he would have felt professionally obliged to remedy matters without putting the time on his timesheet, even if Avecia would have been willing to pay.
Mr Brajkovic submitted that the contract could be terminated immediately by Lorien in certain circumstances without compensation and that his company bore the risk of late payment or non-payment of invoices by Lorien. Novasoft incurred costs of training, printing of materials and stationery, hardware upgrades, library of IT manuals and was required to carry professional indemnity insurance.
The Tribunal concluded that the notional contract would have given Mr Brajkovic a risk of non-payment by Avecia but did not see that as a helpful distinction between a contract of service or one for services in the circumstances of this notional contract.
Provision of equipment
Mr Brajkovic submitted that there was no requirement or expectation that he should provide any IT equipment in connection with the Avecia projects. The IT systems were those of Avecia and there would be security concerns about permitting outside hardware being connected to the Avecia IT system.
The Tribunal concluded that the notional contract between Avecia and Mr Brajkovic would not have required him to provide any IT equipment or software of his own – and indeed may have required him to use only that provided by Avecia, because of security concerns.
Basis of payment
Novasoft was paid an hourly rate for Mr Brajkovic's services, which differed from that paid by Avecia to its employees. The amounts varied from month-to-month, which contrasted with the receipt of a regular monthly amount of salary expected by an employee.
HMRC submitted that payment by reference to project milestones might indicate self-employment, while payment by the hour might be more typical of employment – but accepted that many professional advisers operate on the basis of an hourly charge-out rate.
The Tribunal concluded that the notional contract between Avecia and Mr Brajkovic would have provided for an hourly rate of compensation, and would have required proper invoices to be delivered periodically.
Personal factors
Mr Brajkovic's total length of the contract with Avecia was four and a half years and as the location was only a few miles away from his home it suited him to accept extensions of the assignment there. HMRC submitted that Mr Brajkovic had effectively worked full-time for Avecia from August 1998 until December 2002. HMRC accepted that a self-employed businessman may work exclusively for one client because it is commercially advantageous to do so, but claimed that Mr Brajkovic did not present an image of a businessman offering his services to the marketplace; rather, of someone comfortable working for the same client on terms equivalent to employment.
The Tribunal concluded that the notional contract between Avecia and Mr Brajkovic would not have contained any provisions specifically relevant to this factor.
Employee rights
Mr Brajkovic was not provided by Avecia with any of the types of benefits commonly enjoyed by employees, such as holiday pay, sick pay, pension, bonuses, profit-related pay, paternity leave or redundancy compensation.
HMRC pointed out that Mr Brajkovic did enjoy these rights but by virtue of his employment by Novasoft, his own company, which had responsibility for these matters.
The Tribunal concluded that the notional contract would not have provided for any of these benefits and said that it did not consider it appropriate to 'read across' into the notional contract between Avecia and Mr Brajkovic any features which were confined to the actual contract between Novasoft and Mr Brajkovic, which was twice removed from the notional contract.
Termination of the contract.
Mr Brajkovic said that the contract could be terminated immediately by Avecia in certain circumstances, without compensation, while Avecia employees would be given a minimum of three months' notice.
HMRC submitted that the Upper Contract and the Lower Contract broadly permitted termination on one month's notice which was similar to a normal contract of employment and so was an indicator of employment status.
The Tribunal concluded that the notional contract would have provided for it to be terminable by either party on reasonable stated notice (say, one month) or immediately in the event of breach.
Part and parcel of the client's organisation
Mr Brajkovic highlighted the differences between himself and employees, including that he had no induction or training, did not attend the mandatory annual staff away-days, had a contractor's security pass with an expiry date, was not permitted to use the staff car park, was excluded from Avecia's personal accident insurance cover.
HMRC submitted that Mr Brajkovic was embedded in the Avecia organisation.
The Tribunal concluded that the notional contract would not have provided for any of the points listed by Mr Brajkovic.
Exclusive services
Mr Brajkovic said that he was free to undertake work for parties other than Avecia, subject to a confidentiality undertaking and the agreement of Lorien and, in fact, did undertake another paid assignment at the time, being setting up a website for a music band. HMRC submitted that a single master is indicative of an employment.
The Tribunal concluded that the notional contract between Avecia and Mr Brajkovic would have provided for Mr Brajkovic's services to be provided as required on the projects without competing demands – or at least, taking precedence over any competing demands – for his time; but would not have prohibited him from other assignments that did not conflict with Avecia's business interests.
Mutual intention
Mr Brajkovic submitted that there was nothing in the documentation involving Novasoft, Lorien and Avecia to suggest that he was an employee of Avecia and that he did have an employer, and it was Novasoft.
HMRC submitted that although HMRC accepted that the actual contracts were not intended to create an employment, minimal weight should be attached to that in considering the terms of the notional contract.
The Tribunal concluded that the notional contract would not have provided for any statement of intention.
Conclusions
The Tribunal summarised its conclusions on the factors which would have determined the contents of the notional contract between Avecia and Mr Brajkovic. In summary, the notional contract:
(1) would have required Mr Brajkovic to undertake his work in accordance with standards and protocols necessary to make the project work-product fit for purpose and maintainable in the future by other IT experts but would not have been prescriptive as to exact hours of attendance, or the exact manner in which Mr Brajkovic implemented the skilled tasks assigned to him.
(2) would not have permitted substitution.
(3) would have established mutuality of obligations
(4) would have given Mr Brajkovic a risk of non-payment
(5) would not have required Mr Brajkovic to provide any IT equipment or software of his own
(6) would have provided for an hourly rate of compensation, and would have required proper invoices
(7) would not have provided for any typical employee benefits or statutory protections
(8) would have provided for it to be terminable by either party on reasonable stated notice
(9) would not have provided for any of the points that might indicate that Mr Brajkovic was "part and parcel" of Avecia's organisation.
(10) would have provided for Mr Brajkovic's services to be provided as required on the projects without competing demands
(11) would not have provided for any statement of intention.
The Tribunal reiterated the words of Mummery J in Hall v Lorimer: "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 from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative appreciation of the whole. It is a matter of evaluation of the overall effect of the detail, which is not necessarily the same as the sum total of the individual details. Not all details are of equal weight or importance in any given situation. The details may also vary in importance from one situation to another. The process involves painting a picture in each individual case."
They acknowledged the difficulty in deciding a borderline case and then concluded that the overall picture painted is one of a contract of self-employment.
The question of substitute was an important detail and has been given some emphasis in previous cases, but the Tribunal felt that in the particular situation of Novasoft and taking the picture as a whole that detail does not disturb the overall impression they formed of the notional contract.
Full decision is available online