Usetech loses IR35 case before Special Commissioner
Special Commissioner Colin Bishopp has delivered another blow to the ailing design engineering freelancer Bill Hood, when he found that Hood's company Usetech Limited was caught by IR35 in its contract with engineering group ABB Vetco Gray.
This Special Commissioner's hearing had been conducted in Bill Hood's kitchen because he was too ill to attend at the Commissioners. Clearly when it comes to applying tax law the Special Commissioners do not let sentiment get in the way and the judgement is totally objective.
Mr Hood was supported in his fight by the PCG, who met the costs of having Dave Smith of Accountax fight the case for Hood. Freelancers will feel much sympathy for Bill Hood and this decision is also something of a blow in the general fight against IR35 as it clarifies certain boundaries in the Revenue's favour.
Clearly any case that goes to the Commissioners (Special or General) has a degree of uncertainty. The Revenue are unlikely to take cases that far if there is no chance of their winning – although their decision to fight the Tilbury Consulting case last year might be seen as evidence that they can sometimes back cases that seem to have little chance of success.
I suspect that the participants will be viewing this case with mixed feelings. It would have been a useful one to win, as it would help to shift the boundaries in certain areas – especially control and personal service. But it must also have been apparent that this case had a high chance of failure, based upon the contract and, in particular, the evidence from the client.
Background
Bill Hood worked through his service company Usetech Ltd between 1996 and 2003 when ill health forced him to close the company down.
The judgement in the case USETECH LIMITED (Appellant) and GRAEME W YOUNG
(HM Inspector of Taxes) Respondent records that:
"between 1996 and 2000 Mr Hood undertook work for various companies; in his evidence he identified four engagements. The first was with ABB Vetco Gray ("ABB"). The taxpayer's contract with ABB was effected through the medium of an agency, NES International Limited ("NES"). Mr Hood was interviewed by ABB before it agreed to engage him, although there was at no time any contract between ABB and Mr Hood, nor between ABB and the taxpayer. ABB contracted with NES which in turn contracted with the taxpayer for the provision of Mr Hood's services. The engagement lasted for about 8 months, from June 1996 to February 1997. From then until June 2000 Mr Hood undertook work for companies other than ABB, save for a period of about three months during which the taxpayer was unable to secure any work for him. In May 2000 the taxpayer entered into a further contract with NES for the provision of Mr Hood's services to ABB. The contract was initially expected to be of quite short duration – a matter of weeks – but in fact Mr Hood remained for some 17 months. The taxpayer then secured a further short-term contract with another company before again agreeing with NES to supply Mr Hood's services to ABB; it did so from February 2002 until Mr Hood ceased work in May 2003"
The contract in dispute covered the period 1 June 2000 to 31 March 2001 during the whole of which period Mr Hood's services were supplied to ABB.
The Commissioner heard evidence from Mr Hood, from Gerald Parker, a Revenue officer who made enquiries into the circumstances of Mr Hood's engagement, from Alexander Hunter, ABB's human resources manager and from Paul White, ABB's engineering manager. The evidence from the latter two seems to have been particularly crucial to the decision.
The facts
ABB provides equipment for the oil and gas industry. It has a core staff of 750 to 850 permanent employees, but supplements that staff, when demand requires, by taking on what were described by their HR manager, Mr Hunter, as "sub-contract employees".
The company's needs were identified by managers such as Mr White in charge of its various activities and were notified to Mr Hunter and his team, who satisfied the need by taking on temporary staff.
This they did by means of specialist agencies of which NES was one. The ABB managers confirmed that ABB would in no circumstances enter into a direct contractual relationship with a temporary staff member. In this case ABB had, in the course of their dealings with Bill Hood, offered him permanent employment but he declined it for family reasons.
However, although temporary workers were always engaged through agencies, Hunter confirmed that it was ABB's practice to interview them individually before they were accepted. Mr Hunter had himself interviewed Mr Hood before he was first taken on by ABB in 1996. A temporary worker did not need to be interviewed again before each engagement and Mr Hood had, therefore, undergone only one interview.
The purpose of the interview is primarily to verify that the proposed temporary member of staff had the requisite skills for the work required of him; thus ABB relied on its own judgment and did not accept such temporary staff as the agencies offered.
During the course of working at ABB via NES Bill Hood had had three contracts with NES. Each had slight differences but the Commissioner concluded that the differences were small and not of great significance in reaching his decision. The Commissioner also reported that it was not actually clear which of the three different wordings applied to the period under consideration.
The contract between NES and the taxpayer, so far as was relevant to the appeal, was set out in a letter of 22 May 2000, sent by NES to the taxpayer; the letter stated that it incorporated NES' terms and conditions. It began with these words:
"We are pleased to offer you a contract to supply contract staff in a position as Pro-Engineer Designer" and went on to name Bill Hood as the contract staff. Further similar letters were issued as the contract was renewed by ABB except that the letters did not name Bill Hood specifically.
The Commissioner also saw the contract between NES and ABB. Neither the letters nor NES' terms and conditions specified the hours of work – that is, the starting and finishing times, or the number of hours of work required each day, week or month. By contrast, ABB's agreement with NES stipulated that ABB would provide not less than 37.5 hours of work per week.
Control over work and hours
The judgement acknowledges the argument that neither Mr Hood nor the taxpayer was a party to the contract between NES and ABB and that they would not be bound by it – indeed they may have been quite unaware of its terms. The Commissioner also recognised that the stipulation about hours of work was not repeated in NES' contract with the taxpayer.
Mr Hood gave evidence that he determined himself the hours he would work, starting and finishing at times to suit himself and taking holidays when he wished, although as a matter of courtesy he told ABB in advance of his intentions.
Flexibility was of some importance to him since he lived in Newcastle but was working at ABB's offices in Aberdeen, staying in lodgings. He stayed in Aberdeen for some weekends, working at ABB's offices, but would otherwise travel home. On some occasions he was asked to work at the weekend, but declined as he had planned to travel home.
The judgement also notes that he had no guarantee of work; if, unexpectedly, work he had intended to perform at a weekend was cancelled, or for some other reason there was no work for him to do (such as ABB's computers crashing), Mr Hood was sent home or to his lodgings and, unlike permanent, employed staff, he was not paid in those circumstances: he was paid only for the hours he actually worked. Similarly, he did not receive sick pay, or holiday pay.
However the Commissioner went on to add that:
In substance, that evidence coincided with what I was told by Mr Hunter and Mr White, though each said that, while Mr Hood had some flexibility about the hours he decided to work, he was expected to agree those hours with Mr White or the technical manager to whom he reported and, within reason, to keep to those hours. Mr White's evidence went rather further: he said that staff, both permanent and temporary, were normally expected to begin work at 8am and finish at 5pm, but those hours could be extended and Mr Hood had, in fact, worked longer hours on occasion. As a general rule, temporary staff were expected to work 50 hours a week, and Mr Hood did so. If he wanted time off, or to take a holiday, he was expected to seek agreement in advance to his doing so in the same way as would be required of an employee. If the workload were heavy, Mr White said, he might refuse permission but he accepted that if Mr Hood insisted on taking a holiday he could not, in practice, prevent him from doing so, although the situation had never arisen. Both Mr Hunter and Mr White accepted that Mr Hood could be sent home without pay though, without ruling the possibility out, neither recalled an occasion on which it had happened. He would certainly be laid off, with minimum notice, if the project on which he was working came to an end and no other work was available; as Mr Hunter explained, it was ABB's ability to adopt that course which had led it to engage temporary staff through agencies."
Unfortunately the conclusion that the commissioner drew from this evidence was that:
"It seemed to me from the evidence that, apart from his not being an employee of ABB, any temporary member of staff was treated, on a day-to-day basis, in a manner barely distinguishable from an employee. He was required to carry a security pass (albeit one identifying him as a temporary, rather than permanent, member of staff) and to attend safety briefings, though these two requirements are not, in my view, of any significance; they seem to be no more than common sense demands. Likewise I find it of little significance that (even if after some time had passed by) Mr Hood became a user of ABB's email system. The fact that he was engaged only temporarily did not diminish the need for communication with him. I also read no significance into the fact that the intellectual property rights in the designs produced by Mr Hood were retained by ABB. Whatever his status, it would in my view be quite remarkable if ABB, having paid Mr Hood (if only indirectly) to produce such designs, had then left him at liberty to sell them to its competitors.
More important, to my mind, were the manner in which work was allocated, performed and checked, and the working hours expected of Mr Hood. The evidence showed that work was allocated to the total complement of about 60 engineers and designers available to Mr White at weekly meetings, at which the staff were assigned to project teams. Those teams were led by technical managers, who reported to Mr White. Mr Hood reported to the technical manager to whose project team he was assigned at any given time. Mr Hood was thus expected to, and did, accept those tasks allocated to him at weekly meetings.(my emphasis). ABB provided all the necessary equipment including particularly working space at its own premises (where Mr Hood was required to undertake the work) and the computer and software necessary for its performance. Although nominally Mr Hood was engaged on a project-by-project basis, it was apparent from the evidence that he did whatever was required of him, within his skills, as the demands of ABB's business dictated.(my emphasis) His work was checked in the same way as that of ABB's own employees, but I do not regard that as a significant factor since the stringent safety requirements ABB and its own customers imposed rendered careful checking inevitable. Mr Hood was at pains to point out that, although he was told what he was required to produce, he was not told by ABB how he should go about doing so. He described his own skills as unique, a view which Mr White did not share although he did accept that Mr Hood needed no instruction and was a highly competent user of Pro-Engineer. I accept that Mr Hood, once allocated a task, was able to accomplish it without guidance or instruction and that none was given or offered by ABB. The point was made that Mr Hood had little or no contact with ABB's customers but since it was not explained whether ABB's employees doing similar work might have had such contact I leave this factor out of account."
Substitution
Another key issue in the case was that of substitution. Usetech's contract with NES had a clause that allowed for the substitution, by Usetech of an alternative worker. The three versions differed slightly in their wording, though the Commissioner concluded that in substance all three seemed to be identical.
One version read as follows:-
"14.4 The Sub-Contractor shall be entitled to substitute alternatives for the Personnel, with the prior written consent of the Company – such consent not to be withheld if the proposed replacement has the appropriate skills, qualifications and abilities in the reasonable opinion of the Client."
On the face of it this clause meets the usual requirements for an effective right of substitution. However, while the right of veto appears to be only on the basis of the substitute not being suitably experienced or qualified this veto is in the hands of the agency which is the "company" in question.
The evidence of the client's HR manager was that:
"Mr Hunter's evidence was that ABB's intention was to secure Mr Hood's services. If he had become unavailable, for example because of prolonged illness, ABB would have heeded his recommendation of a replacement, but the replacement would have been interviewed, as Mr Hood himself and all other temporary staff had been, and taken on by ABB only if he was considered suitable. ABB would have regarded his being taken on not as a mere variation, still less a continuation, of the arrangements by which Mr Hood had been engaged, but as a new contract which, in common with all other engagements of temporary staff, would have been effected by means of an agency."
Clearly this fails the basic requirement of an effective substitution clause, which would require that the original freelancer remain responsible for the work of the substitute and that payment to the substitute be made via the original service company. In effect the client's evidence was that this clause provided grounds for terminating the original contract and replacing it with another.
In business on your own account and business risk
In addition to the contract with NES Usetech also had a couple of small contracts. At some expense to the company it had invested in its own copy of the Pro Engineer software which it used on these contracts and to help it keep its skills up to date. This other work was done at weekends and in the evenings. The fees concerned for these contracts were modest – about £800 each. However the crucial evidence again came from ABB. The judgement records the evidence of Mr Hunter as follows:
" Mr Hunter told me that he would not have approved of Mr Hood's doing significant amounts of work for other companies while he was engaged by ABB, which wanted his services full-time, but he would not disapprove of his undertaking small contracts, such as these, in his spare time."
Clearly evidence that the end client can "approve" any other work is a significant pointer towards a contract of service.
The Commissioner concludes that:
"I accept that the taxpayer maintained equipment at Mr Hood's home, and that its doing so points to its having its own business activity; but the equipment was not used in undertaking ABB's work, and is, in my judgment, irrelevant to the issue I must decide. .
On the issue of financial risk the Commissioner concludes:
" Risk and the opportunity to profit are, in many cases, opposite sides of the same coin. Here, it seems to me, they were almost entirely absent. There was a risk that ABB would fail to pay, or that NES would fail to pass on payments; but those risks do not seem to me to be of a different character from those run by an employee. More importantly, the taxpayer was not risking its capital, nor (beyond the risk of non-payment) was there any prospect of its making a loss. Conversely, the only means of making additional profit was for Mr Hood to work more hours. He could not augment the profit by working more efficiently."
This is in contrast to the views of the Special Commissioner in the LimeIT case late in 2002 or the General Commissioners in the case of 'Victor', which I reported on UKTECH recently. In both of these cases they concluded that the freelancer's business was running risks that were greater than would normally be associated with an employee.
Hypothetical contracts
The Commissioner noted that the legislation required him to construct a hypothetical contract between the worker and the end client – or as he put it he is required to consider "a fiction, that is a notional contract between ABB and Mr Hood from which the taxpayer is absent:".
He goes on to add:
" I must proceed upon the basis that, whatever the intentions of the client and the worker, there was a direct contract between them. I accept that other terms of the contracts which were, in fact, entered into cannot be disregarded, but the intention not to enter into a direct contractual relationship must, as part of the fiction, be set aside."
Interestingly he then concludes that:
The test I must apply, as it seems to me, is not whether the contractual arrangements are consistent with a relationship of employer and employee, but whether, after applying the fiction that there is a direct contract between "client" and "worker", there is anything in that notional contract which is incompatible with the relationship between them of employer and employee" (my emphasis)
This appears to be an interesting slant on the concept of being 'innocent' until proved guilty!
Mutuality of obligation
This key issue received a brief airing. The Commissioner concluded that, following the judgement in Nethermere (St Neots) Ltd v Taverna and another [1984] IRLR 240, "the requirement of mutuality may be satisfied by the obligation, on the one hand, to work and, on the other, to remunerate".
The judgement
In reaching his judgement the Special Commissioner used the classic Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968] as his case law starting point. He looked at the three key issues outlined in that case, namely:
" "A contract of service exists if these three conditions are fulfilled. (i) The servant agrees that, in consideration of a wage or other remuneration he will provide his own work and skill in the performance of some service for his master. (ii) He agrees, expressly or impliedly, that in the performance of that service he will be subject to the other's control in a sufficient degree to make that other master. (iii) The other provisions of the contract are consistent with its being a contract of service"."
With reference to the third condition he dismissed Dave Smith's arguments that the fact that " that the fact that the parties did not intend to enter into a contract of service is an important factor" and that "I must proceed upon the basis that, whatever the intentions of the client and the worker, there was a direct contract between them."
He then goes on to conclude that:
" In this case, whatever the contractual relationship, the reality, as I am satisfied, is that ABB required Mr Hood's services. It was not contracting, indirectly, with the taxpayer for the supply of a person competent in Pro-Engineer; it required Mr Hood. It would not have accepted a substitute, if Mr Hood had sent one, without interview and certainly not on the basis that Mr Hood or his substitute might attend as the taxpayer elected from day to day. Mr Hunter's evidence, which I accept, can lead to no other conclusion than that the arrangement was personal to Mr Hood. "
Of some concern to freelancers will be the Commissioner's conclusion that although the right of substitution was not a sham In my view, the "right" of substitution was largely illusory". This suggests that having the right of substitution (with no unreasonable fetter) in a contract between the freelancer's business and the agency is not likely to be adequate by itself if there is no evidence that the right is also present in the agency/client contract or if the client will not confirm that they would accept a suitably qualified substitute.
However the requirement for personal service (which a lack of an effective right of substitution implies) does not, of itself, make the contract one of service rather than for service. The key issue in this case is clearly that of control.
On this key issue the Commissioner notes that:
" While I accept that Mr Hood retained some control over the hours he worked, I am satisfied from the evidence that the degree of control he could exercise in practice cannot be materially distinguished from that which one would expect in any fairly senior employee." and
"I accept that Mr Hood was left largely to his own devices in the manner in which he carried out his work, but that too seems to me to be no more or less than one would expect of any skilled and trusted employee. Mr Hood was taken on by ABB precisely because he knew how to do the work, without the need for instruction or supervision."
He concludes that the evidence showed clearly that:
"Mr Hood was expected to undertake the work allocated to him by ABB and to do so in accordance with its directions and at times of its choosing. Although in theory he could decide whether or not he would work on any particular project, the reality was that he either accepted the work which was allocated to him, or his engagement was terminated. In that, too, he was in materially the same position as an employee……. overall, it seems to me that there is no difference of substance between the measure of control exercised over his work by ABB and that it would have exercised over an employee of his status "
The other main issue that the Commissioner considers in his conclusion is that of Mr Hood being in business on his own account. However the Commissioner concludes:
" In my judgment, whether one asks if the taxpayer, in the context of this engagement, was pursuing a business on its own account, or considers the distinction between a contract of service and a contract for services – tests which in any event overlap to a great extent – the answer is the same: had there been a direct contract between ABB and Mr Hood it would have been a contract of service. I am left in no doubt that ABB was in close control of the work, that it was Mr Hood personally who was required to undertake it and it is quite unrealistic to suggest that, in the relevant period and on the assumption that there was a direct relationship between ABB and Mr Hood, he or the taxpayer was in the course of carrying on a business on his or its own account. The conclusion must be that the notional contract between ABB and Mr Hood was one of service. I can find no factor in the case which is inconsistent with that conclusion."
Not surprisingly therefore the Commissioner found in favour of the Revenue and dismissed the appeal.
Is it all bad news?
Clearly this was bad news for Bill Hood and to a certain extent for freelancers in general.
Control remains, potentially, the most damaging issue as far as being an indicator of a contract of service. Where it appears that the client can determine or vary tasks and priorities on a regular or routine basis then the freelancer will need to be able to demonstrate that they have a cast iron right of substitution if they are to avoid a contract of service.
It will also focus attention once again on the issue of the right of substitution. It seems clear that where agencies are involved there must be a reference in the agency contract's substitution clause to the fact that the original service company remains responsible for the work and for payment to the substitute. Clearly there also needs to be evidence – whether in the contracts or elsewhere – of the fact that the right of substitution is accepted by the client and can only be refused on the grounds of lack of suitability or experience.
The decision also leaves the issue of being in business on your own account somewhat less clear. Although Usetech Ltd had other work in parallel the Commissioner appears to have considered that the main contract with ABB was not being carried out as part of the business of Usetech.
However, the case is not all bad. It has been useful in clarifying once again that several factors that the Revenue often seeks to use as employment indicators are, at best neutral.
Some comment was made at the hearing about the fact that Mr Hood was required to complete time sheets, recording the hours he worked, and to have them signed by a suitable member of ABB's permanent staff.
The Commissioner concluded that:
"I regard that as a matter of no real significance. It seemed to me to be no more than the means by which both he and ABB could record the hours for which he was to be paid, and by which NES could be notified of the hours for which payment was due, since it was through NES that the taxpayer was remunerated."
The Commissioner also concluded that the fact that he was required to carry a security pass (albeit one identifying him as a temporary, rather than permanent, member of staff) and to attend safety briefings:
"are not, in my view, of any significance; they seem to be no more than common sense demands. Likewise I find it of little significance that (even if after some time had passed by) Mr Hood became a user of ABB's email system. The fact that he was engaged only temporarily did not diminish the need for communication with him. I also read no significance into the fact that the intellectual property rights in the designs produced by Mr Hood were retained by ABB. Whatever his status, it would in my view be quite remarkable if ABB, having paid Mr Hood (if only indirectly) to produce such designs, had then left him at liberty to sell them to its competitors."
The Commissioner also looks at the old issue of payment by the hour. On this matter he states:
"Mr Smith accepted that payment by the hour, which was the arrangement in this case throughout, was a neutral factor. On the whole I think that is right, although it might be expected that an employee, in the conventional sense, doing Mr Hood's work would be paid a salary rather than by the hour whereas an independent contractor, such as a professional man, would be paid an hourly rate. However, payment by the hour is common in contracts of employment and I do not think this factor points one way or the other."
Conclusion
Overall, the Revenue will take some heart from this case as, in recent months, the IR35 pendulum seemed to be swinging against them. However, the real lesson to be learned from this case seems to be the need to ensure that, where contractual issues like substitution and control are not clearly in the freelancer's favour, then client's staff are supportive of the freelancer's stance. This was clearly shown in the recent case of 'Victor', which I reported on UKTECH. In this case the client's evidence was clearly very damaging to Mr Hood's case.
I gather that Mr Hood and his advisers are considering an appeal. I must say that my initial reaction is to question on what grounds the appeal would be based? The Commissioner appears to have established the key factors in the contract and the relationship and to weigh up the legal issues on the basis of those facts.
The only legal area where I wonder if the Commissioner may have erred is in his view that in weighing up the hypothetical contract he need only look to see if " there is anything in that notional contract which is incompatible with the relationship between them of employer and employee"
This appears to presuppose that the 'natural' state is that of employee and employer - which appears to be jumping to conclusions. I am not clear why the Commissioner could equally validly have argued that the key test was to establish if there was anything in the fictional contract that was "incompatible with the relationship between them being a contract for services"?
We shall see.