In Dragonfly Consultancy Limited v The Commissioners for Her Majesty and Revenue & Customs (2008), the High Court has held that the IR35 rules on personal service companies apply to the services of a highly skilled IT consultant particularly because the client would have been unlikely to accept an unfettered right of substitution.
IR35 prevents individuals avoiding income tax and National Insurance contributions by providing their services through an intermediary, which is usually a personal service company. Under IR35, HMRC ignores the legal relationships in a particular case. If the individual’s services for the client would have constituted an employment relationship for tax purposes if he or she engaged with the client directly, IR35 imposes employer tax obligations (PAYE withholding and Class 1 NIC) on the intermediary and treats payments to the employee as employment income.
HMRC’s approach to determining an employment relationship takes into account all of the circumstances to paint an overall picture of the notional contract, but particular factors are repeatedly considered in case law.
The consultant in the Dragonfly case specialised in designing and implementing tests on IT systems software, and was highly skilled in the personal and complex analytical skills involved. He was not subject to detailed instructions as to how he should undertake what he did.
The Dragonfly case turned to some extent on the right of personal substitution. If the individual is able to substitute another worker instead of personally performing the services, this is usually indicative he or she is self-employed. However, in this case, the consultant carried out the services personally and did not carry out any significant work for any other person during the periods concerned.
The service company’s contract with the client contained a right to substitute another consultant, but this was not unqualified – the inference was that this would have required the client’s consent.
Mr Justice Henderson took the view that in the light of the evidence in the case, in particular an oral statement from the client that it “did not want any competent tester, it wanted [the consultant]”, it was unrealistic to suppose that the client would ever have agreed to an unqualified right of substitution.
This case shows how important it is for a consultant to be able to demonstrate an unfettered right of substitution before the courts will accept that the arrangement is indicative of self-employment.
Clients of such consultants should therefore be prepared to:
receive more information requests from HMRC in relation to IR35 enquiries into consultants they have engaged, so increasing their administrative burden in relation to using consultants; and
find it harder to hold on to some skilled IT consultants as IT consultants seeking to remain self-employed may demand a real right of substitution, in practice this may even mean that they try to foist other consultants on their clients from time to time in support of this right.