One of the earlier IR35 tribunal cases, the case of Usetech v Young is often used to demonstrate the impact that the upper level contract can have on an enquiry.
It's important to remember that tax tribunals in their current form did not exist in 2004, only coming into place as a result of the 2009 reform of the tax appeal system. Before April 2009, the appeals process consisted of an initial appeal stage whereby HMRC would list appeals for the general commissioners before moving upward to the special commissioners for more complex cases.
Mr William Hood, a computer software specialist, provided his services to ABB Vetco Gray (UK). He did so for a period of 17 months between June 2000 and October 2001 through his own company, Usetech Ltd, via NES International Ltd, a technical recruitment agency.
Following a review of Usetech Ltd's contract and working practices, HMRC deemed that Mr Hood's contract was caught by the IR35 legislation and as a consequence, he was required to pay additional tax and NIC on the income earned during the contract.
As Mr Hood did not agree with the outcome of HMRC's review, he subsequently appealed HMRC's decision. This appeal was heard by the Special Commissioners and was thereafter dismissed.
During his appeal, Mr Hood argued that IR35 did not apply due to the fact that the contract between Usetech Ltd and NES International Ltd contained a valid right of substitution, meaning that his personal service was not required. In addition, Mr Hood argued that mutuality of obligation did not exist as the end client had no obligation to provide Usetech Ltd with work.
Unfortunately for Mr Hood, rather than being bespoke to him, the contract between Usetech Ltd and NES was a standard contract used by the agency when engaging individuals through their own limited company. As this contract was just a generic 'off the shelf' contract that the agency used irrespective of whom their engagement was with, the terms and conditions that it contained were not specific or unique to Usetech Ltd and therefore did not accurately reflect the terms and conditions under which Mr Hood was engaged.
Whilst a substitution clause was present, the upper level contract did not contain the same terms and conditions as the lower level contract between Usetech Ltd and NES. This is a familiar theme in IR35 cases, it is not unusual for the terms and conditions in the lower level contract between the PSC and agency to differ quite significantly from the terms and conditions in the upper level contract between the agency and client.
At the hearing, the right of substitution was described by the Special Commissioner as being largely illusory, and that the hypothetical contract would not have contained a substitution provision. In addition to this, the High Court judge stated that if during negotiation Mr Hood had raised the issue of substitution with ABB then this would not have been entertained by the end client. This point further emphasises the importance on ensuring that the terms and conditions included in a contract are an accurate reflection of the working practices that the contractor will be undertaking. Furthermore, where possible, it is equally important that the terms and conditions of the lower contract are the same as the terms and conditions contained in the upper contract, thereby ensuring that all parties are aware of and in agreement as to the requirements of the contract.
ABB was required by the terms and conditions of its contract with NES to provide and pay for a minimum of 37.5 hours of work. The contract also included a termination clause, which allowed for a 7 days’ notice period by either party.
It was concluded by the judge that, based on these terms, a mutuality of obligation existed between the parties. As such, said mutuality would also have been a feature of the hypothetical contract.
As a result of the issues highlighted above, after hearing all the evidence put forward by both Mr Hood and HMRC, the High Court Judge ultimately dismissed the appeal, and Usetech Ltd was liable for the additional tax, NICs, and interest owed.
The 'upper-level contract' is the term used to refer to the contract between the recruitment agency and end client where the contractual chain involves an agency. The 'lower-level contract' is therefore used to reference the contract between the PSC and agency in this contractual chain.
As demonstrated by this case, upper level contracts can be of high importance. Discrepancies present in the upper contract can have a detrimental impact on a contractor's status during an enquiry, as they can show an alternative hypothetical contract which is more likely to be deemed as the true nature of the working practices.
Unfortunately, most contractors will never get sight of this contract and so cannot easily ascertain their status based on contracts. This is one reason why contractors should ensure that their contract always mirrors the actual working practices and is as robust as possible, to reduce the likelihood of the upper level contract coming into play, and of course, ensuring that the appropriate taxes are being paid.
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