IR35 Factors, IR35 Compliance, are you caught?

Our colleagues at Qdos Consulting have provided this useful summary of the recent Novasoft IR35 case.

Novak Brajkovic, director of Novasoft Ltd, achieved an astounding victory recently when a Tax Tribunal ruled that his company's contracts with Avecia (end client) covering the period April 2000 - December 2002 were not caught by IR35. Astounding, because all the odds were stacked in HMRC's favour and based on the factual evidence not many would have given this brave IT contractor a hope.

Novasoft began contracting to Avecia, a biotechnology company, via the agency, Lorien, in July 1998 and the contract was extended several times through to December 2002. In January 2002, Mr Brajkovic asked HMRC's IR35 Customer Service Unit to provide an opinion on his company's contract. This, however, proved to be the catalyst for an enquiry and many years of uncertainty, strife and cost.

During the course of their enquiries, HMRC interviewed managers at Avecia and concluded that Mr Brajkovic was effectively a full time worker of Avecia. Novasoft disagreed with that opinion and as neither side could agree HMRC issued assessments for tax and NICs in the region of £50k which the contractor appealed against in June 2005.

Qdos Consulting had originally been appointed to represent Novasoft during the course of the enquiry because they had successfully defended a co-contractor of Mr Brajkovic's. HMRC, however, refused to accept the parallels between the two freelancers, trotting out the same old mantra that each IR35 case is judged on its own merits.

After exhausting all possible arguments, Qdos were compelled to advise Mr Brajkovic that his prospects of successfully having his appeal upheld at the First Tier Tax Tribunal were slender due to the weight of evidence against his company and that HMRC had two witnesses onside from Avecia.

Qdos's honesty and integrity was acknowledged by the contractor, as Novasoft would have been looking at a bill for professional representation of up to £10k had Qdos taken the case to Tribunal. Mr Brajkovic therefore took the bold decision to go it alone and represent himself.

At the Tribunal the contractor appeared as an advocate which meant HMRC could not cross examine him. After hearing all the evidence the judge brought together all the factors that would have comprised the notional contract as follows:

Pointers towards employment

Control

• Contractor had to follow team standards and procedures.


• Work was project based as and when allocated to Novasoft by Avecia.


• Commitment of sufficient time to ensure that deadlines and budgets were met.


• Significant absences had to fit with the staffing of the projects.

Substitution

• Not permitted.

Mutuality of Obligations

• Present for the duration of the contract.

Financial Risk

• The risk of non-payment of fees was not sufficient to draw a distinction between a contract of service and a contract for services.

Provision of Equipment

• The use of Novasoft's own IT equipment or software would not have been permitted for security reasons, as Avecia required the contractor to use only their own equipment.

Exclusivity

• Mr Brajkovic would have been required to devote his time to Avecia projects. Although this would not have prevented him from undertaking other assignments, this would have only been possible if these did not conflict with Avecia's business interests.

Pointers towards self-employment

Integration

• Avecia employee's underwent a half to full day induction programme upon joining the company. Mr Brajkovic did not undergo this process.


• Contractor did not attend mandatory annual staff away-days.


• Contractor was not part of Avecia's staff training programme.


• Contractor security pass was different to that of Avecia employees and had an expiry date.


• Strictly prohibited from using the staff car park at any time.


• Excluded from Avecia's personal accident insurance cover.

Neutral/ Minor Factors

Basis of Payment

• Novasoft was paid an hourly rate for their services.

Length of Engagement

• 4 1/2 years working for one client was not considered relevant.

Employee Benefits/Rights

• Mr Brajkovic was not provided with any benefits or afforded other rights enjoyed by Avecia employees.

Termination of Contract

• Termination by either party within a reasonable notice period of say 1 month or immediately in the event of breach.

Intention of Parties

• No intention to create an employment relationship.

It appears that Novasoft won its appeal on the fact that Mr Brajkovic was not part and parcel of Avecia's organisation. As Judge Peter Kempster did not provide any useful reasoning as to why he reached the decision that "the overall picture painted is one of self-employment" one can only speculate that one less major status factor, inconsistent with employment, was enough to tip the balance in the freelancer's favour.

The judge acknowledged that substitution could be an important detail but, in this case, the fact that Mr Brajkovic's personal service was a requirement did not disturb the impression the judge formed of the notional contract.

Whilst this is a great coup for Mr Brajkovic, the contracting world should not be lulled into a false sense of security believing that it heralds a new dawn in the fight against IR35. This was an exceptional ruling and may still be appealed by HMRC, although it is hoped that they do not. HMRC have until 1st June to lodge such an appeal.

Lessons to learn from the case

Two lessons can be taken from Mr Brajkovic's ordeal.

Firstly, never use HMRC's IR35 Customer Service Unit. You very rarely get an impartial view and end up inviting their unwanted attention. Instead, have your contract reviewed by professional experts in the field of IR35 who have no agenda.

Secondly, do take out Tax Enquiry Insurance - just ask Mr Brajkovic. Novasoft's battle cost them £9k in professional fees highlighting just how expensive tax enquiries can be.

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