Court of appeal decision gives comfort on employment status for tax purposes
26 May 2022
The Court of Appeal has held that when determining employment status of an individual for tax purposes the contractual terms should not be disregarded unless they are unrealistic. This decision offers some comfort to businesses which engage self-employed contractors, including those in the gig economy.
From an employment law perspective, the level of rights and protection that an individual enjoys depends on their employment status. An individual can be an “employee”, a “worker” or an “independent contractor”. While there are statutory definitions of worker and employee, employment status is generally determined by applying a complex test developed through (often contradictory) case law. The test looks at a number of factors including the whether the individual is required to provide personal service (which may be defeated by a right of substitution), the existence of mutuality of obligation, the extent of any control, whether the individual is integrated into the engager’s business, and whether the individual is carrying on business on their own account.
The situation is different for tax purposes, as there is no “worker” category. The issue is simply whether an individual is an “employee” or “self-employed” (i.e. an independent contractor). In determining tax status, HMRC apply broadly the same multi-factorial approach which is used to determine employment status in the employment law context. If an individual is an employee for tax purposes, the employer is responsible for deducting income tax and National Insurance Contributions (NICs) on the employee’s earnings and paying employer NICs (currently at 15.05%). In contrast, an individual who is self-employed for tax purposes is responsible for paying their own tax and self-employed NICs.
The importance of the contractual terms
A key issue when determining the status of an individual is the weight to be given to the contractual terms. Generally, when interpreting a contract, the law only considers what is in the actual signed contract and not the parties’ intentions. There are very few exceptions to this general rule. One exception is where the contract is a sham - in other words, where the parties had a common intention that the contract should not actually create the legal rights and obligations which it appears to create.
There have been a number of recent high-profile cases looking at the employment status of individuals working in the gig economy, including in particular the Uber decision in the Supreme Court (SC). In those cases, the courts have held that employment status should not be determined by applying the general principles of contract law referred to above. Instead, because the individuals are claiming the protection of statutory employment rights, their employment status should be determined by reference to statute. This is because otherwise the purpose of legislation, which is to provide protected employment rights, could be defeated by the contractual terms - particularly in light of the unequal bargaining power between the parties.
This approach is not entirely new and can be viewed as a varnish to the established approach formulated by the SC in Autoclenz v Belcher. In this case, the SC confirmed that when determining an individual’s employment status, the tribunal may disregard terms that are included in the written agreement if they do not accurately reflect the genuine agreement of the parties. The bargaining power of the parties must be taken into consideration, and the true agreement between the parties should be ascertained from all of the circumstances.
Businesses which engage self-employed contractors, including in the gig economy, can draw on a plethora of case law to assess risks in their models but have had less clarity on whether HMRC would adopt an Autoclenz approach in determining an individual’s tax status. If an individual who has been treated as self-employed is reclassified by HMRC as an employee, not only would engagers have the obligation to operate PAYE and NICs going forwards, but also the engagers could find themselves with significant historic PAYE and NICs liabilities for up to the past six tax years (although credit would be given for any tax paid by the individual), together with interest and penalties.
The Atholl House case – apply the contract
In this recent tax case, the Court of Appeal (CA) considered the extent to which the Autoclenz principle should apply when determining an individual’s status for tax purposes under IR35.
IR35 is a tax anti-avoidance rule designed to tackle disguised employment where an individual provides their labour to a client or end user via the individual’s intermediary, such as a personal services company. Under IR35 a determination must be made as to whether the individual would be an employee if engaged directly by the end user, applying the same multi-factorial test referred to above.
Atholl House Productions Ltd (“AHPL”) is the personal services company of presenter Kaye Adams. AHPL entered into contracts with the BBC for Ms Adams to present ‘The Kaye Adams Programme’. The contracts contained a minimum commitment from Ms Adams, and a minimum fee payable by the BBC, but Ms Adams maintained ultimate control over the contents of the show and the BBC never placed any restrictions on her working on other engagements. However, the contract included a term giving the BBC first call on her services and a term restricting her from appearing in third party broadcast media without the consent of the BBC.
AHPL argued, on the basis of Autoclenz, that the contractual terms giving the BBC a first call on Ms Adam’s services and restricting her ability to work for third parties should be ignored as neither term had ever been applied by the BBC in practice. AHPL had succeeded in this argument before the First-tier Tribunal (“FTT”) and this led the FTT to conclude that Ms Adams was not a disguised employee and was therefore outside IR35. On appeal, the Upper Tribunal (“UT”) held that the FTT had made an error in applying Autoclenz – there was no basis for departing from the normal principles of contractual interpretation. However, the UT also found that Ms Adams was carrying on business on her own account when she entered into the contract with the BBC and was not, therefore, an employee for tax purposes.
The CA agreed with the UT on the contractual point, holding that the Autoclenz principle was confined to those situations where the issue was whether the individual was entitled to statutory employment rights and did not apply for tax purposes. The CA held that the normal principles of contractual construction should apply, meaning that the contractual terms should not be disregarded unless they are “unrealistic”. The terms in the contract between the BBC and AHPL were not unrealistic as there may have been circumstances in which the BBC would need to exercise such rights.
Other important points from the case
The CA helpfully confirmed that, when determining an individual’s tax status, mutuality of obligation and control are necessary factors for determining that an employment relationship exists - but they are not sufficient by themselves. It is still necessary to consider all the factors to determine whether they are consistent with an employer-employee relationship including whether the individual is engaged in business on their own account.
On this basis the CA held that the UT was wrong to apply only a “business on own account” test rather than properly analysing all the factors, including the circumstances known to the parties when they entered into the contract. The case has therefore been sent back to the FTT to determine Ms Adams’ employment status under IR35.
Atholl House is another case which demonstrates the difficulty and inconsistency when determining status for employment rights and tax purposes. That said, the restriction on applying the Autoclenz principle to employment rights only, and not to questions of tax, provides some welcome comfort for businesses who engage self-employed contractors.
The Atholl House decision should not be treated as complete shield against liability. While the written agreement will be the starting point for determining whether an individual should be treated as an employee for tax purposes, not all contractual terms will necessarily be taken at face value. HMRC and the courts will still disregard a written term if it is unrealistic. If the parties act differently from the contractual terms, HMRC will still consider in appropriate circumstances whether the terms are realistic. In some cases, this could lead to a finding that an individual’s tax status has been dealt with incorrectly.
HMRC v Atholl House Productions Ltd – judgment available here.