The fact that HMRC – who you would think to be experts in these matters – have lost three of four IR35 cases to come before the tax tribunal this year proves just how complex IR35 is.
But as each new IR35 case is published, one thing is becoming clearer: you can’t just dress up what is an essential component in any contract – doing something in return for payment – and call it “mutuality of obligation”.
Mutuality of obligation is a highly technical concept, and quite difficult to explain. For present purposes, however, it is sufficient to know that it is one the three indicators which must exist for an employment contract to be on foot. These indicators are drawn from the seminal 1968 labour law case called Ready Mix Concrete v Minister of Pensions and National Insurance:
- Mutuality of obligation;
- Other factors which point towards a contract of service.
Factors to be considered in the ‘other’ category include whether, for example, there is a right to substitution.
If these three indicators are not present, there cannot be a “contract of services” (a legal term which means an employee-employer contract) and IR35 does not apply.
It all sounds rather simple, then, doesn’t it? It should be easy to create an online tool to help work out IR35 status because it only needs to test three factors?
Well, as we know, it’s not that simple. One reason is because caselaw in this area is so complex. Courts have repeatedly said there is no comprehensive checklist to go through to determine whether a contract of services exists. Take substitution as an example. If your contract has a right to substitution, but the substitute can only be selected from a pool which has been approved by the engager, then this might point towards employment, but it also depends on other factors.
The second reason is the fact that HMRC purposely designed the CEST tool not to take into consideration mutuality of obligation.
This is because HMRC assumes that mutuality of obligation is present in all employer-employee and hirer-contractor engagements within the public sector, so why bother testing for it?
They have argued that where one party agrees to provide services for the other in return for payment, then this satisfies mutuality of obligation between the two parties.
However, HMRC’s assumption has been undermined by several recent tribunal cases, including Jensal Software v HMRC, published in April.
In this case the hirer had a series of short contracts with an IT professional. However mutuality of obligation did not exist because the contractor was engaged under separate, short contracts; there was no obligation to provide work between contracts; there was no continuing obligation on the hirer to provide contracts; and the contractor could not demand further work.
In the Jensal case, the Department of Works and Pensions was the hirer, undermining HMRC’s argument that mutuality of obligation can be assumed in every public-sector engagement.
In another case from last year which recently came to light (Armitage v HMRC) the presiding officers at the tribunal said the following of HMRC’s argument:
HMRC’s case is that where one party agrees to work for the other in return for payment then this satisfies mutuality of obligation between the two parties. That would be true of every contract both employment and for services otherwise the contract would not exist at all. The mere offer and acceptance of a piece of work does not amount to mutuality of obligations in the context of employment status.
What is even more concerning is that this case came out just months before HMRC launched the CEST tool. So HMRC either knew, or should have known, that their argument about mutuality of obligation was on shaky ground when they launched the tool.
In essence, the tribunals have said you can’t just take what is an essential element of any contract – doing something in return for payment – and call it mutuality of obligation; proving this essential factor of employment requires evidence of something else, something more.
By not testing for mutuality of obligation, and just assuming it exists, the legal matrix which underpins the CEST tool is compromised and incorrectly pushes people inside IR35.
Using the CEST tool may not be mandatory, but public-sector hirers feel compelled to use it because IR35 is so complex they don’t know how else to make these difficult determinations. And HMRC have said they will stand by the results of the tool.
How can the government, in good conscience, even consider extending the ill-judged IR35 changes to the private sector without fixing fundamental problems with the CEST tool?