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Executive Summary
Background During the last 30 years the UK has developed an extremely flexible workforce. As businesses have focused on their 'core capabilities' they have outsourced non-essential tasks and sought additional resources for project based work. In IT and other sectors, clients typically engage these additional 'knowledge based' resources via agencies, who in turn contract with the companies owned by the independent contractors. These arrangements have served industry well. Generally clients have sourced their projects from a pool of highly skilled, flexible workers; they do not want to take on permanent employees. For their part the contractors sought independence, variety and entrepreneurial reward. In addition, the use of limited companies gave the contractor certain tax and National Insurance advantages, while the client was insulated from employment rights claims. However, there is increasing evidence that employment tribunals and the Courts are willing and able to extend employment protection rights to workers who are engaged via their own limited company. Relationship with IR35 The personal services legislation, commonly known as IR35, was introduced in April 2000. It has brought into focus the issue of employment status. IR35 applies where:
If an independent contractor 'fails' IR35, then the Inland Revenue will deem the contractor to be in 'disguised employment' and subject his company to increased tax and National Insurance. Importantly, the tests used under IR35 are practically identical to those used by employment tribunals when considering employment law issues. Every contractor using a limited company has to consider whether he is caught by IR35. The legislation has therefore caused a focusing on employment status even when the contractor would not have otherwise had any reason to consider whether he had employment rights. Previously, contractors guarded their independence and were extremely reluctant to seek employment rights, as they would risk their advantageous tax situation. Now however, a contractor already paying tax under the IR35 rules has little to lose financially by making a claim - for instance, for redundancy or holiday pay. So will the courts support a claim for employment rights? When IR35 was introduced, the government and the Revenue gave reassurance that IR35 does not mean that the client becomes the employer of the contractor. Earlier case law decisions in this area were Winter v Westward Television [1978] EAT 589/77 and Catamaran Cruisers v Williams [1994] IRLR 389. In the former case it was held that it was not possible to 'look through' a service company where it 'was not a sham and had been genuinely entered into to achieve the object which those who put it forward had in mind.' However in the later case of Catamaran Cruisers an individual, previously an employee of Catamaran Cruisers, subsequently provided his services via a limited company. The court held that he was able to claim unfair dismissal because:
The court clearly thought that the service company was merely a device for tax purposes, and did not change the underlying relationship of employment. The tribunal was influenced by the fact that the individual had previously been an employee, and had carried on working under very similar arrangements once the service company had been introduced. However 'importing' a company into an existing relationship can be distinguished from the normal company-to-company arrangement which applies from inception in most contractor relationships, and thus it was believed that the contractor could not normally claim employment rights. In O'Murphy v Hewlett Packard [2001] Case Nr 5300148/01, an Employment Tribunal sitting in Bristol held unanimously that an individual working through his own limited company was an employee of his client. In a reserved decision they found that the existence of the individual's limited company
and the individual could thus claim that he had been unfairly dismissed. This case has recently been overturned on appeal, but the arguments were not exhaustive. It is possible that a court in the future could grant employee status to workers who otherwise have little access to employment protection, despite the existence of a service company. In this context it is worth noting the remarks of Mr Justice Burton, the judge in the March 2001 judicial review of the IR35 legislation brought by the Professional Contractors Group. Although the Court eventually found against PCG, the Judge, Mr Justice Burton, made a number of important observations that could have far reaching consequences for the relationship between contractors and their clients. For example Justice Burton noted that a contractor:
Thus, if the individual is caught by IR35, then it is more likely that, applying similar tests, an employment tribunal will decide that the individual is an employee of the client. It is thus recommended that clients take steps to work with independent contractors both to minimise the chances of claims for employment rights and to ensure that the contractors are outside IR35. What happens if personal service is required by the client? Where a client is looking to work with an individual contractor with certain key skills, then the contract can still be 'business to business' based on other employment status tests, such as control. Many clients still believe that they need to retain close control over a contractor. However, the consequence of too direct a right of 'supervision, direction and control' is that the contractor may be able to claim employment rights. In many cases clients can achieve a satisfactory degree of reassurance, not by having detailed control over what the contractor does, but by defining carefully what the outputs of the contract will be and by setting clearly defined deadlines. Contracts where the worker provides fairly general services based on time rather than more clearly defined project-based tasks always appear to be more employment like. Similarly, contracts that specify that the contractor must attend the client's premises between set hours and must always work on site also look more like an employment. If a client is prepared to accept a greater degree of flexibility then it is more likely that the contractor will have no claim for employment rights against the client. Clients using independent contractors (whether direct or via an agency) on terms that equate to self-employment will almost certainly be in a position where they cannot be held to be the employer of the contractor. How do you change your arrangements? There is no statutory definition of the key terms that will ensure that the relationship is one that passes the relevant tests. Instead, status case law has developed over many years and tests that were once considered decisive have become less important as new tests have evolved. It is recommended that clients take professional advice and work with the service companies in order to optimise the situation on both sides. The PCG's website has a section dedicated to clients which gives some guidance here. Conclusions In order to minimise the risk of claims from contractors for employment right, clients should ensure that they are contracting with limited companies, whether directly or via an agency, and that the terms of the contracts ensure that the worker would be self-employed had he been working directly for the client. Produced by PCG with additional comments from Anne Redston, Partner, Ernst & Young. Additional Information
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