Contractual Terms vs. working practices: which is more important?

It is a founding principle in law that contracts can be written, verbal or implied, which suggests that the real answer to questions of employment status ought to be determined by the actual arrangements. But is that true? The argument for contracts At Markel Tax, we argue that the basis for any engagement of the self-employed or Personal Service Company (PSC) contractors under off-payroll working (IR35) is the contract. The written terms set the framework within which all parties operate, with any schedules or statements of work determining the deliverables of that particular assignment. HMRC guidance at ESM0506 confirms this point: “It is necessary to establish the full terms and conditions of the contract. This includes any practices or conventions which exist in certain trades and industries which, although not expressly agreed between the parties, still form part of the agreement. Once you have all the information, check that the terms of the contract have been kept by comparing what is supposed to have happened with the actual working arrangements.” This approach follows through to enquiry where HMRC, via a ‘Check of Employer Records’ letter, will typically request “copies of all contracts and supporting documentation”. At Tribunal level, judges inevitably start their reasoning by considering the written terms which govern the entire contractual chain. Focusing on the established status tests laid down by Ready Mixed Concrete v Minister of Health and Pensions in 1968 before considering whether any in-business factors. Once established, the judge will then review the working practices. However, one cannot rely on the contract in isolation, as demonstrated by the case of Autoclenz Ltd v Belcher and others. The contract in this case bore all the badges of self-employment: right of substitution, lack of mutuality of obligations and plenty of in business factors. However, the Supreme Court found that the workers did not operate in the manner stipulated within the written terms and ruled that the contracts could not be relied upon. The case was decided on the basis of the working practices. Where both parties intend to create legal rights and obligations in writing which do not exist in practice, the written contract is a ‘sham’. So, it is the working practices which determine status? Returning to the Check of Employer Records letter, HMRC has the ability to “check that the terms of the contract have been kept by comparing (these) … with the actual working arrangements” and asks the contractor to respond to the following: “Would you please also tell me whether you have considered the possibility of the company being subject to what is commonly referred to as the IR35 legislation and the date you considered it? If you have and have concluded that the company is not subject to that legislation, then please explain to me the basis upon which you arrived at that conclusion.” This cannot be done without reference to the contractual terms and the working practices, but this exercise – as suggested by the letter – should not be undertaken at the point of enquiry. This needs to be undertaken at the outset of an engagement if a contractor or end client is to demonstrate reasonable care in their IR35 decision-making. The Tribunal will consider the working practices in detail, and this is often where in business factors will be seen more clearly and arguments can be strengthened. The “in business on your own account” argument has seen recent success in the broadcasting cases. Lorraine Kelly’s counsel in Albatel Ltd v HMRC succeeded in the argument that Lorraine Kelly was a ‘brand’. Adrian Chiles (Basic Broadcasting Ltd v HMRC) successfully argued he was in business on his own account by virtue of his many other non-broadcasting engagements and use of PR and paid assistance. Kaye Adams (HMRC v Atholl House Productions Ltd) successfully ran the in-business argument past the First and Upper Tier tribunals, (albeit not so successfully at Court of Appeal where the case was remitted back to the First Tier). A typical contractor is unlikely to successfully win their case on business factors alone. The Judge in McCann Media Ltd v HMRC made clear the approach should be to start with written terms, establish the fundamentals and only then move on to working practices. So, both contracts and working practices need to be aligned? The short answer is yes, but recent cases show re-affirm our mantra that the contract is king. Clear, unequivocal, terms that reflect the intention of the agreement have proven consistently to provide a sound defence, whether you are an engager of self-employed subcontractors, a medium to large-sized engager responsible for IR35 status or a PSC engaged by a small or wholly overseas company. But the working practices need to support the contractual terms and vice versa. We strongly recommend that clients seek independent advice: employment status has always been a grey area of tax; the off-payroll working reforms haven’t added any clarity. Now that HMRC’s ‘light touch’ regime has ended, the requirement for all the relevant parties to take care in their IR35 decision-making has become even more important.