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Dragonfly – Has Anything Really Changed?

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The recent High Court decision in the Dragonfly case has sent waves of unrest through the contracting world. But has anything really changed?

Background to the case

Mr Bessell provided his services as a computer system tester via his company, Dragonfly Consulting Ltd ("Dragonfly") and via an agency, DPP ("The Agency") to the end client, The AA.

Mr Bessell is the sole director and 50% shareholder of Dragonfly.
Dragonfly supplied Mr Bessell's services to the Agency under a series of contracts & extensions ("The Lower Contract"), between January 2000 and January 2003.
The contract between the Agency and The AA ("The Upper Contract") remained the same throughout i.e. it was still on pre-IR35 terms .

So why did the taxpayer lose?

The courts are increasingly looking at the practical realities of contracts and the attitude of the end client and of its employees who supervise the contractor.

Substitution:

Having a substitution clause used to be considered a cast-iron way of ensuring that a contract would be outside IR35. Not any more.

In this case, the Court decided that he did not have a genuine substitution clause, because:

  • He had never sent a substitute.
  • The Lower Contract gave a limited right to send a substitute but this was not mirrored in the Upper Contract. He could only send a substitute with the prior written consent of the agency and this was not seen to be an unrestricted right to send a substitute.
  • The Court felt that the AA had selected Mr Bessell personally and did not want him to send anyone else. One of the AA's managers stated that a substitute would not be accepted.
  • Some contracts specifically referred to Mr Bessell rather than to Dragonfly.

Control:

Several factors pointed to this arrangement being similar to that of a skilled professional employee:

  • Work was not detailed and agreed in advance, it was allocated by the team leader at the AA as the contract progressed. Mr Bessell could only refuse any unreasonable requests.
  • It was previously thought that control only meant whether the end client could control how the work was to be carried out. However, this case went further and looked at how work was allocated and monitored.
  • Mr Bessell's work was monitored by the team leader and they could ask him to perform certain tasks to check the quality of his work.
  • Early contracts referred to the client's "direct supervision and control" and "direction".
  • The individual was required to comply with the same "customary rules and regulations as the client's own staff".

Other factors:

  • The series of contracts and extensions were not helpful as the Court took the view that the later revisions were watered down but that this was only done to make the contract more "IR35 friendly". As a result of all of the changes, it was unclear what the terms between the parties actually were.
  • None of the parties had intended for this to be an employment agreement, but their intentions could not overrule the true legal effect of the relationship.
  • Mr Bessell appeared to have become integrated in the AA's team after being with the AA for an extended period.

Factors for contractors & advisors to consider going forward:

Extended or revised contracts: is it the earlier or later terms that more accurately reflect the practical reality of the contract?

All work should be detailed and agreed in advance by all parties. Any changes or additional work should also be documented and agreed. The agreements should allow for additional fees to be charged for additional work.

Do the upper and lower contracts mirror each other? Agencies and end clients should be making the relevant parts of the upper contracts available to the contractor or at the least confirming that the upper and lower contracts are mirrored.

Unfortunately, it will take a while before such behaviour is not deemed to be heresy and so the next best action to take is for the freelancer to ask the Agency to confirm in writing that the contracts are mirrored, or more realistically the End Client to confirm in writing their understanding of the real arrangements.  End Clients will sign a template and this is an opportunity to confirm not only substitution, but also that they do not expect to exercise control over the Interim's method of working, nor is there any expectation that future work will be offered and/or accepted.

In the event that such a letter is signed off by the End Client, it is a formal record which in the event of an enquiry should be enough to stop HMRC approaching the Client.  Not only is this "insurance" for the contractor, the Client should appreciate that it may stop its staff from being embroiled in the enquiry, which must surely be a selling point to the Client.

Abbey Tax have dealt with two enquiries where the 'Real Arrangements Letter' has halted the Status Inspector in his tracks and have also dealt with an enquiry where the End Client was so fed up with time being spent dealing with an enquiry that it seems to be the main reason why one freelancer had a tender rejected for further work. The effect on a contractor's marketability of an ongoing enquiry should not be underestimated.

The sure way of ensuring that a substitution clause is genuine is to send a substitute at least once. Does the contract provide an unfettered right to send a substitute, without needing the prior agreement of the end client and agency? Or does the end client really just want a specific worker? Will the immediate manager within the organisation even be prepared to accept a substitute?

Does the end client have control over how work is allocated and carried out and how closely does the end client monitor the work? Is the worker integrated into the end client's team? This is not a heading so can we move it up to the end of the following paragraph?

The contractor should consider taking a bigger salary in excess of the Tax/NI thresholds so the client is less attractive for HMRC to start an IR35 challenge, as there would be less tax for them to collect.

Above all, freelancers should consider getting all contracts and extensions reviewed. The new tax penalty regime (for return periods starting after April 2008) means that contractors and their companies must seek professional advice on each contract if they wish to avoid penalties for "not taking due care".  Penalties for this alone can be up to 30% of the additional tax due should IR35 be found to apply.

Conclusions

The Dragonfly case does not signal the end of contracting in its current form.

The day-to-day practicalities are being given increasing precedence over the wording of contracts, where the former are a more accurate reflection of the working arrangements between the parties. HMRC can and do approach the end client and its line managers.

The relevant parts of the Upper Contract between the end client and the agency must be made available to the contractor. The end client's staff who will supervise the contractor must also be made aware of the terms of those arrangements.

Agencies must take a greater responsibility and be prepared to amend their "standard contracts" when it is pointed out to them that contractors are more than likely to be caught under IR35 if clauses remain as they are.

Contractors (and their companies) must also consider getting contracts professionally reviewed, if they are to appeal against any penalties for not taking "due care" should a contractor considered to be outside IR35 later turn out to be caught.

Abbey Tax
November 2008

© 2008 All rights reserved. Reproduction in whole or in part without permission is prohibited.
Image: i want change by m.a.r.c.

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