Northern Lights v The Commissioners for Her Majesty's Revenue and Customs [2021] UKUT 134 (TCC) confirmed a purposive ‘real life’ approach to substitution clauses in IR35 determinations. In making Status Determinations, businesses must analyse whether they are capable of operating as a matter of practical reality. Status determinations relying heavily on a substitution clause must be revisited.
The Offending Case:
Northern Lights concerned an appeal from Mr Lee’s tax determination from HMRC concerning his period working for Nationwide between 2012 – 2014. Mr Lee worked gave project management services to Nationwide through his own Personal Service Company (PSC) since 2007. As such he was taxed as a contractor not a business. HMRC ruled he was operating under a contract of employment. Mr Lee appealed citing, amongst other things, that his right of substitution in his explicit contract with Nationwide meant that the contract was not one for personal service. As such, following normal status determinations he was not an employee. He further claimed there was a lack of control as Nationwide could not move him to other projects.
HELD: Appeal Rejected
The Upper Tax Tribunal rejected Mr Lee (technically Northern Lights’) appeal. The upper tribunal restated the findings of the first tier tribunal going through a 15 part “hypothetical contract” between the parties to determine the true nature of the relationship. The tribunal held control was satisfied given that Mr Lee was constrained by Nationwide’s general policy of accountability and working practices. While he was not held for disciplinary meetings, this overarching policy control framework was deemed satisfactory and overruled the inconsistency of not being able to move to other projects.
As for the substitution clause the Tribunal held that this was unable to rely in practice. The test the Court applied was different from the normal “sham” doctrine which tests whether the clause was intended at the time of contracting. Rather, the Tribunal asked what was the “dominant feature” of the contract. In other words, was the contract predominantly one for personal work with no substitution, or for services with a substitution clause. The Tribunal reasoned that given Mr Lee was hired for his expertise in this sector and the length of time he had been working it would be difficult if not impossible to find a suitable substitute. As such, the dominant feature of the contract was for personal work. The express substitution clause was discounted from the determination. Given the presence of control and personal work, Mr Lee was determined to have a contract of employment and Northern Lights was ordered to pay tax arrears.
Implications
While only a decision of the Upper Tribunal the implications of this decision could be far reaching. It is well worth reviewing your status determinations in respect of two key factors
1. Substitutions - if you relied in part or in whole on a substitution clause in the contract. Think can the substitution clause realistically be used. Some factors might be
2. Control – the Court here has adopted a similar approach to that of Uber. Seemingly even an important factor in control can be overridden with a sufficient framework for tax purposes. Similar to the above, it is well worth reviewing your status determinations given the potential expansion. Was there overall control? If you are relying on a ‘silver bullet’ to find a lack of control is that truly fatal to finding control or do other factors override the finding?
It is still possible to have substitution clauses, but the Court has made it a lot more difficult to rely on them. If you are unsure whether your status determination still stands, have a look at our services here.
Personal Note:
This decision highlights the material unfairness of the IR35 regime I alluded to in my previous post. Ultimately both parties either negligently failed to make a proper tax determination or maliciously tried to defraud the treasury. If the Court is going to impose a status on an individual for benefit of the Treasury purse, then it is unclear why both parties who made or acquiesced to the determination should not have been liable. For example, Mr Lee in this case took three weeks holiday every year around Christmas which, as a contractor, he was not entitled to be paid for. Given that for tax purposes he has been deemed to pay tax like an employee and ordered to pay arrears in light of these, why is there not further arrears payable for holiday leave amongst other things. Essentially the Courts have created a new form of Employment Status a “Section 230(8) Employment Rights Act” visible only to them. This special legislative provision declares “An employment contract is found where extensive tax obligations arise but no substantive rights or protections.”
The cynic may argue that such arrangements have already taken a substantial benefit out of the old regime, to which I agree that this is undeniable. However, the potential perpetuated harm could be substantial with further Gig work relying on this new section to pay taxes but solidify denial of employee rights. Status determinations and employment rights must develop symbiotically or not at all. This is beginning to occur with Courts noting the importance of wider Labour Law jurisprudence.
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Expertise: Intern
Alex graduated with a BA Laws from Homerton College, Cambridge. He is currently studying for his LLM in Public Law at UCL whilst also interning at The Legal Stop; during his internship Alex will be writing blog posts explaining topical areas of the law, as well as more opinionated pieces on the state of the law. Outside of working hours you can often find Alex in the gym, in the kitchen or reading up on history.