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BKL Tax comments that a recent adverse Court decision regarding the 'IR35' rules is not necessarily the end of the World for contractors.

No: this is not a piece about the machinations going on below the shores of Lake Geneva, whose connection with taxation is tentative to say the least. On the contrary it is about the affairs of one Jonathan Bessell and his company Dragonfly Consultancy Limited, which was found by the High Court in a decision released a few days ago to be within the notorious "IR35" rules, resulting in a reported tax bill which, at £99,000, may not technically speaking be the end of the world but will doubtless seem like it to a one-man consultancy business. The case has been reported in the industry as spelling the end of freelancing as we know it: but what are the real implications?

The nub of the matter was of course whether any hypothetical contract between Mr Bessell and the ultimate client (in this case, the AA) would have been one of employment or of self-employment. In upholding the Commissioner's decision that Mr Bessell would have would been an employee, the High Court paid particular attention to:

• the effect of a limited right on the part of Mr Bessell to provide a substitute rather than to do the work with his own hands, and
• the extent to which the AA had the right to control Mr Bessell in his work.

The first point - that of a right of substitution - has sometimes been regarded as tantamount to an amulet which will in all cases prevent a contract from being one of employment. That was probably always a dangerous view to take, for a "right of substitution" can encompass anything from a complete and unfettered right to send at will some other person to do the work, through to a limited right to send a substitute subject to the end-user's express written consent given in advance. The former will certainly be inconsistent with employment: the latter may not be, particularly where (as in the Dragonfly case) there is plenty of evidence to show that "the AA did not want [just] any competent tester, it wanted Mr Bessell".

The second point - that of control - is an essential ingredient of a contract of employment. The question is - what kind and degree of control? In the Dragonfly case, the problem seems to be that - certainly in the earlier versions of the contracts - there was an explicit and apparently wide-ranging right of control. That right had been watered down in later versions but the suspicion on the part of the Court seems to have been that these were merely cosmetic changes which did not reflect any substantial change in the conduct of the parties.

So where does that leave freelancers? Does it really mean that they are mostly caught by IR35? The answer, in our opinion, is no. Certainly the Dragonfly case is unhelpful but like all of these cases it was decided on its own special facts and we do not believe that, properly analysed, it represents any change in the law. Without any doubt it remains possible to put into place an IR35-proof contract but whether any particular contract and set of surrounding circumstances is vulnerable requires a close examination of the facts. Close attention to the wording of the documentation will not necessarily take you all the way home, but it will get you a long way - and where the documentation is unhelpful (as it may well have been in the Dragonfly case) HMRC will be quick to exploit the slightest chink in the freelancer's armour.

BKL Tax Newswire - 10 September 2008