Dragonfly Consultancy Ltd v HM Revenue & Customs

Under the IR35 legislation, the court must construct the relevant hypothetical contract and decide whether it would have been a contract of service. The income tax and National Insurance tests are similar but not identical. The National Insurance test requires the arrangements involving the intermediary to be embodied in the hypothetical contract, whereas the income tax test focuses on the services and the statutory circumstances.

A limited substitution clause is not necessarily inconsistent with employment. The question depends on all the circumstances. Control remains relevant, but need not extend to the detailed manner in which skilled work is performed. Statements that the parties did not intend employment may be considered, although they will usually carry little weight. The IR35 legislation requires the court to distinguish between employment and self-employment, not to apply intermediate statutory categories of worker.

Dragonfly appealed against a decision of the Special Commissioner, reported at [2008] STC (SCD) 430, concerning PAYE income tax and National Insurance Contributions for services supplied through an intermediary to the Automobile Association during 2000–2003.

The Special Commissioner constructed hypothetical contracts between the worker and the client and concluded that the worker would have been an employee. Dragonfly challenged the conclusions concerning substitution, control, the parties’ intentions and the relevance of intermediate worker status. The appeal raised the proper construction of the two statutory hypotheses and whether the Special Commissioner had made errors of law.

1. Appeal dismissed. The Special Commissioner had applied the correct legal approach and his conclusions were findings of fact or mixed fact and law which disclosed no error of law.
2. The income tax hypothesis in paragraph 1(1) of Schedule 12 to the Finance Act 2000 and the National Insurance hypothesis in regulation 6(1) of the Social Security Contributions (Intermediaries) Regulations 2000 are not identical. The National Insurance test requires the arrangements involving the intermediary to be embodied in the notional contract. The income tax test directs attention to the services provided and to the circumstances, which include but are not confined to the contractual terms. The different wording will usually produce the same result, but that cannot be assumed in every case.
3. The inquiry under regulation 6(1) is initially factual. Identifying the arrangements and circumstances, and constructing the hypothetical contract, may involve questions of fact, law and mixed fact and law. On an appeal limited to questions of law, the fact-finder’s evaluation cannot be displaced merely because another view is possible.
4. A right of substitution must be evaluated with all the other circumstances. A limited right requiring the client’s approval of the particular substitute may be compatible with employment. It differs materially from an unqualified right allowing the worker to choose a replacement and profit from doing so. The findings that the client had engaged the particular worker and would have required consent to any substitution supported the conclusion that the hypothetical contracts were for his services.
5. Applying the guidance in Ready Mixed Concrete (Southeast) Ltd v Minister of Pensions and National Insurance [1968] 2 QB 497, the personal service and sufficient-control conditions were satisfied. The worker was integrated into the client’s teams, performed allocated testing work within project timetables, and was subject to supervision, monitoring and quality control. Detailed control over how a skilled professional performed the work was unnecessary.
6. Statements disclaiming an intention to create employment cannot prevail over the true legal effect of the arrangements. They may assist in a borderline case. In this case, statements made in contracts involving the agency did not materially illuminate the hypothetical contract and could not alter the result.
7. The IR35 legislation is concerned only with whether the hypothetical contract is a contract of service. Intermediate categories of worker created by specific statutory codes, such as the Working Time Regulations 1998, were irrelevant to that question.

• High Court (Chancery Division): Dragonfly’s appeal on questions of law was dismissed.
• Special Commissioner: The appeals against the PAYE and National Insurance decisions were dismissed in a decision reported at [2008] STC (SCD) 430.