How does previous employment impact your IR35 status?

In seeking to benefit from preferential tax rates, individuals began providing services through their own limited companies and, rather than receiving a salary subject to PAYE tax and National Insurance deductions, funds would be drawn from the limited company in the form of dividends. To combat the issue of individuals receiving tax relief that they were not entitled to, IR35 was introduced to distinguish between those who are truly in business of their own account, and those who are merely disguised employees of their client in a bid to ensure that the correct levels of tax are paid by those operating through their own limited company.

So, can an assignment be compliant with IR35 where a contractor has a previous employment relationship with their client?

Independent contractors who have been engaged with their client as a permanent employee prior to their contracting engagement risk falling within the scope of IR35 and therefore being viewed, in the eyes of the HMRC, as ‘disguised employees’. Put simply, if the client once had a permanent need for that individual as an employee, how can it be justified that they now receive financial benefits although working for the same organisation? A good example of this is the case Cable & Wireless plc v Muscat:

Mr. Muscat was an employee of EI Limited (which was later taken over by Cable and Wireless). In 2001, Mr. Muscat was told that in order to continue working he needed to be a contractor, albeit doing the same job. Accordingly, Mr. Muscat set up a limited company (which EI paid for), and received a payment in lieu of notice along with a redundancy payment from EI. Mr. Muscat began his contracting role less than 7 days after terminating his employment.

It was decided that Mr. Muscat was operating as an employee.

The fact of the previous employment, however, is not in itself problematic; it rather acts as a ‘flag’ to indicate that there may be certain employment indicators [LINK TO RELEVANT BLOG] remaining between the two parties which are inconsistent with a true independent contractor status.

Looking back to ‘Muscat’, its key facts were:

Mr Muscat Worked under the supervision of managers, he was labelled as an employee within the client’s organisational chart, and he was supplied with equipment such as a mobile phone and laptop by the client. He therefore was seen to have remained integrated within the business of his previous employer, that is to say that his role (and therefore he himself) was part and parcel of the organisation.

It was not Mr Muscat’s previous employment which led to this outcome per se, but rather the employment-like level of control that was exerted over him (the supervision by managers), the integration of Mr. Muscat (the organisational chart) and the lack of financial risk (the equipment) presented by Mr. Muscat, or his limited company, which had flowed into the contracting engagement from that employment relationship.

The above case is of course quite extreme; however, it clearly highlights the risks present when engaging with a previous employer as an independent contractor.

MITIGATING THE RISKS

Contractors who have been previously employed by their client will not always fall within the scope of IR35, but additional information will need to be provided in the event of an HMRC enquiry. If the day-to-day working practices of the contracting assignment are similar to those of the employment, it is likely that the HMRC would deem both engagements to be periods of employment. This would mean that any income generated through the limited company should also be subject to PAYE tax and National Insurance Contributions.

It is possible to operate truly independently from a client with whom a previous employment relationship exists; however, employment status is assessed on a case by case basis so may vary from that of Mr Muscat’s. The key findings from this case can be used to assist in understanding whether a contracting role with a previous employer is viable, or whether it may receive the same treatment as was applied in Mr. Muscat’s circumstances.