What will the comments on substitution rights mean for the tax status of contract staff and enforcement of the new IR35 regime against staffing companies and users of contract staff?

The Supreme Court has yesterday (13 June 2018) handed down a significant decision, holding that a plumber, VAT registered and paying tax as a self-employed contractor, was a ‘worker’ and therefore entitled to certain employment rights, such as minimum wage, holiday and sick pay.

In many ways the decision is not surprising – many involved in the use or supply of contract staff will not be very surprised that the extent of control exercised by Pimlico Plumbers over working arrangements led to a decision in favour of worker status.

However, the decision also makes some interesting points about what will not “count” in terms of right of substitution. Although this case was not directly about tax, these points in the decision may have a big impact on the tax status of contract workers (including personal service company contractors affected by IR35) where substitution rights are relied on as a “get out”, and may point to how tax tribunals will look at IR35 status claims in the next few years.

Employment Tribunal entitled to conclude that claimant was a worker

The claimant in this case was a plumbing and heating engineer, working for Pimlico Plumbers between August 2005 and April 2011. Mr Smith worked for the respondent on the basis he was a self-employed contractor. However, following a dispute in 2011, he issued Employment Tribunal (ET) proceedings alleging, amongst other matters, that: he had been unfairly dismissed, an unlawful deduction had been made from his wages, and he was entitled to statutory annual leave. Whilst finding that Mr Smith was not an ’employee’ for unfair dismissal purposes, the ET held that he was a ‘worker’ for the purposes of the legislation governing the other claims in dispute. The Employment Appeal Tribunal, Court of Appeal and now the Supreme Court have all upheld this decision.

What made the claimant a worker?

The Supreme Court proceeded by determining whether Mr Smith was a ‘worker’ under just s230(3) Employment Rights Act 1996 (ERA) on the basis that all his claims under the ERA and the other legislation in dispute would ‘stand or fall‘ together depending on this outcome. Taking this definition, the Supreme Court noted that it was necessary:

  • For him to have undertaken to personally perform his work or services for the respondent; and
  • That the respondent be neither his client nor his customer

Dominant feature of Mr Smith’s contract was an obligation of personal performance

The Supreme Court noted that the ET had found that Mr Smith had in practice a ‘limited facility‘ to appoint another Pimlico operative to do a job he had previously quoted for but no longer wished to undertake (as more lucrative work had come up). However, there was no clear express right to appoint a substitute in the contractual documents governing the relationship. Overall, the dominant purpose of contract was found to be clearly directed to performance by Mr Smith personally (for example, referring to ‘your skills’), and the right to substitute was in reality ‘a means of work distribution between the operatives and akin to the swapping of shifts within a workforce‘.

All involved in the use or supply of contract workers will sit up and take notice of this comment – it seems that the Supreme Court considers that where the reality is that personal service is expected from a particular individual it may be hard to argue that a technical right of substitution (which is in fact only used in a limited way or involves only selecting people from a limited pool) will not defeat a finding of ‘worker’ status.

Written contractual documents strongly militated against Pimlico being a client or customer of Mr Smith

The Supreme Court concluded that the ET had rightly held that there was an umbrella contract governing the relationship between Mr Smith and Pimlico, both during and between assignments, and that attention should therefore focus on the wording of the written contractual documents to determine whether Pimlico was a client or customer of Mr Smith. The Supreme Court noted that Mr Smith was free to reject a particular offer of work and was free to accept outside work if no work was offered by any of Pimlico’s clients. He also bore some of the financial risk of the work and was not supervised by Pimlico in the manner in which he undertook that work. Indeed, he ‘correctly presented himself as self-employed for the purposes of income tax and VAT‘.

However, the Supreme Court also found that there were features of the contract which ‘strongly militated‘ against recognition of Pimlico as a client or customer of Mr Smith including:

  • Pimlico’s tight control over Mr Smith’s attire – he was required to wear a branded uniform, drive a branded van (which was tracked) and carry an identity card;
  • Pimlico’s control over the administrative aspects of the job;
  • The ‘severe‘ terms as to when and how much it was obliged to pay him, which ‘betrayed a grip on his economy inconsistent with his being a truly independent contractor‘;
  • References in the contract to ‘wages‘, ‘gross misconduct‘ and ‘dismissal‘ – which may have been ‘ill-considered lapses‘ but equally may ‘shed light on its true nature‘; and
  • A suite of covenants restricting his working activities following termination.

These factors led the Supreme Court to declare that ‘on the evidence before it, the tribunal was, by a reasonable margin‘ entitled to conclude that Pimlico could not be regarded as a client or customer of Mr Smith.

A ‘tsunami’ of claims?

Pimlico’s, chief executive, Charlie Mullins has stated that the ruling ‘can only lead to a tsunami of claims‘ and that this is a case of a ‘highly-skilled, self-employed‘ person ‘wanting to have his cake and eat it‘. But is he right?

The decision comes at a time when employment status is under particular scrutiny with: recent decisions from the ET and EAT on the rights of those working in the gig economy; the government consultations on its recommendations coming out of the Matthew Taylor review into the modern workforce; and a new consultation recently published looking at new IR35 rules in the private sector. Against, this backdrop and considering the publicity this case alone has generated, the spotlight is clearly shining on the employment status of freelance and gig economy workers and the potential for agreed working relationships to be unpicked.

The rapid changes in the world of work seen in the last decade and the emergence of the gig economy has given people freedom from 9:00 to 5:00 working and the flexibility to work in a way that exploits the varying skills they can generate income from. However, this flexibility comes with some clear down-sides, including increased uncertainty and no paid sick leave, holiday or pension contributions. As this case shows, the gig economy model may work well for some during certain periods of their lives, but less well for those who later need the support a more traditional employment relationship provides – as was the case for Mr Smith when health problems required him to reduce his working week. For companies using freelancers and contractors, this decision will certainly call into question the desirability of these engagement models and whether they are sustainable going forwards.

And what about tax and IR35?

Interestingly, the Supreme Court decision appears to support the stance HMRC has recently taken in relation to rights of substitution and how those affect tax status. As such, this case may further encourage HMRC to bring claims against users and suppliers of contract staff for retrospective PAYE and NICs and will reduce the ability of staffing companies, contract workers and end-users to argue that the new IR35 rules do not apply to their situations. The size of potential PAYE and NICs claims resulting from this could dwarf the value of the workers’ rights claims which were the main focus of this case.

However, what today’s Supreme Court decision highlights is that each case will still turn on its facts, and many users and suppliers of contract staff will say that they do not exercise the degree of control exercised by Pimlico Plumbers in this case and so are unaffected. All involved in the use of supply of contract staff should nevertheless now take steps to understand where any historic liabilities may lie (bearing in mind limitation periods) and identify potential issues going forward. Consider: what terms are individuals engaged on; do these reflect the reality of the relationship; how do substitution rights work, and are they crucial to employment status in their case; should a new business model be adopted; and importantly, what would be the tax and employment liability repercussions, as well as the practical implications, for the relevant parties? All this must be considered against the backdrop of the existing litigious landscape and the government’s proposals for reform.

The case will now return to the ET to determine Mr Smith’s entitlements as a ‘worker’ which can include entitlements such as paid holiday, sick pay and auto-enrolment into a workplace pension scheme.