Mutuality

Mutuality of obligation is one of the IR35 key tests of employment used by a Tax Tribunal or Court to establish whether a Contractor is a disguised employee and therefore subject to the provisions of IR35.

Under a normal (typical) employment contract there exists a mutuality of obligation (MOO).  This means that the employer is obliged to provide work for the employee, and the employee is obliged to accept it.

Employees of a Company expect to receive payment, holiday entitlement and other benefits regardless of whether the business is making a profit or a loss.  Only when the business is making large losses or there is a change of operations, can the business dispense with the services of an employee by making them redundant.  As a self employed  Freelancer there is no obligation to receive additional work and payment after the original contract ends.  There is no obligation on the Hirer to provide future work for the Contractor.

Genuine Freelance professionals, trading through their own Limited Companies should neither expect nor receive such mutuality of obligation, particularly if they are looking to Pass IR35.  A Contractor’s Limited Company should be engaged on a contract for services basis, to perform a specific task for a specific project, and once the project is over the Contractor moves on, or may be offered a new project by the client.

For most professional Freelancers this MOO does therefore not exist, and is one of the most significant factors indicating that the assignment passes IR35.  After an initial contract, the Contractor is not obliged to accept another one and is free to go.  Equally, the Hirer is not obliged to offer a new assignment or continue paying the Contractor.

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MBF Design v HMRC
On 19 January 2011 a Tax Tribunal ruled in the case of MBF Design Services Limited v HMRC. The Tribunal cited lack of ‘mutuality of obligation’ as key to ruling in favour of taxpayer.

The first tier Tax Tribunal awarded in favour of Freelance Engineering Contractor Mark Fitzpatrick against HMRC over IR35 status. Mr. Fitzpatrick was officially cleared of using his Limited Company MBF Design Services to avoid tax, in reference to his time working as a Freelance Contractor for Airbus. The Tribunal reported a knock-out case victory across three IR35 pillars noting a lack of MOO as a significant factor in their decision. Key MOO points, in favour of MBF, included:

  • Airbus could cancel MBF’s contract without notice.
  • Specifically there had been occasions where due to computer failure Contractors were sent home without pay whereas employees had to remain on-site.
Carmichael and Another v National Power PLC
The issue of MOO appears in Carmichael and Another v National Power PLC (1999).

The interesting aspect of this case, which was heard in the House of Lords, is that it introduced mutuality of obligation as a common phrase widely used when dealing with status disputes and IR35.

In this case Mrs. Leese and Mrs. Carmichael accepted work as guides at Blythe Power station starting in 1989 until 1995. The contracts explained that “Employment will be on a casual as required basis”. Both women applied for the positions and received written letters confirming their appointments. Both signed and returned their letter, which stated “Station Guide – Casual Employment”. I am pleased to accept your offer of employment as a station guide on a casual as required basis.”

When paid, both women were shown on the Company payroll. However the women brought a case against the Company claiming they were employees, and not really self employed. The Industrial Tribunal held that their case “flounders on the rock of absence of mutuality”.

The decision was based on the fact that when the women were not working for the power Company the correspondence failed to evidence that there was a contractual employment relationship with the Company. The Company was offering work when it was necessary but there was no obligation to provide the work and there was no obligation for the work to be accepted by either woman.

In this landmark case the question was asked whether there was obligation to offer and an obligation to accept future work. There was not and therefore there was not sufficient mutuality of obligation to form a “ contract of service“. The individuals were therefore not deemed to be employees. In IR35 terms, they would Pass.

There is still a need for caution. Even a case with no MOO can still be challenged by HMRC, particularly where the Freelance Professional works regularly at the same Hirer either on new contracts or on a “rolling contract”. This can be a pointer used by HMRC towards employment.

Hall v Lorimer
In the case of Hall v. Lorimer (1992), which we refer to several times on this micro site, we can see a lack of MOO.  Mr. Lorimer did not have any full-time contracts with one Company.  He was able to accept or refuse work as he wished.  Likewise, the production Companies could offer him work or not.  Mr. Lorimer operated on “a first come first served” basis so there were times he would refuse work for different Companies if he had already been booked. This also points towards Financial Risk, which is discussed elsewhere.
Parade Park Hotel v HMRC
In the case of Parade Park Hotel v HM Revenue & Customs (HMRC) (2007), HMRC were of the view that Paul May was an employee of the proprietors of the hotel and claimed income tax and NI Contributions for the period in question. The hotel and Mr. May appealed against this decision to the Special Commissioner of Taxes.

Mr. May first worked at the Parade Park Hotel when he was one of three self employed painters and decorators hired by a building firm to work on an extension. Before the work was finished, the building firm closed down and Mr. May and another man were asked to stay on until the work was complete. Mr. May was subsequently offered further decorating work at the hotel and general maintenance work. At first he quoted a price for the completion of each task but was later paid at an agreed daily rate. There was no written contract governing the arrangements. At first Mr. May worked for five days a week, but later this became three days and sometimes there was no work. During this time he did work for other clients.

Mr. May provided his own tools and clothes, chose which jobs he wanted to do and could decide which days he would work. The proprietor could not make him do jobs that he did not wish to do. At first Mr. May was reliable but as time went on his hours worked, and reliability as to whether or not he turned up were often influenced by his acknowledged problem with alcohol.

HMRC argued that there was the necessary MOO between Mr. May and the Hotel for a contract of service to exist. He did not have the right to substitute anyone else to do the work and, in reality, there was an expectation that work would be given to him as evidenced by the length of time he had worked there and the regularity of the payments made to him. Furthermore, the issue was not whether MOO existed from one job to the next but whether it existed during each individual contract. In HMRC’s view, to argue that there was no MOO if the work provider was not obliged to offer future work and the worker was not obliged to accept it was ‘tantamount to saying that a short-term engagement could not be a contract of service. HMRC also argued that the proprietor of the hotel exercised control over Mr. May’s work, dictating what he did, how he did it, and when and where he did it.

The Special Commissioner rejected this argument. The regular pattern of payments made to Mr. May did not in itself amount to evidence that he was an Employee. Whilst there can be mutuality of obligation in respect of separate engagements, this was no greater in respect of each separate day on which Mr. May actually worked than it was over the whole period of the working relationship. In these somewhat unusual circumstances, Mr. May was not under an obligation to carry out work for the Hotel but he could choose to do so. Similarly, the Hotel was not under an obligation to offer him work but could choose to do so. As regards control over his work, the proprietor had to accept Mr. May’s refusal to do particular tasks and had no right of control over the way in which he did his work. There was therefore insufficient control for the engagement between the two parties to constitute a contract of service.

JLJ Services Limited v HMRC
In JLJ Services Limited v HMRC (2011) the Judge argued that the case law in relation to this test, progressively indicated that it was of diminished importance, or that it was nearly meaningless.  There was mutuality of obligations which seemed to be a cornerstone of the Judge’s decision in determining that the period from January 2004 onwards was caught by IR35 due to the continuing nature of the relationship and the fact that there was no longer any project work.  Prior to 2004, the Judge accepted that Mr. Spencer never knew whether the various contracts would be renewed. He had been used to short-term engagements with worrying gaps between most of them, and would certainly not have felt confident that he had been taken on, with some hope or prospect of being engaged as an employee of Allianz; i.e. before 2004, there was no mutuality of obligations.
Assignment Contracts
The following clause is typically used in contracts to ensure there is no contract of Employment ( contract of service):

“The client is not obliged to offer ongoing contracts or work to the company nor is the company obliged to accept such contracts or work if offered.”

This factor alone will not ensure the assignment definitely passes IR35. The whole picture needs to be viewed. HMRC can argue that the assignment contract does not reflect the working practices of the relevant engagement. Once again, the contract MUST reflect the true reality of the situation – otherwise it will be disregarded.

Similarly, where a Professional Freelancer regularly works for the same Client on new or “rolling contracts”, this can be a pointer used by HMRC towards Employment.

HMRC Position
In its Employment Status Manual, ESM0543 – Guide to Determining Status: mutuality of obligation, HMRC says that:

“There must be an irreducible minimum of mutual obligation for there to be a contract of service. That irreducible minimum is that the engager [Hirer] must be obliged to pay a wage or other remuneration, and that the worker [Professional Freelancer] must be obliged to provide his or her own work or skill. However, the irreducible minimum could be present in either a contract of service or a contract for services and therefore, by itself, it will not determine the nature of a contract.”

This means HMRC will investigate a Freelance Professional using a Limited Company to assess mutuality of obligation and IR35 status.

HMRC continues, saying that there does not need to be a contract in place, or a clause in a contract that explicitly says the client must offer work and the Contractor must take it. Importantly, mutuality of obligation can exist without a contract.

For example, a freelancer may be working on a project specified in the contract and the client then asks the freelancer to do something outside of the scope of the original contract. If the contractor completes the task, this is evidence of mutuality of obligation.

Mutuality of obligation is only one indicator of Employment, and both case law and HMRC guidance to its own compliance officers say that there is no single simple answer to determining employment status, and therefore whether IR35 applies. Equally, each case is separate and will be judged on its own merits. So what may be significant in one Employment status test or IR35 case may not be so important in another.

As At 2011
In a landmark ruling on 19 January 2011 Freelance design engineer Mark Fitzpatrick was cleared of disguised employment after a lengthy investigation relating to his work for Airbus while operating under his Limited Company, MBF Design Services.

The court in Bristol cited a lack of mutuality of obligation – specifically that the Hirer could have terminated their contract with MBF Design Services at any time should they have so wished. Crucially, on one occasion, contractors were sent home due to a computer failure, whereas regular Employees had to stay. In this case the court deemed there was no mutuality of obligation, and therefore MBF’s assignment passed IR35.

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