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What do businesses need to consider when employing service companies?

What do businesses need to consider when employing service companies?

Posted on November 20, 2018, by Sonya Bassett

In some industries it is commonplace for individuals to be engaged by an end-user business via their own service company. Philip Sayers, Employment lawyer, and Partner and Head of Corporate and Commercial Sonya Bassett discuss some of the issues for businesses to consider.

Many businesses use service companies for functions such as IT, marketing and HR and is common among certain sectors, such as training companies and in the oil industry. It can be attractive for both the individual and end-user business for tax reasons. It also means the business avoids the burden of employment rights.

However, HMRC are addressing the taxation of using service companies via IR35 taxation. Businesses should also be aware that employment tribunals can be willing to look beyond the somewhat artificial arrangement and hold that there is a direct relationship between the individual and the end-user business.

Is a service company employee entitled to employment rights from the end-user business?

When someone is engaged to work at a business through a service company, it can be surprisingly difficult to determine if they have no direct relationship with the end user or if they should be classified as a worker or employee of company. A key issue in working out whether or not they are entitled to employment rights is to look at whether or not the individual is personally obliged to perform work for the end user.

Service companies normally only consist of one individual and are used as a vehicle for that individual to provide their labour. That means the practical reality is that often the individual will be obliged to perform work personally for the end user. However the existence of the service company nominally acts as a barrier between the individual and the end-user business. Therefore tribunals will often analyse the real position on the ground rather than simply look at the paperwork agreed between the parties.

Please note that if a service company employs several people who could each be sent to perform the work for the end user it is very unlikely that these individuals would be classed as employees of the end user.

The importance of employer and employee relationships

In the recent case of Sprint Electric Ltd v Buyer’s Dream Ltd, the courts were willing to look beyond the artificial separation between the employee and the end user when the employee was engaged via their own service company.

In this case, an individual was employed through his service company, Buyer’s Dream Ltd, for his particular programming expertise to help Sprint Electric Ltd expand. This was for tax reasons. The individual, Dr Potamianos, later became a shareholder and a director of Sprint Electric Ltd.

When disagreements about management later arose, Dr Potamianos was removed from the company, but he retained a computer. Sprint Electric Ltd claimed intellectual property of the source code created by Dr Potamianos, while he and Buyer’s Dream Ltd counterclaimed that they owned the copyright.

Sprint Electric Ltd’s claim was successful, as it was found that Dr Potamianos was obliged to personally perform the technical services through his service company, Buyer’s Dream Ltd. Therefore, the relationship was one of employer and employee and Sprint Electric Ltd owned the copyright to the source code. This case is a comparatively rare example of an individual being held to be an employee when they would have preferred to be held to be self-employed. The large majority of Tribunal cases concern the opposite scenario whereby the individual is trying to establish that they are, or were, an employee or the end user.

Why businesses need to understand IR35 legislation

One of the reasons that companies engage individuals through their own service companies is to avoid paying tax. HRMC have been cracking down on this and introduced the IR35 legislation to try to ensure they receive a similar amount of tax as if the individual was an employee, paid via the company payroll.

If the individual has to personally do the work, they are likely to be caught by the IR35 legislation and be subject to similar taxation as an employee on the payroll.

The outcome of tax cases about IR35, and employment tribunal cases to determine employment status, however, are hard to predict as they are always fact sensitive and judged on an individual basis. In one case, the IR35 legislation would apply, and income tax need to be paid, while a similar situation, the case may result in a different outcome. Because this is complex, it is worth companies getting expert advice to ensure they understand the implications of their arrangements with service companies.

For more information on this or any Employment enquiries contact Philip Sayers, Employment and HR team on 01872 246200 or philip.sayers@coodes.co.uk or Sonya Bassett, Partner and Head of Corporate and Commercial on 01736 362294 or sonya.bassett@coodes.co.uk