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THE
PROFESSIONAL CONTRACTORS GROUP
And
THE JUDICIAL REVIEW
RELATING TO IR35
Contents:
- Background
- Professional Contractors Group
- IR35
- IR35: Summary of the Legal Challenge
- Background to the judicial review
- Illegal provision of state aid
- Breach of the right of establishment
- De Facto Confiscation of Property
- Evidence
- Representation
- 3. Judicial Review - the process
- What is a judicial review?
- The legal process
The Professional Contractors Group
is seeking the permission of the High Court to proceed with
a judicial review against the UK Government relating to
the introduction and implementation of IR35 - the so-called
'stealth tax' which affects small independent businesses,
mainly in the IT and engineering sector.
PCG's case is that IR35 is contrary
to EU law - and should therefore be struck down - on several
counts. First, it is illegal state aid as the Government
is taxing small contractors more harshly than their larger
competitors; and secondly, it is a breach of the right of
establishment, as it discourages contractors from trading
in the UK. Thirdly, under the Human Rights Act that came
into force on October 2, it is de facto confiscation of
property contrary to the European Convention of Human Rights.
This paper expands on the details of
PCG's case, the nature of a judicial review and the background
to PCG and IR35.
Susie Hughes
Head of executive services & Press officer; Professional
Contractors Group
020 7462 7955
0403 486276
BACKGROUND
1.1 The Professional
Contractors Group
The Professional Contractors Group was formed in May 1999
by a group of independent contractors from the IT and engineering
sector, who saw that the Government's budget proposal, IR35,
was likely to make it impossible for many small businesses
to continue operating.
At the time, these contractors, working
in the new flexible knowledge-based economy had no representative
body which promoted or defended their interests.
The PCG operates as a web-based organisation
sharing information and intelligence through its web site.
Its members have been actively involved in local political
and media campaigns against IR35, making some media and
politicians, including a Government spokesmen, pay tribute
to the scale and persuasiveness of PCG's members.
In February 2000, the PCG held an internet
ballot of its members, when they over-whelmingly voted to
retain PCG as the representative body for independent contractors.
While IR35 continues to dominate the PCG's activities and
the lives of its members, the group, under the current Chairmanship
of Gareth Williams, has a broad remit to give contractors
a collective voice on all issues that affect them and their
businesses.
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1.2 IR35
IR35 - Inland Revenue's press notice number 35 - was released
after the Budget in March 1999. It suggested that the Government
intended to clamp down on people who left employment on
a Friday to start in the same job at the same place on a
Monday - but this time operating through their own service
company rather than as an employee.
However, a few weeks later when the detail
was announced, it was clear that the Government's intention
was much broader and it was targeting all small businesses
in the knowledge-based sector.
The proposal, which came into effect from
April 6 2000, means that many small companies, mainly in
the IT and engineering sector are unable to operate on equal
terms with their larger competitors as their turnover is
treated - for tax and NI purposes - as salary. This means
they are unable to operate as the legitimate businesses
they are because they are unable to make or retain profits,
unable to allow business expenses such as training and computer
equipment against tax, and cannot therefore invest for the
future or plan to grow and develop.
IR35 states that, in order to be treated
as a business, these companies must pass the case-law 'self-employment
tests' which were not devised for businesses in the knowledge-based
sector, but are more suitable for manual or skill-based
traditional businesses.
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IR35: SUMMARY OF THE LEGAL CHALLENGE
2.1 Background to
the judicial review
The PCG is applying for permission to judicially review
those provisions of the Welfare Reform and Pensions Act
1999 and the Finance Act 2000, which provide the new tax
rules relating to the provision of services through an intermediary.
If permission is given PCG will be asking the courts to
declare that IR35 is incompatible with European Law and
hence unenforceable because:
- IR35 is an illegal provision of state aid to larger
competitors;
- IR35 is in breach of the fundamental EC right - known
as the right of establishment;
- IR35 is in breach of the fundamental right protected
by the European Convention on Human Rights in that it
amounts to a confiscation of property contrary to Article
1, Protocol 1 of the Convention. With effect from October
2 2000, it is a breach of the Human Rights Act 1998.
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2.2 Illegal Provision
of State Aid
The EC Treaty prohibits state aid, which is granted by Member
States or through state resources; and which distorts competition
by favouring certain undertakings; and affects trade between
Members' States. Differential tax rates affecting a specific
sector have been held to constitute an illegal state aid.
PCG's case is that IR35 is a state aid,
which will distort competition by taxing small knowledge
based contractors in a materially harsher way than their
competitors. As a result, many independent contractors will
cease to trade. Given the nature of the IT industry it is
inevitable that inter state trade will be affected.
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2.3 Breach of the
Right of Establishment
The EC Treaty provides that a Member State ('the host state')
must not impose restrictions on the freedom of a national
of another Member State to establish himself in the host
state. Neither may the Member State restrict the provisions
of services in 'the host state' from an establishment in
another Member State.
PCG's evidence shows that IR35 discourages
EU (non-UK) knowledge based contractors from trading in
the UK because of the lack of certainty as to the tax to
which they will be subject or the substantial tax disadvantages
that they will incur. Nine IT contractors (both UK and non-UK
nationals) have provided evidence, which shows they have
or may cease trading in the UK as a direct result of IR35.
Two of these contractors are joint applicants in this case.
PCG's evidence shows that the legislation
cannot be objectively justified and is disproportionate
to its stated aims.
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2.4 De Facto Confiscation
of Property
The Human Rights Act, which came into force on October 2,
requires UK laws to comply with the provisions of the European
Convention on Human Rights. IR35 represents a de facto confiscation
of property because it prevents a legally constituted limited
company from operating as such, allowing its expenses against
tax and making a legitimate profit, and therefore prevents
its shareholders from enjoying the benefits of owning the
company.
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2.5 Evidence
In support of their application and, in addition to the
evidence described above, PCG has provided cogent evidence
of the effects of IR35 on their large and wide-ranging membership.
This evidence is supported by the expert evidence of Dr
Leslie Willcocks of Templeton College, Oxford.
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2.6 Representation
Counsel for PCG are Mr Gerald Barlling QC and Miss Kelyn
Bacon both of Brick Court Chambers. They are instructed
by Tony Askham, head of litigation at Bond Pearce, Solicitors.
Counsel for the Inland Revenue are Mr Richard Plender QC
of 20 Essex Street Chambers and Mr Rabinger Singh from Matrix
Chambers. They are instructed by the Solicitor for the Inland
Revenue.
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JUDICIAL REVIEW - THE PROCESS
3.1 What is a judicial
review?
A judicial review is the legal procedure where the courts
ensure that public bodies such as local authorities, Ministers,
Departments of State, regulatory bodies and, to some extent
Parliament, operate within the law when making decisions.
The most recent - and high profile case - was the High Court
ruling in favour of Camelot after the Lottery regulatory
body had rejected its application and decided to pursue
the bid only with Sir Richard Branson's People's Lottery.
The court found the Lottery Commission had not acted in
accordance with the rules and they had to reopen negotiations
with Camelot.
A judicial review will deal with the
process and the legality of the decisions of public bodies.
While the UK Parliament has a right to introduce laws, it
must ensure that they do not contravene European legislation.
If UK laws are contrary to European measures, the European
law will prevail and the UK law can be struck down by the
Courts by way of a judicial review. The PCG is claiming
that IR35 contravenes European law.
A judicial review will not examine the
'good' or 'bad' of a measure or consider if Minister or
Department of State might have acted differently - the court
will only concern itself with the lawfulness of that measure
.
The European Communities Act 1972 provides
that where European Union law applies, EU law overrides
UK law.
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3.2 The legal process
The first stage of the judicial review process is to seek
the permission of the High Court to proceed with the judicial
review. Both parties have an opportunity to present an outline
of their case and the judge will decide whether there is
sufficient merit to proceed.
The decision can be appealed.
If permission is granted, a date is set
for a full hearing.
The court could at any stage decide there
are issues on which the advice of the European Court of
Justice is required and refer those issues to the ECJ.
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ANNEX 1 - THE CHRONOLOGY
OF IR35
March 9 1999 - The Budget
Immediately following Chancellor Gordon Brown's 1999 Budget,
a series of Government press notices were released to deal
with the detail of the proposals. The 35th press notice
from the Inland revenue (IR35) announced the intention to
introduce measures to counter avoidance in the area of personal
service provision. The Chancellor cited the target group
for this measure, the so-called Friday-to-Monday workers
who leave a company on a Friday only to return to the same
job on a Monday as a self-employed contractor.
March 13 1999 - Engineerjob.com
Businessman Andy White, who started as contractor and went
on to build several successful, larger businesses, thought
that despite the Government's claims to be targeting the
'Friday-to-Monday' workers, they would spread their net
much further and target legitimate small businesses. He
expressed his concerns to a wider audience through an email
newsletter and his web-site www.engineerjob.com to see if
others shared his concern. Within two week, the site had
received 40,000 hits.
April 22 1999 - IR releases draft proposals
The Inland Revenue releases its draft proposals relating
to IR35 and requested comments from interested parties.
It was then clear that the original concerns had been well-founded
as the target was now plainly any small businesses which
worked in the knowledge-based sector. The proposals indicated
that, unlike other businesses, total turnover should be
treated as salary for tax and NI purposes - preventing expansion,
investment or even allowing the company to make a profit.
May 4 1999 - PCG formed
Following the response to the engineerjob.com newsletter,
2000 contractors agree to fund the start up of their own
group to represent their interests in IR35. And so the Professional
Contractors Group was formed.
May 13 1999 - New clauses
While the Revenue was still receiving comments on its proposals,
draft new clause were tabled for inclusion in the Welfare
Reform Bill giving effect to the proposals.
May 17 1999 - IR35 enters legislation
The new Clause giving effect to IR35 was voted through at
Third Reading of Welfare Reform Bill in the House of Commons
and was included in the legislation.
May 21 1999 - Closing date for comments
Several days after the IR35 provisions had been put into
a Parliamentary Bill, came the closing date for comments
to the Inland Revenue on its draft proposals.
May 21 1999 - Regulatory Impact Assessment
The Government's Regulatory Impact Assessment which examined
the effect of IR35 was published on a DSS website. It showed
that IR35 would close 66,000 small businesses and gain the
Revenue more than £400m.
June 10/11 1999 - IR meetings
A month after IR35 was introduced into Parliament, the Revenue
held its first consultation meetings with the interested
parties, including the Professional Contractors Group, about
the draft proposals.
June 10 1999 - Lords Second Reading
Second Reading of the Welfare Reform Bill in the House of
Lords. The subject was debated but in keeping with Parliamentary
convention there was no vote at this stage. However, there
was an indication from several Peers that they felt the
proposals were introduced without full consideration and
were damaging to small businesses.
July 20 1999 (and other dates) - Lords
Committee
Clause 70 debated in Committee Stage in the House of Lords.
The Government spokesman Lord McIntosh promises further
discussion in the summer with interested parties in return
for the Opposition Peers not pushing the matter to a vote.
September 1999 - Financial Times
Although the Revenue had promised consultation during the
summer, none had been offered. Then the Financial Times
reported that there had been a series of secret meetings
within the Revenue and that it was about to announce its
decision
September 22 1999 - IR calls meeting
Perhaps as a result of the concern over reports of 'secret
meetings' and 'decisions behind closed doors' the Revenue
invited several groups, including the PCG, to a meeting.
During that meeting the groups were told that Ministers
had had already reached a decision and an announcement would
be made shortly.
September 23 1999 - Self employment
tests
The day after the meeting with the various pressure groups,
the Revenue announced that, after 'consultation' it had
revised its proposals. The principle remained the same but
the test moved from the 'illogical' direction, supervision
and control - to the 'unworkable' self employment tests.
The self employment tests belonged to a pre-high tech era
and do not fit as a measure for evaluating a knowledge-based
business. As the PCG said at the time, it was like asking
someone to weigh something and providing them with a ruler
to do it.
October 13 1999- IR35 defeated in the
Lords
When the Welfare Reform Bill returned to the House of Lords
at Third Reading, the Peers signalled their dissatisfaction
with the IR35 proposals and the manner of its introduction.
After a heated debate, the Lords rebelled against the Government
and voted Clause 70 - containing the IR35 provisions - out
of the legislation.
October 27 1999 - PCG's RIA
The PCG produced its own Regulatory Impact Assessment, factoring
in items which had been omitted by the Revenue. When they
took into account loss of income from people who would move
overseas, losses in corporation tax, increased compliance
costs and other costs, the PCG found that IR35 would cost
the Revenue £700 million rather than the predicted £400
million gain.
November 3 1999 - Contractor Wednesday
Despite the Lords removing the measure from the Welfare
Reform Bill, the Government indicated that it intended to
use its significant majority to reintroduce the clauses
in the Bill. The PCG organised 'Contractor Wednesday' and
invited any of its members to come to Parliament to discuss
their concerns with their MPs. More than 700 businessmen
and women arrived at the House of Commons to discuss their
concerns with their MPs.
November 3 1999 - Commons reintroduce
IR35
Despite this show of concern and the fact that the Government's
back benchers were deserted during the debate on the reintroduction
of IR35, the Government whipped the vote and IR35 was back
in the legislation.
November 8 1999 - Back to House of
Lords
In keeping with Parliamentary, the Lords, while continuing
to oppose the measure, did not remove it for a second time
and IR35 became law in the Welfare Reform and Pensions Act
1999.
February 7 2000 - Guidelines
IR publishes guidelines - with the opinion that standard
agency contracts over one month duration would be within
IR35.
March 13 2000 - Finance Bill clauses
The Inland Revenue published the draft regulations and the
clauses on IR35 which would go into this year's Finance
Bill.
April 6 2000 - Implementation
Implementation of IR35 provision
April 6 2000 - PCG launches judicial
review
May 2000 - Tax Faculty give three out
of ten
The well respected Tax Faculty of the ICAEW analyses IR35
and the manner it has been implemented and awards the Government
a poor three out of ten.
July 7 2000 - Joint letter
The Financial Times publishes an open letter from the PCG,
CBI and FSB criticising IR35 and calling on the Government
to rethink before its too late.
July 28 2000 - Royal Assent
Finance Bill receives Royal Assent
Summer 2000 - Fast track visas 'in'
and IT contractors 'out'
As a number of survey reveal that about 25 per cent of IT
contractors where considering leaving the country because
of IR35, the Government announced measures to introduce
fast-track visas for non-EU residents with IT skills.
October 9 2000
PCG seeks permission in the High Court to judicially review
IR35
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