THE PROFESSIONAL CONTRACTORS GROUP
And
THE JUDICIAL REVIEW
RELATING TO IR35

Contents:

1. Background
   1. Professional Contractors Group
   2. IR35
2. IR35: Summary of the Legal Challenge
   1. Background to the judicial review
   2. Illegal provision of state aid
   3. Breach of the right of establishment
   4. De Facto Confiscation of Property
   5. Evidence
   6. Representation
3. 3. Judicial Review - the process
   1. What is a judicial review?
   2. The legal process

• Annex 1 - The chronology of IR35

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.
  

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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