Update No.2

Counsel for the PCG, Gerald Barling, stood up at 10.30

The Judge indicated that he had only received the documents the previous day at lunchtime so had not had the opportunity fully to read or understand them. He had however managed to read both the skeletons (skeleton arguments - the documents that provide the outline of each side's case).

It must be borne in mind throughout that the Judge, starting from a position from zero knowledge about the contracting industry as it exists in this country at this time, might and indeed did naturally make some assumptions about how contracting works which are false. After all, the Revenue did. Throughout the session, as he got more and more words in edgeways, Barling was able to take the judge further towards a position of understanding. It must also be borne in mind that this is at least a three-day event.

None of the first session was really "the main event" - it was really clearing up questions from the judge about the cases on either side. Most of the points that were covered here will be covered in more detail later on.

There was a small delay while counsel for the Revenue, Richard Plender, apologised for a few typographical errors in his submission, including the implication that IR35 favours small companies over large ones.

The Judge started off by asking questions on the outline arguments as a whole. He asked whether there was basically one point only to the JR, that IR35 had effect to the detriment of small companies in the knowledge-based sector. The Revenue's position was that IR35 applies in principle to all sectors, not just the knowledge-based ones. Plender said that only people who were effectively employees would be hit. Barling said this was not the case and this would be proved as he went through the PCG's evidence. The Judge asked if IR35 applied only to those who were "in effect employees". Barling said that not even the Revenue would use that phrase.

The Judge rehearsed some of the arguments on both sides and explored the difference between composite companies - those, in which shareholders with an arbitrary shareholding can be caught, not just those with a 5% shareholding. In these companies, typically each member is issued a different class of share and dividends are declared against those classes effectively in proportion to the money that person has brought into the company.

The judge then rehearsed a situation where Gerald Barling set himself up as a contractor. He asked why, if it was the case that typically a contractor would fail the Schedule D/Schedule E employment tests, Gerald should not have to pay the same tax and NI as if he were "officially" an employee. The point was that if an individual, intermediaries and agencies notwithstanding, was in a position where he would normally be regarded as an employee, why should any special cases at all be made. The contracts in such a situation would be irrelevant, the reality of the relationship would decide the matter.

He then asked about the PCG's point on uncertainty: how is status uncertain if contracts themselves are irrelevant to the determination of status. Barling replied because there is no contract and determination is made on the basis of an hypothetical contract that does not actually exist. The judge asked if IR35 applied only to the knowledge-based sector and Barling replied that clearly it was intended to be. The judge asked about pop or sports stars - would they be affected and if so why couldn't he see Elton John. Barling replied that they could be; sportspeople more likely than entertainers, who would likely not be subject to IR35 due to the short-term nature of their engagements.

The judge asked about targeting. Barling said that there is significant though not across-the-board competition between contractors and big consultancies to whom IR35 does not apply. The judge asked if IR35 could apply to big companies and Barling said in principle yes but not in reality (excluding the construction industry). The judge concluded that IR35 only applies to big companies where people are not paid through PAYE but via dividends on different classes of share.

There then followed a discussion about expenses. Barling pointed out that a contractor's company could pay that company a "perfectly proper" salary but still fail the IR35 tests. The judge said in that case the contractor might as well not have set the company up and would close it down. Barling agreed. Indeed it was the stated aim of the legislation to force some 60,000 small businesses to close.

The judge asked why a contractor couldn't just receive money PAYE from the client. Barling answered because the market wouldn't allow it; the work contractors do is typically project-based and the client would not want the overhead or risk of having employees for work which by its very nature was short-term. The point was made that contractors do not receive employment benefits. Barling read a long list of these out.

The judge then asked why a contractor company would have more than 5% expenses. Barling said the average expenses figure was 16.6%. The judge said did that include things that would be allowable under Schedule E (and therefore under IR35) and Barling said yes. Barling said that no other companies were artificially restricted to 5% expenses. Why should "personal service companies" be treated any differently. The judge said that the Revenue's position was that that was a fair reflection of reality.

Barling said that there were many reasons to set up a company - limited liability, building a business, establishing a brand, setting up in competition to big companies. He said that IR35 tied at least one hand behind the back of the small companies in this competition. He pointed out that for Corporation Tax purposes there are other expenses not tied to a particular contract, e.g. training.

The judge asked did this matter: if a contractor earns £X and pays £X/2 one year and £X/2 the next as dividend, why not get taxed on the whole lot up front. Barling said why are we singled out: small manufacturing companies are not disadvantaged in this way against big ones, small retailers are not disadvantaged against big ones, so why should a small consultancy be disadvantaged against a big one.

At 11.15, there was a discussion on timings. If the case overruns, due to other commitments on behalf on the Judge and Plender, it would resume on Monday 26th March (sic). In any event, there will be a decision before April 19th.

Barling then pointed out that status is decided on each contract separately, not on the sum of a businesses activity over a year. The judge seemed taken aback: he had assumed it would be a once-a-year assessment. Barling pressed the point: this is a key element of the uncertainty engendered by IR35. He also mentioned the issue of back-to-back contracts, pointing out to agreement from the judge that a contractor had no right (nor should have a need) to know what was in any contract between an agency and a client.

Barling said that our evidence would show that it is overwhelmingly clear, practically to the point of being self-evident, that competition not just in principle but in practice exists between small consultancies and large ones. An outcome of IR35 is that many small consultancies will close and their staff will go and work for their competition.

There was a discussion of standard agency contracts. Plender said "...one form of [standard agency contract] which is widely used in IT has been assessed as caught".

There was then a discussion about freedom of movement. The conclusion reached was that while levels of similar taxation - e.g. the corporation tax rates in two countries - could not be a valid restriction on freedom of movement. The tests a measure has to pass in order to qualify as a potential bar to free movement under Article 39 were proportionality - is it a sledgehammer to crack a nut - and reasonableness, as defined by the European Commission. We allege IR35 is a prima facia restriction to freedom of movement. A technical discussion on what constitutes a restriction followed. In saying IR35 is not proportionate, Barling does not have to define what is or would have been proportionate (he did suggest "only tax tax avoiders"). As regards reasonableness, again the points about uncertainty, lack of employee benefits, and casting the net too wide apply.

The judge said the Revenue's position was that IR35 stopped the Revenue losing money.

Barling said that the competition is between small and big companies. The Revenue's position is that the competition is between contractors and permanent employees. When asked how he responded, Barling replied, "it's just wrong". The point about benefits was made again. Barling compared IR35 to an iron fist squidging small companies into inappropriate ways of working. Why should IR35 be limited to contractors, why not corner-shop owners or small manufacturers.

The judge said it wasn't stated like that, and Barling replied that almost all affected companies are in the knowledge-based sector. He gave the body-shopping example.

The clang as the penny hit the floor could be heard from the back of the court.

At 12.30 Barling read out IR35 in its original form to the Judge. There was a discussion on what has changed. The RIA was produced and the 60,000 business figure presented. Barling stated that IR35 was stifling entrepreneurship, investment and training.

There then followed a discussion of a 4% versus a 5% shareholder, with special regard to the case where the company works for one client only for a whole tax year.

Another clang.

It may sound as if the judge is being very inquisitive. He is - that's his job. The evidence will now be presented slowly and carefully. He's had to start from behind the starting line as he had so little time to read the skeletons. This afternoon, Gerald will take him through our case in some detail.