Update No.4

The second session started with a discussion of the 5% figure for expenses. Barling stated that this was a major bone of contention and a major factor in the case for State Aid. Working from the cited figure from the Frontier Economics Survey, the judge suggested that a figure of 16.6% (the average expenses actually incurred by a contracting company) be used instead. Barling said that while this would indeed remove a large tract of the unfairness of IR35, it would surely be better for each company’s circumstances to be decided on an individual basis. He said he could not see why a contracting company should not claim expenses as allowable “just like any other company”.

The judge asked what kinds of things the expenses covered. Barling mentioned training and equipment; in particular training which was not linked to any particular engagement (as this would not be allowable in any event under IR35).

There was then another historical discussion. The original statement from the Paymaster General seemed to imply a once-and-for-all status, not a per-contract status. IR35 ostensibly was aimed at the enforced F2M situation, whereby a worker was forced by a malign employer to form a Personal Service Company thereby relieving said employer of responsibility for employment rights and benefits. It was therefore aimed at clients.

This changed. IR35 is now intended to provide a taxation environment whereby operating as an employee under Schedule E or as a contractor through a Personal Service Company was broadly tax and NIC neutral. The judge stated that indeed this could be viewed as the outcome; although the situations are not cost neutral.

Barling stated that it was a fundamental fallacy to compare contractors and employees. Contractors get paid more because by employing them, a client reduces his own risk. That risk is taken on by the contractor, particularly in regard to sickness. Contracting allows a skilled person to use their skills in an efficient way and clients to hire contractors as and when needed rather than keep an expensive member of staff on board full time when in reality their skills are only required on a project-by-project basis.

The judge summed our position up by saying that in our reality, the clients want to outsource to limited companies, contractors want to run limited companies. The IR ploughed on with IR35 regardless of this reality.

Barling said that even if allowances were increased, there would still be an inherent unfairness in the treatment of contrators’ companies in comparison with other companies. For example, under IR35 a contractor cannot retain profits within their company

Barling then referred once again to a leitmotiv within Plender’s skeleton argument: that IR35 is not targeted either at a particular sector or at small companies. He quoted extensively from various parliamentary debates, principally in 1999. He argued that incorporation is tax mitigation, not tax avoidance. He also cited a House of Lords case in which it was established that a crucial point in employment status cases is the intention of both parties as expressed in the contract. IR35 runs explicitly counter to this (of course it’s allowed to – it’s primary legislation – however it would lead to a contradiction in the way statuses are determined between those operating personal service companies and those operating as sole traders).

Barling then asked how one was supposed to start a big company. The judge said that certainly several cars nowadays start at 20mph. Maybe this was the intention for companies too.

There was some discussion on the extent to which the fact that a contractor’s own company pays that contractor’s sick pay, holiday pay, pension contributions and so on is indicative that the contractor would never fall within IR35. The judge thought that this should be a major factor in determining status. Barling said that since almost all contractors’ companies would pay these sums, it was at best a minor pointer. This led on to a further discussion of Charlotte – an estimated 40% of contractors “are” Charlotte.

There was brief discussion of the back-to-back contracts issue again, in relation to the point that a contractors tax status can under IR35 be determined by a contract to which s/he is neither party nor privy. Barling stated that the uncertainty engendered by this was very significant, particularly in terms of the risk and potential for cost to the contractor. The Revenue can show up five years after a contract is finished and demand money the contractor no longer has. A company can build up a profit only to have it taken away again.

There then followed a lengthy section in which some of the evidence submitted was discussed. This is hard to cover adequately since I do not have a copy of any of it!

Brief highlights of Gareth Williams’ evidence were given, with particular regard to the ongoing uncertainty and the opinions of leading bodies such as ICAEW. IT touched on the control test, and the difficulty of substitution arrangements in an industry where an individual project will typically have a large ramp-up time.

The judge interrupted to say he only had sympathy for the uncertainty point.

Then the submissions of Michael Synnott and Andrew Cox were mentioned.

The judge asked why these people couldn’t just close down their personal service companies and operate as sole traders. 20% of business is direct to client so surely this is possible. Barling said he would cover this later on, but the judge returned to it. If any of these could trade qua Henry but as a sole trader, what’s the problem. The uncertainty between Schedule D/Schedule E status would be no worse than the uncertainty over IR35 and probably better.

Williams’ affidavit includes a list of reasons, and a quote: “the very uncertainty of sole trader status is now descending on limited companies”. The suggested approach would mean that entrepreneurs would not be able to take advantage of a corporate structure in the way that they have been able to to date.

Barling also referred to the portion of Professor Willcocks’ evidence about uncertainty. He covered targetting again. The judge said that not all builders take their kit on site. He wondered if there might be a difference between software and hardware engineers – maybe hardware engineers might take a screwdriver.

Barling said that 81.8% of companies affected by IR35 are in the knowledge-based sector. The judge said “so what”. Barling did not answer. This surprised me: at the permission hearing the case of Italy v Commission (173/73 [1974] ECR 709 p718 para 13) was cited in this regard: in approaching the legality of the statutory provisions, the court should have regard to their effects rather than their causes or aims.

The court then turned to the competition point. Barling cited the Frontier Economics report finding that the markets in which contractors typically operate are not segmented by size. A small and a large company can and indeed routinely do compete for the same outsourced business.

The judge said “Suppose Mr Jones has a personal services company; 50% of his work is within IR35 and 50% is not. He competes with a big company. That’s State Aid – is it?”. He seemed very sceptical.

Barling replied yes, it is: Mr Jones’ company could compete head to head and on an equal footing with the large company, until the 1st April 2000. Thereafter, Mr Jones had IR35 to contend with whereas the big company did not.

The judge went back again to an individual. This (hypothetical) individual was an employee, decided to go it alone, then formed a limited company, and now has that company taken away. So what. He can go back to being a sole trader.

Barling said that the issue was competition between two companies. The judge did not seem to take one-man companies very seriously for this point, though he did say there could be a case when someone has 5% of the shares of a larger firm.

Barling cited evidence again: a number of projects where small (contractors’) companies and large companies (EDS, KPMG etc) competed, with various outcomes. The judge said that if a one-man firm was “genuinely in business” (sic) then clearly it would come up against big companies from time to time. Why were we mentioning it? Barling said that this point is actually disputed between the sides – the Revenue maintain, as they must if they are to avoid losing on State aid, that there is no competition between small and large companies, and the key competition is between employees and contractors.

We then lost our way a little with some evidence that involved a contract project manager who hired some people for a client then moulded them into a lean, efficient coding machine. The judge thought this made the contractor more of an employer (sic) than anything else! Barling corrected this oversight.

The judge wondered aloud if we were not tilting at windmills. We should not be fighting the argument that we should be treated like employees, we should be fighting to say that our situation should be tax and NIC neutral in comparison with employees. Then you can bumble along going in and out of IR35 without it really troubling you too much.

Barling said this was “nonsensical” (with a large amount of respect, of course). The judge said “well that’s what the legislation says”. Barling said “Yes, I know. That’s why we’re here”.

I swear I saw him blowing smoke from the end of his gun at this point before twirling it back into his holster. I may however be wrong about this.

Then Barling took the judge through the salient points of bodyshopping again. The judge asked “do personal services companies pay PAYE”?(!). Barling replied yes, of course – on average 24% of turnover is paid out via PAYE. The judge asked what about the rest. Barling replied some invested in the company, some drawn as dividends, just like any other company. The judge said but now instead of 24% they’ll have to pay 95%. Barling said yes, that’s quite dramatic, isn’t it.

Barling then cited some evidence regarding a former one-man company which had grown to 15 employees. There was some confusion as to the shareholding of the director, and Barling promised to have to figures ready for the morning. However the clear implication was here was a business that had grown from a contracting company that could not grow in the same way (or at all) today.

The session finished at 1640 with Barling giving the judge a reading list for the night.

The course of the proceedings to date may well seem confusing to readers. The way it works is this. The barristers do not take the judge through the case from zero, in the way that I would explain it to my daughter (actually, since my eldest daughter is under two, that’s probably just as well). Rather we are bringing the case on a number of points of law. These are necessarily rather technical. The judge and barrister go through these, examining what parts of the submitted evidence are applicable to each point. This is why certain matters are visited and revisited all the time.

The judge is an interesting character. He is antagonistic, but I think in character rather than specifically towards us. He won’t let anyone get away with sloppy argument. I’m looking forward to seeing Plender face him tomorrow.

Tomorrow’s business starts at 10.15. We will probably finish giving our evidence in the morning. Then Plender gives the Revenue’s version of affairs, after which we get a “redirect” – a short time in which we can rebut what Plender has said but not introduce anything new.