Update No.6

Judicial Review Session Three – Wednesday 14 March 2001, morning

Proceedings started at 10.15. The judge announced that he had not had time to read everything requested overnight: he had read the submissions of Williams, Walker and Williams’ reply to Walker, Synnot and van Zulott. He had not however read the expert evidence. He said he now understood that when witnesses referred to “contractors” they meant the contracting company i.e. the personal service company, not the director of that company. He said that he was beginning to master the jargon.

He raised the question of the case where 10-20% of a contractor’s fee is taken by an agency. Is this allowable under IR35. Plender replied that deemed salary calculations are indeed net of any such charge.

Walkers submission had said that advice on contracts was available but widely had been spurned. Barling said that this advice was available only on signed contracts. The judge wondered if this was indeed the case: it would “be nice” if it was available pre-contract. This would clearly address the uncertainty issue. Barling pointed out that an opinion was only given on signed contracts. Barling said that Walker stated in her evidence that there was a new service to help someone see if they would be caught, did this mean prior to signing. Plender confirmed that opinions were only available post-signing but advice is available pre-signing.

That’s the first time I’ve heard of that service. No doubt it will have been the subject of some research by the time I read the PCG fora this evening.

There then followed a discussion on Social Security benefits that were NIC-related. Barling maintained that benefits such as SSP and SMP were only assessed on actual, not deemed salary levels, whereas NIC was due at the deemed rate. Plender said this was incorrect and he would answer this point later.

Barling referred in particular to the unavailability of Unemployment Benefit. If deemed within IR35, a contractor is viewed as an employee of the client while a client exists but of the personal service company when there is no client. This was inconsistent. Surely the contractor is the employee of the personal service company throughout, irrespective of the existence or otherwise of a client. The revenue wanted to have their cake and eat it.

The judge said there were three points: a caught contractor could not get UB; there is a question as to whether or not the contractor benefits in terms of SSP, SMP etc from the deemed rate of NIC, and there’s a question in terms of someone receiving UB – is this taxed at a marginal rate which takes into account actual salary only or deemed salary (which might push tax due into the 40% bracket).

The judge said that a significant factor is multiple clients. Under IR35 can we say that even though someone is on site, largely under the direction and control of the client and part of a team, the factor that the contractor will leave at the end of the project is a factor pointing to SE. But, he asked, how is this possible if IR35 is assessed on a per-engagement basis as opposed to, for example, a per-annum basis.

Barling said that this was indeed an issue and contractors were turning down extensions precisely for this reason.

The judge said that having read Williams’ statement, he was concerned to know precisely with what he had to deal. He wanted neither to act per pro a house of commons committee nor per pro a legislator. He did not have to decide fairness, whether the legislation was politically acceptable or any other such matters. His opinion would be limited to the legality. He then turned to the three grounds on which relief is being sought.

State Aid. On the balance of probabilities if company A is in competition with company B and have imposed on them something which does or has the potential to affect that competition, that is a State Aid. If a Government imposes a State Aid, it must normally notify the European Commission of this fact, unless there is justification. Justification can include such things as correcting an anomaly or stopping tax avoidance. Barling confirmed that as per Lunn Poly if there was a clear case of tax avoidance, the Government would not have to notify the Commission of a State Aid. However, IR35 is not an anti-avoidance measure. It was originally aimed at the F2M situation. In this regard it is wholly disproportionate.

Freedom of Movement. We say IR35 is effectively a bar to Freedom of Movement. Again justification rears its head, although for this ground there can be no reliance on “justification” as in State Aid. However Barling said the Revenue could rely on “effectiveness of fiscal supervision” – i.e. setting the right tax under the law. The difference between this latter and justification is that this means measure to enforce existing law, not new law.

The judge said that this line seemed very narrow and he was worried about elevating Freedom of Movement to the level where anything and everything other than varying rates of direct taxation or harmonisation of indirect taxation could be viewed as a ground.

Human Rights. This can also be an issue to justification. HR is being raised in relation to de facto confiscation of property. Barling said that someone may have spent many years building a company, a brand, a market position and be on the verge of a breakout into a larger company only to have it all taken away by IR35. He cited the RIA which said 60,000 businesses would close. He also cited uncertainty in this regard, especially that engendered by a per-engagement rather than a per-annum assessment scheme.

The judge said that if the standard agency contract was caught, surely the usual market pressures would cause that contract to disappear in favour of contracts that weren’t. Barling replied no – the agencies don’t care, as they are not directly affected by IR35. Agencies can be Service Providers too and often wanted to employ ex-contractors as permanent employees.

At this point the judge did something very significant. He stated that in the case that we lose, one outcome could be a statement from him – which would carry considerable force as he is a High Court Judge – saying that if a contractor is in business on his own account then that would be the major determining factor, modulo length of contract. He seemed to think that a period of one year would be a reasonable cut-off.

This would be a Big Deal.

Barling said that IR35 says that a contractor can be in or out of business on his own account on a per-engagement basis. The judge said under his hypothetical scheme he would do his best to word his statement to make sure that the effect was sensible. Barling said that when tendering for a renewal there would be a risk of moving the company from one status to the other. The judge agreed. Barling cited EDS who have a 10-year outsourcing deal from the Revenue. Why should they be able to have such a deal whereas a small consultancy could not.

The judge said (as we all knew anyway) that our case on State Aid and Freedom of Movement was stronger than our case on Human Rights. He wondered if there was legal authority to say that it’s a denial of a fundamental human right to say someone can’t set up a corporate structure. Barling said yes, for sure. The judge said this alone was not sufficient and Barling argued that the combination of this and the uncertainty formed our HR case.

Then Barling gave the judge a contract and some correspondence regarding it. The same tax office had adjudged the same contract first not caught and then caught.

The judge looked at the contract and the “caught” letter. He shook his head repeatedly, saying (effectively) “but the contract doesn’t say that”. He said “I think that’s a misconception”. He said “This is a matter for substantial criticism”.

This is the first time any contract has been before any judge in an IR35 status determination context. The fact that that judge was in fact a High Court judge and was so scathing of the Revenue’s position is something of considerable note.

Barling said the individual Hector was not to blame: the criteria very, very “woolly” and difficult to apply.

There was then discussion of a company with 30 employees whose managing director occasionally did outsourced work. This director could certainly be subject to IR35 as he owned 95% of the company. The judge remarked that he’d need to be careful with share options not to give any employee more than 5% of the shares.

The judge said he was troubled by the legislation’s history. IT didn’t start as being aimed at a “disguised employee”. He said it may be hard to shake the origins of the thing off. Barling said that there were many other options that would have achieved the Revenue’s stated aims in a more reasonable and proportionate way. For example, raising NICs on dividends for close companies, having a rule about the proportion of income a closed company can declare as dividend, and so on. IR35 was simply about raising more tax. Raising more tax cannot be a justification for a State Aid or for not notifying one.

There was then discussion of the expert evidence from Frontier Economics. There was discussion of the assertion that because a contractor takes higher fees than an employee they pay more actual tax, though proportionally less tax. Barling asked again why small companies were being singled out. The judge said if we had a socialist government – “and some may question if we do” – it might want to punish entrepreneurs, and if this was the case it was not his place to stop them.

The judge talked about the second RIA and Williams’ evidence and said it addressed the reason why contractors set up as limited companies rather than as sole traders. This was not contested by Plender.

The judge said IR35 made a caught company uncompetitive in relation to an uncaught one. Barling said yes – the caught company would have to put up prices. There was discussion on the extent of such a forced raise necessary to constitute competitive disadvantage: if a contractor could charge 10% of a big consultancy’s fees then he could surely raise to 20% and still say competitive. Barling said that it was not an argument in European Law against State Aid to say the impact is small. The test is not even that a measure does distort the market, merely that it has potential to.

Barling then said we have expert external evidence whereas the Revenue have unsubstantiated assertions (this in regard to competition). The Revenue’s assertion is that contractors are outsourced employees and not in the same market as big consultancies. The judge said he’d read the expert evidence after the hearing and come to a view.

The judge said there were two different mindsets – contractors as outsourced employees and contractors as small consultancies – and he had to decide with which mindset he agreed.

This is what will decide the case.

Barling listed what the typical breakdown of the average 16.6% expenses was. He attacked the Revenue criticism of the Frontier survey. Frontier is an independent body and they did random checks at Companies House. IR say 21% of tax paid before IR35, we say 27% - the Revenue ignored expenses.

The judge asked about other affected parties outside the knowledge based sector. He said that it would be hard for him to give relief to any other than the sectors represented by Barling. Barling said the judge would be right to limit relief to the sectors on which evidence had been given.

Barling went through the rest of his skeleton clarifying minor point.

Then “for some light relief” he said he’d go over the relevant European Law and applicable cases. I will not cover these in detail (see the background documentation).

The judge’s attitude has been less confrontational. He is according us a lot more respect now he has had a chance to read our evidence.

It is crucial to remember that any hypothetical discussions regarding outcomes where we win or lose are simply that – hypothetical. The judge is not expressing any view as to the likely outcome of the case, save to say that our HR case is weaker than the other two grounds (we knew that anyway). So please don’t read anything into any of the above – he’s not saying we’re winning and he’s not saying we’re losing.