Update No.10 - Thursday PM update

Judicial Review Session 6: Thursday 15th March 2001, afternoon

Barling resumed his case, giving evidence regarding competition in the Engineering sector, specifically in the Sugar industry between a small Chemical Engineering consultancy and another company.

He then presented to court two documents: the ICAEW report that gave IR35 30/100, including marks of 0/10 on fairness and 0/10 for effect on competition; and the Select Committee report to the House of Commons which contained criticism of IR35, including the lack of proper consultation.

He said that IR35 was aimed at tax avoidance: this was the original aim and this has never changed. This was categorically stated repeatedly in parliament. He quoted Timms: “all that has changed is the proposition that contractors must pay themselves a sensible salary”. If the Revenue were now to claim that it was a general measure, that has never been claimed before.

The judge said that if it is a general measure to raise tax not counter avoidance, and if it is intended to attack overall the benefits of a corporate structure, he still didn’t see the proportionality argument (this is in the hypothetical context regarding Freedom of Movement that I mentioned this morning). Barling cited the legal costs of having to decide “is my company in/how do I keep it out”; and the accountancy costs in having to prepare two lots of figures on the same activity, one regarding deemed salary for IR35 purposes and one for Corporation Tax in the usual way. The judge remarked that in this regard IR35 could be seen as “State Aid for accountants”. “And lawyers”, added Barling.

Barling then turned to expert evidence comparing the tax take on the same gross generated turnover for an IR35-caught company and an employee. The IR35-caught company paid 38% whereas the employee paid 32%. He also produced a letter from the PPS to the PMG saying, “IR35 is aimed at tax avoidance”.

Plender then rose to confirm that Barling is correct: IR35 always was about tax avoidance and still is. This point is not contested.

There was then some more discussion of relevant cases and their implications for this case. Details were not read out, so I cannot summarise sensibly; the cases referred to various definitions of “justification” in the State Aid and Freedom of Movement contexts. Uncertainty was a major factor; legal certainty is also relevant to the HR ground; Barling finished with three case references relating to the HR aspect of the case. The judge remarked that this was the first time since October 1st 2000 (when the HRA was enacted) that anyone has come to court and said “…and finally, human rights for five minutes”.

Richard Plender QC, counsel for the Revenue, rose at 14.40. He started by addressing miscellaneous points from Barling’s submission. He quoted the PMG from the Commons Debate: “IR35 is not to prevent self employment but to protect the status of the self employed. [It is] to stop employees using self-employment arrangements or personal service companies … anyone operating a legitimate business is OK”. IR35 is always limited to the case where a person would have been an employee but for the existence of an intermediary.

IR35 is “generous”. Not only does an IR35-caught company get travelling expenses – unlike employees – they also get allowances for PI insurance and pension contributions. The average cost of setting up and administering a small company is 2% of its turnover. An allowance of 5% is therefore generous.

The judge said that training costs were not allowable under IR35. Plender said he would return to this point. He said he would for the benefit of all state the obvious. Any new regime designed to neutralise advantage conferred by tax avoidance must necessarily impact those affected.

The judge returned to training costs. For an employee, the employer pays for training. An IR35-caught company is expected to pay for training – but it may have no money left to do so after IR35 is paid. Plender contested this saying the higher fees commanded by contractors should leave plenty of room for training. The judge said that money a contractor would like to spend on training would surely now go on Tax and NICs. Plender said it wouldn’t.

The question of penalties was then raised. Plender reeled off the standard line that if a contractor is unable to calculate IR35 liability by April 19th, then can in any event submit estimated accounts and correct for any error later. Penalties would not be severe in the event of genuine mistakes and account would be taken of whether or not the contractor had taken all reasonable steps to ascertain their status. Plender asserted that the assessment was not entirely per-engagement and cited Charlotte in this regard. In this case the whole business picture was taken into account: if someone is genuinely in business with multiple simultaneous clients, that is a strong SE pointer.

The judge said if that was right, he felt reassured. He then raised the matter of the two letters.

Plender stated that he had been instructed to apologise to the Court for this situation. In order to understand it, it was necessary to look at the correspondence as a whole. The worker in question was a 7% shareholder employee of a company, which had a policy of not declaring dividends. So the original response declared that she could not be subject to IR35 on this ground: the employee has no rights to dividends.

The judge said this was patent nonsense. She absolutely has a right; the company may well decide to declare a dividend in the future and she would be entitled to 7% of it. As a non-director she had no control or influence over this. The correct statement is that the worker will not receive any dividends so long as the board maintains its no-dividend policy. Plender said yes – that was the mistake that Hector had made. Hence the second, corrective, letter. This does not illustrate uncertainty, merely that status is difficult to assess on the basis of one contract and a short letter.

The judge said that this illustrates that the legislation not only in theory, but in practice does cover companies that are not one-person companies. Plender said that’s right – composites are covered too. The judge said this isn’t a composite. Plender said oh no, so it isn’t. (Readers will recall that a composite company is one where several people each have a different class of share capital; typically dividends are declared on each class in proportion to the work each shareholder has done for the company. This isn’t the case here: the worker was a non-director and only a 7% shareholder, but the company patently is not a one-person company).

The contract in question gave an estimated price for the contract (SE pointer) but also a daily rate (E). The company was to supply one or more persons with a named team leader (SE) but the right of substitution is limited by a right of veto from the client (E). Plender said that clearly the contract was shaped with IR35 in mind. He hoped that if this was an artificial construct by Barling that Barling would say so. Barling looked somewhat taken aback and somewhat shocked at this suggestion. I personally thought it was unnecessarily insulting and displayed a clear lack of understanding about the approach any contractor is now going to take to contractual matters.

The judge said that maybe the extra 3% (5% expense allowance minus 2% costs of maintaining the corporate structure) went towards paying a lawyer to draft the contract. Plender could not reply to this.

The judge said that Barling’s point on this was to uncertainty: the letter stating the contractor was caught cited a notice clause in the contract, which did not actually exist in the contract. He said this was “very concerning”.

Plender said that the uncertainty engendered by IR35 was at worst no more than the uncertainty between self employed and employed status in common law. The judge said that Barling’s point on this was that a strong motivation for setting up a corporate structure was precisely to avoid this uncertainty.

The question of payments while unemployed then arose. Plender confused the notion of benefit to the worker while unemployed with unemployment benefit. He then stated that Barling had said that monies paid to the worker in an IR35-caught company not in a contract would have to come out of taxed income. He said that as salary paid throughout the year increased, so the amount of deemed salary decreased: the total salary that had to be paid in the year remained constant. Salary was therefore only taxed once.

I don’t think anyone understood the point Plender was trying to make with this. Certainly he didn’t. Equally certainly it didn’t address Barling’s point. In my view, Plender was very weak on this ad libertam segment of his evidence. I do not think he was in command of his brief. Rabinder Singh (IR counsel) seemed to mouth “…but that is illogical, captain”, but I may have caught it wrong.

Plender then raised the Carmichael case. This concerned a group of workers who were power station guides. There was an hourly rate of pay and direction and control; however there was no mutuality of obligation (MOO hereafter). There was no obligation on Mrs Carmichael to work for any set number of days, nor on the employer to provide work for any set number of days in the year.

The judge said that this House of Lords case changed the common law E/SE test. There is now an essential component to employed status: an “irreducible minimum of mutual obligation”. He asked Plender how this new MOO test operates with regard to imaginary contracts.

Plender blathered for a while. The judge put him out of his misery: surely your answer must be that to construct the imaginary contract, terms from such actual contracts as exist must be inserted. In particular the contract between the client and the intermediary – or, crucially, the agent – must define whether or not there is obligation (within the meaning of the new Carmichael test) from the client to the contractor. The judge reminded the court of Barlings point that the status of the contractor was therefore, in the case where there was an agency, controlled by a contract to which that contractor was neither necessarily party nor privy.

Plender then seemed to say that in fact the contract was irrelevant and the reality was what counted. The judge said that the statue does not invite but requires the Revenue to construct an imaginary contract from the contract or chain of contracts that exists or may exist between client, agency, intermediary and contractor. The judge said that if the client has no obligations under the imaginary contract constructed from the chain, the conclusion of any assessment must be “not caught”. Plender agreed.

This might be of interest to contractors currently negotiating contract terms.

This concluded the ad hoc points Plender was raising in response to Barling. He then proceeded to his skeleton.

Once on this familiar ground, Plender became much more assured and seemed much more in command of what he was talking about.

He said that the application for relief – even as amended – was so vague and impractical that any court should never grant it. He said that this very vagueness illustrates the lack of specificity within IR35. He questioned the definition of the affected sector – was a North Sea Oil diver included or not? He said that all inhabitants of any affected sector could potentially benefit from other inhabitants of that sector being within IR35, not just large inhabitants. He said that for State Aid, Barling needed and had failed to demonstrate that all participants in the market in question were affected. The Aid must be in favour of a group specifically identified as beneficiaries under the legislation (or, as in the case of IR35 which is alleged to be a negative State Aid, disbeneficiaries (I’m not sure if that’s a word, but that’s what he said)).

He said the Italy case establishing that the effect not the intent was the relevant factor could not be used to sidestep this fundamental requirement. He raised the differential CT rate – could the lower rate of CT paid by small companies be said to be a State Aid in favour of small companies to the detriment of EDS?

He said the Lunn Poly case did not apply because in that case the economic sector – the travel industry – was well defined and that definition was widely accepted.

The judge said that Plender’s submission was that Barling had to effectively represent all small companies or none of them. Some of them didn’t cut it.

Plender said the loosest acceptable definition might be something like “the manufacturing sector”. But even in this case a State Aid must amount to something that gives advantage to all big companies within manufacturing, not just some.

Plender then left his notes and turned to the Peacock case, in which the PCG claimed competition between small and large consultancies was demonstrated. In fact, said Plender, Peacock helped him more than Barling, as it demonstrated that the client requirement was at the level of an individual person, not a company. The judge asked what about a requirement small enough for a one-man company to undertake it: surely then contractors and the likes of Accenture could be said to exist. Plender said no – even in this case the reality would be that the competition would be between two individuals, irrespective of what corporate structures they came from.

Plender returned to his skeleton and addressed State Aid and Freedom of Movement.

He said that to succeed in State Aid, Barling must show that IR35 confers an advantage on specific undertakings. He hadn’t and wouldn’t.

On Freedom of Movement, he would show that the PCG’s definition of “obstacle” was incorrect, and that in any event IR35 was having no deterrent effect on migration of workers to the UK, PCG evidence notwithstanding.

The aim of IR35 is to discourage tax avoidance and promote equal fiscal treatment of workers whose positions were identical except for the interposition of an intermediary.

The judge raised the question of tax mitigation as opposed to avoidance. Plender said this was a semantic in which he would prefer not to get involved. Any complex series of arrangements in which one would not otherwise have engaged except to reduce tax liability is de facto avoidance.

The judge said: but if a company has half its engagements within IR35 and half outwith IR35, clearly the company structure is not artificial. Plender said that IR35 was always intended to apply on a per-engagement basis. The judge said “you didn’t answer” (but not in so many words). Plender said he wasn’t making a value judgement on artificiality.

Plender then read (parts of) the original IR35 out. He contended that F2M was an example, not a definition of the entirety of the government’s aims. The judge said the next sentence (the one following the first mention of F2M) showed Plender was wrong. He said it was “unfortunate that this kind of emotional language was used in a serious document such as this”. Plender said well it is a Press Release. The judge said use of the word “disguised” was also unnecessary and wrong. He said “You’ll inevitably be on the back foot when the Inland Revenue, which is a Government body, uses this kind of emotional language”.

Plender said that the Government sought to “enervate” (sic – I’m not sure this is what he meant!) entrepreneurial activity. However widespread avoidance represented a Schylla and Charybdis in this regard. As a result of consultation, “extensive” changes were made to IR35. The central change, which the PCG had welcomed, was to shift the responsibility for the collection from the client to the contractor. This change had been made to minimise the effect on entrepreneurs.

The judge said that the second document contained the first reference to “the legitimate use of service companies”, The first document had no such reference. Plender said “these are press releases” and the Government had not undergone a Damascene conversion regarding entrepreneurs.

There then followed a discussion on timing. Plender would not finish by the end of Monday. All parties agreed that the case could continue on Tuesday on the assumption that it wouldn’t be finished on Monday.