The
long-awaited end result of the PCG's Judicial Review challenge to the IR35
legislation is finally with us.
The PCG had set out
to challenge the legislation implementing IR35, on the grounds that it offended
against both Human Rights and EC legislation.
They did not succeed in this challenge.
The Judge ruled that whilst there were certainly criticisms that could
properly be made, particularly about the approach hitherto taken by the Revenue
to applying it, the legislation itself offended neither against Human Rights
nor EC legislation, and emerged unscathed (though with a little
clarification); the Government was
entitled to legislate as it did, and in the way that it did. The end result is that IR35 remains with us.
That said, there are
many respects in which the judgment is in my view very helpful.
The judgment runs to
101 paragraphs, over 49 pages (the numeric references in this article are to
the paragraphs and not to the pages).
PCG members can get a copy from the PCG website http://www.pcgroup.org.uk./ . A copy can also be downloaded from http://www.egos.co.uk .
As with any reported
Court judgment, there are certain parts of it which actually represent interpretation
and rulings on the law - which may then represent binding legal authority
affecting other situations in the future where similar questions arise; and there are certain parts which do not. To understand the legal effects of the
judgment, it is important to understand the difference, and to recognise where
the dividing lines lie.
In this case, the
structure of the judgment is as follows:
1
1 to 19 deal with the
background to IR35 and to the case, the history of the legislation, and the
overall relative positions of the parties.
None of this creates new legal authority - it simply sets the scene for
understanding what follows. The only
comment I will make here is that it seems to me, from reading this section (and
indeed from the whole of the judgment)
that the Judge had reached a point where he had a good understanding of
the way in which the industry worked in practice, and of the ways in which it
was affected in practice by IR35.
2
In 20 to 37 the judge
set out what he saw as the 8 issues of fact which he felt he had to decide on,
before he could begin to consider applying the law to those facts. These too do not create legal authority - a
judge's finding as to what the facts in a case are never does. The facts he found and on which he based his
decision were as follows:
a. The intent of IR35 is to eliminate the avoidance of tax and
NIC on payments made by clients in respect of services provided by those who
are in fact equivalent to employees;
and that it has that effect on the companies to which it applies
b. Many service contractors will be required to pay more monies
and earlier to the Inland Revenue under IR35 than under the earlier
arrangements
c. At least two thirds of service contractors are in the [IT,
engineering, telecomms, and management and business consulting] sectors
d. Instead of certainty as to the impact of tax and NIC,
service contractors as a result of IR35 will have uncertainty as to whether
IR35 will or will not apply to a particular engagement
e. In respect of engagements or contracts sought, or services
to be provided, by service contractors, there is or would be competition with
companies who would be unaffected by IR35
f.
Companies unaffected
by IR35 will have greater flexibility to arrange their tax affairs, to allocate
tax between income and corporation tax, to defer tax liabilities, and to pay
lesser salaries to those providing the services and higher dividends to
shareholders, then service contractors
g. Some service contractors may not continue to operate in the
UK as a result of IR35, and some who have intended to come to the UK to set up
or work as service contractors may not now come to the UK
h. [the last 3 factors] may have a effect on trade between (EC)
member states
3
In 38 to 51 the judge
gives his reasoned decision as to why he considered IR35 did not offend Human
Rights legislation. It is in relation
to this issue that some of the most interesting comments are made:
a. In 48 the Judge clarifies certain aspects of the law, and
expresses criticisms of inconsistencies (i) between the Revenue's guidance and
the legislation and case law, (ii) between the Revenue's guidance and their own
practical application of that guidance, and (iii) even of the way in which
different Revenue inspectors reached opposite conclusions on the same facts. The importance of a 'sensitive and
cooperative approach' by tax inspectors, and of 'clear and helpful (Revenue)
guidance' was stressed - and the occasional (?) absence of either or both
noted.
b. In 49, the Judge expressed the view that the fact that the
Contractor might have to seek professional advice before reaching a decision on
his/her IR35 status in relation to a particular contract did not of itself
create sufficient uncertainty to offend this legislation
c. In 50, he made the point that whilst being treated as an
employee for tax purposes did not conclusively mean that an
individual was an employee for other purposes, the tax status might well be a
significant factor.
4
In 52 to 68 the judge
gives his reasoned decision as to why he considered IR35 did not offend EC
legislative prohibitions on distortion of competition by giving state aid
5
In 69 to 100 the
judge gives his reasoned decision as to why he considered (1) IR35 did not
offend EC legislative freedoms of establishment etc, and (2) was justified as a
purely taxation measure.
I have no doubt that
PCG will, in collaboration with its advisors, consider carefully whether or not
the decision discloses any proper grounds for appeal. However, even if an appeal is brought, the end results of that
are likely to be much further down the line, and Contractors must in the
meantime continue to manage their affairs on the basis that IR35 remains in
force. Life goes on.
The parts of the
judgment which are capable of amounting to binding legal authority, which other
Courts (unless they are higher Courts) will be bound to follow,
are the essential logical steps applying the law so as to lead from the decided
facts to the answers to the initial questions raised and which the Court was
asked to decide. Anything else the Judge
may have said along the way (other than those essential logical steps) is at
best what is called obiter dicta - and whilst it may be of persuasive
value, it is not binding legal authority.
The judgment
therefore makes clear that IR35 does not offend either Human Rights or EC
legislation, as had been claimed by the PCG - and precludes others from arguing
these points. To this extent it is
binding legal authority. The essential
steps in the reasoning towards those conclusions are, it seems to me, of little
more than academic interest, and do not otherwise affect the positions of
Contractors.
As to the comments
which the Judge did make in 48 to 50, whilst they are obiter dicta (as
explained above), they certainly have persuasive value, both to a Court or to
Tax Commissioners, and in argument with the Revenue themselves. In this section of the judgment, he also
refers to points which the Revenue's barrister himself accepted - a fact of
which it may certainly be helpful to remind the Revenue in the future, should
they seek to take a different view!
· In business on one's own account
The
Revenue's barrister accepted (p49(ii)) that whether the individual is 'in
business on his own account' is 'essential to (a) consideration'
(my emphasis) of whether or not the relationship is of the employment
type; the Judge said that 'notwithstanding'
the terms of the contract under examination itself, if a Contractor has
other engagements, for other clients, whether before or after (and particularly
during) the current engagement and is therefore 'carrying on business on his
own account, (that) is and must be a central consideration'
(again, my emphasis). Here, perhaps, is
the one area in the entire judgment where the actual law in relation to IR35
(as opposed to the Revenue's interpretation of it) is clarified.
The
legislation requires consideration of the IR35 position on an engagement by
engagement basis, and says (Schedule 12 Finance Act 2000):
'1(1)(c) the circumstances are such that, if the services were
provided under a contract directly between the client and the worker, the
worker would be regarded for income tax purposes as an employee of the client.'
'1(4) The circumstances referred to in
sub-paragraph (1)(c) include the terms on which the services are provided,
having regard to the terms of the contracts forming part of the arrangements
under which the services are provided.'
The significance is this: here we have
(a)
the Judge saying that the simple fact that a Contractor may,
by reference to other engagements, be 'carrying
on business on his own account, is and must be' not only another factor to take
into account, but ' a central consideration' - thus clearly
also falling within the 'circumstances' referred to in 1(1)(c) to be
considered, alongside the terms of the contracts themselves
(b)
the Revenue's own
barrister accepting that it is 'essential for the fact that the
Contractor is 'in business on his own account' to also be taken into
consideration
So, even where the contract terms themselves are
IR35-negative, a past, present, and future 'history' of engagements for other
clients - and clearly the more, the merrier - may yet save the day.
· Client-agency contract
Where
the tax inspector had access to the Client-agency contract, this should be
disclosed to the Contractor (48(iii))
· Standard Agency Contracts
Also
in 48(iii): the Revenue's 'inflexible'
position in connection with their own definition of an agency 'standard
contract' and its consequences was described as 'inappropriate'; the Judge made clear that it is still
necessary to consider all relevant factors. The Judge's comments suggest to me that his
view is that the IR35 status of each engagement should be considered on its own
merits, and that the Revenue's position on agency standard contracts is
unsupportable - and indeed, regular readers of this column will know that I
have always taken the view that the Revenue guidance in this respect was wholly
unsupported by any legal authority.
Thus,
in the light of what I can only view as scathing judicial criticism, it
may well be that the Revenue's published guidance on standard agency contracts
will henceforth be of little value.
· Mutuality of Obligation
The
Revenue's internal guidance notes telling their staff to disregard the
(admittedly complex) subject of mutuality of obligation (MOO) unless the
individual himself raises it were criticized by the Judge - who said 'it cannot
be right'. Case law makes clear that
another 'central piece of guidance' on the question of whether a
relationship can be of the employment type is whether the necessary 'irreducible
minimum of mutual obligation' is present; the Judge suggests that this principle must apply equally to the
hypothetical employment relationship at the root of IR35 as it does to conventional
employment. I have to say that it seems
to me that the Revenue's position on his point has hitherto been consistent
with saying 'we don't understand MOO - so we'll pretend it doesn't exist'. Complex and difficult to understand it may
be - and I confess it took me a while to do so - but its relevance as a
'central piece of guidance' has now been reinforced.
Here's
the point: if the Client's
obligations do not extend significantly beyond paying the agency or the
Contractor for the services that are actually provided, then there may well be
insufficient MOO for even the hypothetical relationship to be of the employment
type.
· Equipment
48(iv): The fact that the software specialist,
unlike the plumber, may not bring tools or equipment was noted; the Judge however reinforced the point that
'all the aspects of the relationship must be considered' (again,
my emphasis).
So a
reminder that whilst a requirement to provide equipment may be a positive
pointer, the absence of such a requirement is not necessarily negative.
· Substitution
· 48(iv): The Judge noted that concern
that once a computer Contractor had started work, his expertise may become such
that he may then be irreplaceable. The
Judge commented that (1) the ability to substitute is only one of the factors
to be taken into account; (2) this very
irreplaceability may itself be a 'strong counter-indicator against employment'; (3) the terms of the contract (certainly of
a contract to which the Contractor was not a party) will not necessarily be
conclusive; (4) the Revenue's guidance
on this issue was again criticized for its inflexibility; and (5) a requirement to obtain the Client's
permission before substituting neither 'necessarily negates the existence of a
right of substitution', nor points to employment.
So, (1) a
right of substitution may remain valid (ie as a way of disproving an
employment type relationship), even if the Client's consent is required; and (2) where substitution is impracticable
because of the fact that Contractor may have become irreplaceable in the
project, that irreplaceability may itself be almost as strong a
non-employment pointer as the right of substitution would have been.
· Employment rights
50: the Judge said that whilst being treated as
an employee for tax purposes did not conclusively mean that an
individual was an employee for other purposes, the tax status might well be a
significant factor when considering that question; so where an individual's contract falls within IR35, that simple
fact may at least go a significant way towards being able to claim
employment-related rights against the client and/or the agency.
Agencies
and Clients who are 'difficult' about agreeing to contract on IR35 friendly
terms which more accurately reflect the true nature of the relationship may
well be reminded of the additional exposure they are choosing to accept. They cannot expect both to have their cake
and to eat it. And doubtless in
suitable cases, claims (including eg unfair dismissal) will be brought under employment
legislation.
· Lack of review and grievance procedures
Not an issue in the PCG case, but a
reminder of something that emerged from another recent case (Montgomery v
Underwood 9th March 2001) - the lack of review and grievance procedures can also
be a significant non-employment pointer.
Overall: I began writing this article feeling
negative. However, the more I examined
the Judge's comments in these particular areas, the more positive I began to
feel. True, this was not a test case on
the question of whether or not a particular relationship fell within IR35.
However, factors relevant to that question and to the interpretation of the
legislation and case law have emerged, which (whilst they may not have the
status of binding legal authority in these areas) are, without exception, very
helpful, and we may certainly expect the Judge's comments on these points to
have strong persuasive value to Courts and to Tax Commissioners deciding such
cases in the future. And also to bring
about some moderation to the hitherto excessive and arbitrary yardsticks
applied by the Revenue.
It remains
fundamentally important that Contractors should:
1
carefully consider
the potential impact of IR35 to each contract, before they enter it; and ensure that contract terms are where
necessary modified so as to more accurately reflect the reality
2
as each assignment
progresses, keep the IR35-relevant aspects under ongoing review (see my article
'Staying Outside' in Freelance Informer 9th February 2001). If the opportunity for other concurrent
engagements arises, it would be particularly helpful to take advantage of
these.
3
before 19th
April in each year, carefully consider in relation to all contract income
during the tax year just ended whether or not IR35 applies, taking professional
advice where necessary, and be prepared at a later date to justify the
decisions arrived at.
Contractors who have
had negative IR35 advice in relation to contracts during the past tax year may
wish to reassess their position, in the light of the Judge's comments in this
case.
6th
April 2001
I'd really appreciate your feedback on this FAQ - so mail me and tell me what you think of it, if it's been useful to you, or let me know of any specific problem you have where I may be able to help.
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