Case No: C/200L’0895
Neutral Citation No.[2001] EWCA Civ 1945
IN TUE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CiVIL DIVISR~)
ON APPEAL FROM THE HIGH COURT OF JUSTiCE
QUEEN’S BENCH DiVISiON ADMiNISTRATIVE COURT
(BURTON I)
~py~ouns of Jo sfl cc
Strand. London, WC2A2LL
2 I December 2001
B e fo r e:
LORD JUSTICE AULD
LORD JUSTICE ROBERT WALKER
and
LORD JUSTICE DYSON
PROFESSIONAL CONTRACTORS’ GROUP AND ORS ~ppeIIants
- and -
COMMISSIONERS OF fiNLAND REVENUE Respondents
Mr Gerald Darling QC and Miss Kelyn Bacon (instructed by Bond Pearce for the
appellants)
Dr Richard Plender QC and Mr Stephen Morris (instructed by the Solicitor of Inland
Revenue for thc respondents)
JUDGMENT : APPROVED BY THE COURT FOR HANDING DOWN (SUBJECT TO EDITORIAL
CORRECTIONS)
Judgment : Anproved by the court for handinE dowis (subject to Professional Contractors’ Group and em — v — Commissioners of
editorial correctioias~ Inland Revenue
Lord Justice Robert Walker:
Introduction
The distinction between a contract of service and a contract for services (in other words, the difference between the position of an employee and that of a self-employed contractor) has important implications in several different fields of law. The law student first meets the distinction in studying vicarious liability in tort. This appeal is concerned with the tax implications of the distinction, and in particular with the lawfulness under Community law of legislation which the Government announced in 1999, and which Parliament has since enacted, to counter tax avoidance by individua]s by the use of what are loosely called service companies.
2. Employees are liable to income tax on their earnings under Schedule E, and they and their employers have to pay National Insurance contributions (°NTC”) on the Class 1 (employed) basis. Taxation under Schedule E has several well-known disadvantages as compared with the taxation (under Schedule D Case 1 or II) of those who carry on a business or profession. These disadvantages include immediate taxation at source under PAYE, and a much more restricted scope for the deduction of expenses. Moreover if an individual employee of a company became the controlling shareholder of a service company which (as an independent contractor) provided his services to the former employer as a client, he could achieve a double advantage. The service company would pay a low rate of corporation tax on its profits as assessed under Schedule D, and the individual could decide how much of the company’s revenue should he distributed either as remuneration or by way of dividend (free of NIC) to himself and other members of his family who might be employed by or shareholders in the service company.
3. On 9 March 1999, which was Budget Day, the Inland Revenue published (among numerous other press releases) one designated lit 35. which has achieved unusual notoriety. The press release began with what the trial judge described as unduly colourful language:
“The Chancellor announced today that changes are to be introduced to counter avoidance in the area of personal service provision. This move underlines the Government’s commitment to achieving a tax system under which everyone pays their fair share.
There has for some time been general concern about the hiring of individuals through their own service companies so that they can exploit the fiscal advantages offered by a corporate structure. It is possible for someone to leave work as an employee on a Friday, only to return the following Monday to do exactly the same job as an indirectly engaged ‘consultant’ paying substantially reduced tax and national insurance.
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The Government is going to bring forward legislation to tackle this sort of avoidance. The Inland Revenue will be discussing the practical application of new legislation with interested parties and will work with representative bodies on the production of guidance. The new rules will take effect from April 2000.”
4. The expression 1K 35 has come to be used, and has been used in this litigation, as a shorthand identification for the measures which have since been enacted (although only after substantial modification of the original proposals). They consist of section 60 of, and Schedule 12 to, the Finance Act 2000 (“the 2000 Act”) and (in relation to NIC) sections 75 and 76 of the Welfare Reform and Pensions Act 1 999 (“the 1999 Act”) and the Social Security Contributions (Intermediaries) Regulations 2000 (“the Regulations”).
5. Tn June 2000 three claimants (the appellants in this court) sought permission to apply for judicial review of the lawfulness of JR 35. They are (1) Professional Contractors’ Group Ltd (“PCG”) a body formed to represent the interests of service companies, (2) Mr Ruud Van Zundert, a Dutch national resident in the United Kingdom who has since 1997 operated a service company in the information technology (“IT”) field, and (3) Square Mile Projects Ltd, an English service company. PCG represents about 11,000 members and was originally formed for the specific purpose of opposing 1K 35, although it now has wider purposes. Its members are predominantly in what has been called the ‘knowledge-based’ sector, an imprecise but useful expression which covers IT, specialised engineering skills, telecommunications and management and business consultancy.
6, On 10 October 2000 Gibbs J gave the applicants permission to apply for judicial review. The principal relief sought by the application as reamended was a declaration that the JR 35 legislation is
incompatible with European Community law as being:
(a) an unnotified State aid contrary to Articles 87 and 88
EC in respect of the following areas of business activity:
(i) Information Technology
(ii) Engineering (including oil and gas)
(iii) Telecommunications
(iv) Management and Business Consulting;
(b) an unlawful hindrance to free movement of workers,
freedom of establishment and freedom to provide
services, contrary to Articles 39, 43 and 49 respectively;
and cannot lawfully be applied.”
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7. Both sides put in a volume of written evidence and frill arid detailed skeleton arguments. After a hearing which extended over four days Burton J on 2 April 2001 dismissed the application with costs and refused permission to appeal. Permission to appeal was granted on paper by Laws Li on 16 May 2001.
8. Before looking at the judge’s reasoning and the grounds of appeal I should say more about the genesis, purpose and legal and economic effects of the JR 35 legislation. The judge made eight findings of fact which neither side has squarely challenged, although there has been a good deal of argument about their implications and the legal inferences to be drawn from them.
The ITt 35 legislation
9. As a matter of parliamentary procedure the enactment of the 1K 35 proposals had to be split between the 1999 Act (which received the Royal Assent on 11 November 1999) and the Regulations made under the 1999 Act, on the one hand, and the 2000 Act, on the other hand. But all the measures had the same objectives. They came into force or operated from the same day, 6 April 2000, and the conditions for their operation were expressed in the same language.
10. Between the publication of TR 35 on 9 March 1999 and the operative date of 6 April 2000 there was extensive consultation which led to some changes in the proposals, announced by the Paymaster General in a press release issued on 23 September 1999. There were also two Regulatory Impact Assessment exercises, the results of which were published on 21 May and 8 October 1999. The main changes resulting from the consultation process were the abandonment of a new test for distinguishing between employment and self-employment, and the placing of responsibility for compliance with the new system on the intermediary (rather than the client). These changes are reflected in the summary which follows,
11. The basic conditions for the application of the new regime are set out in section
4A of the Social Security Contributions and Benefits Act 1992 (“the 1992
Act”) as inserted by section 75 of the 1999 Act, in paragraph 6(1) of the
Regulations and in paragraph 1(1) of Schedule 12 to the 2000 Act. These are
in almost identical terms and it is sufficient to set out the provision in the 2000
Act:
“This Schedule applies where —
(a) an individual (“the worker”) personally performs, or is under an obligation personally to perform, services for the purposes of a business carried on by another person (“the client”),
(b) the services are provided not under a contract directly between the client and the worker but under
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arrangements involving a third party (“the
intermediary”), and
(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.”
12. In the provision set out above sub-paragraph (c) is of great importance, and it needs to be stressed because some of the written evidence of Mr David Gareth Williams, the Chairman of PCG, tends to overlook its importance. The legislation does not strike at every self-employed individual who chooses to offer his services through a corporate vehicle, indeed it does not apply to such an individual at all, unless his self-employed status is near the borderline and so open to question or debate. The whole of the JR 35 regime is restricted to a situation in which the worker, if directly contracted by and to the client “would be regarded for income tax purposes as an employee of the client”. That question has to be determined on the ordinary principles established by case law (see for instance two cases mentioned in the written evidence, Market Investigations v Minister of Social Security [1969] 2 QB 173 and Hall (Inspector of Tares~) i’ Lorimer [1994] 1 WLR 209).
13. The following summary adopts the terminology of Schedule 12, paragraph 1(1) of the 2000 Act in referring to “the worker”, “the client” and “the intermediary”, and it assumes that the intermediary is a trading company established and resident in the United Kingdom. But it is important to note that the intermediary need not be a company. It could be a partnership or even another individual, and the [K 35 regime is concerned primarily with the taxation of the worker, not the intermediary (although it includes provisions to avoid double taxation of the intermediary). The tax avoidance at which it is aimed is avoidance by the individual worker, not by the intermediary.
14. Where the intermediary is a company the JR 35 regime applies (Schedule 12, paragraphs 2 and 3) only if the worker has a material interest in the company (in broad terms at least a five per cent interest, aggregating the interests of the worker himself and any associates of his) or receives what the judge called a ‘traceable dividend’. The application of the regime is triggered by the worker receiving, or becoming entitled to receive, directly or indirectly, a payment or benefit not chargeable to tax under Schedule E. The consequence of its application is that the worker is treated as receiving from the intermediary a “deemed Schedule E payment”. This is treated as made at the end of the tax year. Its amount (Schedule 12, paragraph 7) is determined by a fairly complicated code but the general effect is to tax the worker under Schedule E on the frill amount, less the deductions mentioned below, of all payments and other benefits received by the intermediary during the tax year in respect of the worker’s “relevant engagements” (Schedule 12, paragraph 2(3)). The only permissible deductions are 5 per cent of the gross amount and any actual expenses which would be deductible under the restrictive test applied for Schedule E purposes. There are special provisions for “multiple
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intermediaries” and for avoidance of double taxation (Schedule 12, paragraphs
13-17).
15. The Regulations produce the same effects for the purposes of Class 1 NIC. The key provision is in regulation 6, paragraph (1) of which is a close parallel to Schedule 12, paragraph 1(1) to the 2000 Act. Paragraph (3) of regulation 6 provides,
“Where these Regulations apply
(a) the worker is treated, for the purposes of Parts I to V of the [1992] Act, and in relation to the amount deriving from relevant payments and relevant benefits that is calculated in accordance with regulation 7 (“the worker’s attributable earnings”), as employed in employed earner’s employment by the intermediary, and
(b) the intermediary, whether or not he fulfils the conditions prescribed under section 1 (6)(a) of the [1992] Act for secondary contributors, is treated for those purposes as the secondary contributor in respect of the worker’s attributable earnings,
and Parts Ito V of that Act have effect accordingly.”
The judge’s findings of fact
16. The aims and likely effects of the JR 35 legislation were the subject of a good deal of written evidence placed before the judge. Mr Williams put in two witness statements, the first very lengthy (it has over 300 paragraphs) and accompanied by numerous exhibits, including two reports made in January 2001 by Frontier Economics. There were several other witness statements on behalf of the claimants including one from Doctor Leslie Willcocks of Templeton College, Oxford, exhibiting a report dated 3 May 2000 which he had prepared. The evidence on behalf of the Inland Revenue consisted largely of a witness statement of Miss Sarah Walker, who had since June 1999 been Assistant Director of Personal Tax at the Inland Revenue with special responsibility for JR 35, and (exhibited to a witness statement of Mr Paul Lanser) a report prepared in Febmary 2001 by the Inland Revenue’s Analysis and Research Department in response to the reports from Frontier Economics.
17. It is not necessary to summarise all this evidence. Its general effect is best addressed by reference to the judge’s findings of fact. Mr Gerald Barling QC and Miss Kelyn Bacon (for the claimants) have claimed in their skeleton argument that the judge found in their favour on almost all factual issues, and rejected their case on what they described as narrow points of law. Counsel for
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the Inland Revenue, Dr Richard Plender QC and Mr Stephen Morris, have put the matter rather differently. They have pointed out that the judge was from the outset sceptical as to whether there were major differences between the parties on factual issues (as opposed to differences of approach and mindset). Tn the course of argument the judge put forward eight provisional conclusions about which he said this:
1 put them to both Counsel, and they were amended to some extent in the course of argument. Neither side of course agreed all of them, and they are my conclusions: however equally neither side was able with any great vigour to contest that they were conclusions open to me upon the evidence.”
The judge then set out his conclusions, with some short comments. I repeat his conclusions verbatim with some reference to his comments and a few further comments of my own.
18. The first conclusion was that the intention of the JR 35 measures 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 it has that effect on the companies to which it applies.”
The judge added some comments about tax evasion, tax avoidance and tax mitigation, implying that the individuals referred to (echoing the original press release) as ‘Friday to Mondays’ might be regarded as tax evaders but that the aim of the proposals was not limited to such blatant cases, I do not think it helpful to explore the obscure boundary between avoidance and mitigation. The judge referred to the Revenue’s suggested figure of £3 50m a year as to the overall tax loss from the increased use of service companies (estimated by the Revenue as an increase from 30,000 in 1981 to 90,000 in 1999). He said (paragraph 23),
“Whatever the precise figures are, the reality is that if the service company is indeed substantially or wholly captured by IR 35, then it will pay more tax. Hence the Revenue’s desire for change and the Claimants’ desire to challenge it.”
19. That led inevitably to the judge’s second conclusion, that
“Many service contractors will be required to pay more monies and earlier to the Inland Revenue under IR 35 than under the previous arrangements.”
20. The judge rightly emphasised the point, which I have already noted, that the service contractors adversely affected would be those who provided the equivalent of employees’ services (and not the services of self-employed
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independent contractors). The extra tax paid by the companies would be Schedule F tax and NIC paid on account of the workers who were equivalent to employees.
The judge’s third conclusion was that at least two-thirds of service contractors are in the sector referred to in the amended relief (that is, IT and the three other components of the ‘knowledge-based’ sector mentioned in paragraph 6 above). The judge noted that it was not contended that the legislation was targeted against this (or any) particular sector, It has also affected many other workers in fields as diverse as locum doctors, constmction workers and pizza deliverymen. It is tme that all the examples in official guidance published in Febmary 2000 were in the IT field but that was explained by PCG and others having complained to the Revenue about the absence of case-law as to the boundary between employed and self-employed status in that field.
21. The fourth conclusion was as follows:
“Instead of certainty as to the impact of tax and N1C, service contractors as a result of lIft 35 have uncertainty as to whether IR 35 will or will not apply to a particular engagement.”
The judge commented that this was very much a part of the claimants’ complaint, and that the Revenue could not really deny it. Service companies did until 6 April 2000 shield those who used them from having to face up to the often difficult question of whether they would, on the terms and in the context of a particular engagement, be on the employed or the self-employed side of an elusive dividing-line. The immunity conferred by the service company had now gone, and the service contractor had to decide the question for himself~ with such help as the Revenue could provide either in the way of informal advice or (once an engagement had been entered into) a formal ruling in the course of the tax year. Mr Barling made the valid point that a taxpayer’s difficulties may be increased by the question arising at one or even two removes (that is through separate contractual links between client and agency, agency and service company, and service company and individual; the latter difficulty may be self-inflicted but the former is not if the client recruits contract services only through an agency).
22. The judge’s fifth conclusion was that in respect of engagements or contracts sought, or services to be provided, by service contractors, there is or would be competition with companies which would be unaffected by JR 35. In view of the vast field of economic activity to which JR 35 relates, this conclusion was probably inevitable, despite Miss Walker’s evidence (in relation to the IT sector) that the services offered by large IT companies (such as EDS, Andersen Consulting, Cap Gemini Ernst and Young, Logica and Sema) are fundamentally different in scale and in nature from those likely to be offered by small service
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contractors. The main report from Frontier Economics indicated that the pattern is quite complex and that some small service companies are in direct competition with the largest companies.
23. The judge recorded the Revenue’s submission that the relevant comparison, in terms of competition, was not between a large company and a small service contractor but between a genuine employee and a service contractor:
“The Revenue submits that the real competition was between those who were doing the work at the clients’ premises, sometimes in the same team: on the one hand employees, whether of the client or of the service provider, and on the other the service contractor. That is the competition that Dr Plender QC submitted to be the relevant one.”
24. The sixth conclusion was as follows:
“Companies unaffected by TR 35 would have greater flexibility to arrange their tax affairs, to allocate tax between income tax and corporation tax, to defer tax liabilities, and to pay lesser salaries to those providing the services and higher dividends to shareholders, than service contractors.”
This is an important building-block in the claimants’ case on state aid. The judge said that he was entitled to make this finding on the evidence, but noted three points made by the Revenue. First, the companies alleged to enjoy this greater flexibility would already be deducting income tax and NIC under PAYE in respect of the whole of their employees’ remuneration. Secondly (and following from the first point) IR 35 was restoring a level playing field. Thirdly, service contractors would continue to enjoy the same flexibility so far as they were engaged in genuine ‘independent contractor’ work.
25 The seventh conclusion was another important building-block in the claimants’ case on Community law, although the judge emphasised that it was a limited finding based on expert evidence which had not been tested by cross-examination:
“Some service contractors nay not continue to operate in the United Kingdom as a result of lIP. 35, and some who have intended to come to the United Kingdom to set up or work as service contractors may not now come to the United Kingdom.”
Finally the judge reached his eighth, ‘very limited’ conclusion, that his fifth, sixth and seventh conclusions might have an effect on trade between Member States.
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State aid and general measures
26. As well as issues of state aid and freedom of movement (on which he was not asked to make a reference to the Court of Justice under Article 234 because of the disputed issues of fact), the judge also had to consider arguments based on Article 1 of the First Protocol to the European Convention on Human Rights. He rejected those arguments and they have not been pursued on appeal. I can therefore proceed at once to the issue of state aid, considered at paragraphs 52 to 68 of the judge’s judgment.
27. Article 87 (formerly 92) begins with paragraph (1) in the following terms:
“Save as otherwise provided in this Treaty, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, insofar as it affects trade between Member States, be incompatible with the common market.”
Paragraphs (2) and (3) then instance types of aid which are compatible, or may be considered compatible, with the common market. Article 88 (formerly 93) relates to the review of aid by the Commission and the notification of aid proposals to the Commission. Neither side has placed much reliance on these provisions in this court and 1 need not make any further reference to them.
28. The judge identified six elements which are characteristic of the type of aid which may contravene Article 87. In view of the judge’s unchallenged findings only the first and third of these elements are directly in issue (and they are, as the judge said, intertwined). But for the sake of completeness 1 will set out the judge’s list in frill:
“(1) An ‘aid’ in the sense of a benefit or advantage which
(2) is granted by the state or through state resources,
(3) favours certain undertakings over others (the ‘selectivity’ principle)
(4) distorts or threatens to distort competition,
(5) is capable of affecting trade between Member States and
(6) has not been notified to the Commission.”
All these points go to make up what this court (in Queen (Lunn Poly,) v Commissioners of Customs & Excise fl999] EuLR 653, 662) called a ‘global question’. It is a question for the national court.
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29. In this case the two contentious elements of aid and selectivity are particularly closely intertwined because at first sight IR 35 is not providing an aid or benefit to anyone. At first sight it is imposing a detriment on service providers in order to prevent tax avoidance and restore fiscal parity. It is very well established that state aid may consist of a tax concession or relief (rather than a direct subsidy): see the early Case 30/59 Steenkolenm;jnen v High Authority [1961] ECR 1, 19. But the detriment imposed by IR 35 can constitute aid only if it is to be seen as favouring other competing undertakings, in breach of the selectivity principle.
30. The principle of selectivity is of fundamental importance in this case, as both sides agree, because it is the primary means of differentiating between objectionable state aid (which favours one or more identifiable undertakings nr sectors of the economy) and general measures which do not have that effect. A recent example is the judgment of the Court of First Instance in Case T-55/99 CEJM v Commission (judgment 29 September 2000). In 1994 the Spanish Government had introduced a ‘plan renove industrial’ (“PM”) under which small and medium-sized enterprises and regional public bodies (but not large commercial enterprises) could obtain loans on favourable terms in order to purchase commercial vehicles, so long as an old vehicle was withdrawn from service on each purchase of a new vehicle.
31 Tn rejecting the argument that the PP.1 should be regarded as a general measure the Court of First Instance said in paragraphs 52-54 (with some references inserted):
“Measures entailing differences in treatment between categories of undertakings or between sectors of activity may be justified by the nature or structure of the system of which they form part (see Case 173/73 italy v Commission, [1974] ECR 709, paragraph 33 and Case C-75/97 Belgium v Commission [1999] ECR 1—3671, paragraphs 33 and 34; see also Case T-67/94 LacThroke Racing v Commission [1998] ECR il-I, paragraph 76).
In the present case, however, the sole circumstance, put forward by the applicant, that the PP.1 was aimed at modernising the commercial vehicles on the road in Spain in the interest of environmental protection and improving road safety cannot suffice for a finding that the PRI constituted a system or a general measure in itself or formed part of any ‘Spanish system’, which, moreover, the applicant does not even identify. If that argument were followed, it would be sufficient for the public authorities to invoke the legitimacy of the objectives which the adoption of an aid measure sought to attain for that measure to be regarded as a general measure outside the scope of Article 92(1) of the Treaty. That provision does not distinguish between measures of State intervention by reference to their causes or aims but defines them in relation to their effects (Case
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C-56/93 Belgium v Commission [1996] ECR 1-723, paragraph 79, Case C-24l/94 France v Commission, [1996] ECR 1-4551, paragraph 20, and Case C-75/97 Belgium v Commission, [1999] ECR 1-367 1, paragraph 25).
Furthermore, as the Commission points out in its written submissions, the applicant does not explain how the exception for large undertakings was justified by the nature or structure of the alleged system to which the PRI corresponded or of which it formed part. In any event, the objectives which the applicant claims the Spanish authorities sought to attain by means of the PP.1 do not justiflj such an exception, since the age of commercial vehicles used by large enterprises also presents risks in terms of environmental protection and road safety.”
32. An element of official discretion as to the recipient of special treatment is also inconsistent with the character of a general measure: see Case C-200/97 Ecotrade v Alliforni e Ferriere di Servola (Court of Justice 1 December 1998), a case on the so-called Prodi law for the extraordinary administration of large insolvent companies. The Court of Justice said in paragraph 40:
“In those circumstances, having regard to the class of undertakings covered by the legislation in issue and the scope of the discretion enjoyed by the minister when authorising, in particular, an insolvent undertaking under special administration to continue trading, that legislation meets the condition that it should relate to a specific undertaking, which is one of the defining features of State aid (see, to that effect, Case C-241/94 France v Commission [1996] ECR 1-4551, paragraphs 23 and 24).”
33. Another instructive case is Case C-75/97 Belgium v Commission {1999] ECR
1-3671. In 1981 the Belgian Government had introduced a social security system (Maribel I) under which lower rates of contributions were paid by manual workers. The Commission did not object to this scheme because it regarded it as ‘general and automatic’. But in 1993 and 1994 the Belgian Government introduced the ‘Maribel bis’ and ‘Maribel ter’ schemes which further reduced contributions for workers in various sectors most exposed to international competition. These new measures had a selective effect in favouring large but identifiable sectors of industry, and so they amounted to state aid. Their social character was not sufficient to exclude them (see paragraphs 24-34 of the judgment).
34. The judge referred to these and other authorities as examples of what he called ‘positive aid’ and then said that a more difficult question arose in relation to what he called ‘negative aid’. This expression seems to have been coined by the judge. Although it is a vivid expression I respectfully doubt whether it is useful. For the state to confer a benefit on an identifiable group of undertakings is at first sight state aid. For the state to impose a detriment (for
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in stance, a ‘windfall’ tax on privatised utilities) can be state aid only if it can be seen as occasioning a corresponding advantage to identifiable business competitors of those who have to bear the detriment (see Miss Bacon’s article State Aids and General Measures (1997) 17 YEL 269, 318). The expression ‘negative aid’ may be unhelpful by appearing to assume what has to be proved.
35. The judge then referred to two Commission notices, UJ 1995 C 3 12/07 (on cooperation between national courts and the Commission on state ald) and UT 1998 C 3 84/03 (on the application of the state aid rules to measures relating to direct business taxation). The latter notice contains a section headed ‘Distinction between state aid and general measures’ which merits full quotation:
“13. Tax measures which are open to all economic agents operating within a Member State are in principle general measures. They must be effectively open to all firms on an equal access basis, and they may not de facto be reduced in scope through, for example, the discretionary power of the State to grant them or through other factors that restrict their practical effect. However, this condition does not restrict the power of Member States to decide on the economic policy which they consider most appropriate and, in particular, to spread the tax burden as they see fit across the different factors of production. Provided that they apply without distinction to all firms and to the production of all goods, the following measures do not constitute State aid:
- tax measures of a purely technical nature (for example, setting the rate of taxation, depreciation rules and rules on loss carry-overs; provisions to prevent double taxation or tax avoidance)
- measures pursuing general economic policy objectives through a reduction of the tax burden related to certain production costs (research and development (R&D), the environment, training, employment).
14. The fact that some firms or some sectors benefit more than others from some of these tax measures does not necessarily mean that they are caught by the competition rules governing State aid. Thus, measures designed to reduce the taxation of labour for all firms have a relatively greater effect on labour-intensive industries than on capital-intensive industries, without necessarily constituting State aid. Similarly, tax incentives for environmental, R&D or training investment favour only the firms which undertake such investment, but again do not necessarily constitute State aid.
1 5. In a judgment delivered in I 974 [Case 173/73 Italy v Commission [1974] ECR 7091, the Court of Justice held that
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any measure intended partially or wholly to exempt firms in a particular sector from the charges arising from the normal application of the general system ‘without there being any justification for this exemption on the basis of the nature or general scheme of this system’ constituted State ald. The judgment also states that ‘Article [87] does not distinguish between the measures of State intervention concerned by reference to their causes or aims but defines them in relation to their effects, The judgment also points out that the fact that the measure brings charges in the relevant sector more into line with those of its competitors in other Member States does not alter the fact that it is aid. Such divergences between tax systems, which, as pointed out above, are covered by Articles [94] to [97], cannot be corrected by unilateral measures that target the firms which are most affected by the disparities between tax systems.
16. The main criterion in applying Article [87] (1) to a tax measure is therefore that the measure provides in favour of certain undertakings in the Member State an exception to the application of the tax system. The common system applicable should thus first be determined. It must then be examined whether the exception to the system or differentiations within that system are justified ‘by the nature or general scheme’ of the tax system, that is to say, whether they derive directly from the basic or guiding principles of the tax system in the Member State concerned. If this is not the case, then State aid is involved.”
36. Mr Barling submitted (although the point was, I think, developed only in the course of his reply) that IR 35 is on its face selective because paragraph I of Schedule 12 to the 2UUU Act (and the corresponding provisions in the Regulations) do relate to an identifiable sector of the economy, that is small worker-owned companies which provide the personal services of workers to other businesses. A sector may be very broadly defined but still fall within the principle of selectivity: see the Commission’s proposal for appropriate measures in respect of Irish corporation tax UT 1 998C 395/19 (preferential rate of corporation tax for the whole manufacturing sector).
37. This submission calls for serious consideration but I do not accept it. I think Dr Plender had already answered it in anticipation by referring to the decision of the Commission on the Danish tax relief notified to the Commission in 1999 under Article 88(3), and cleared as not amounting to state aid. The tax relieI~ intended to attract highly-qualified experts to Denmark, took the form of taxation at a gross, fixed rate on foreign experts employed for between six months and three years in a Danish business or research organisation. The Commission’s decision stated,
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“The Act itself is not seen as benefiting certain businesses or certain activities, since it applies to experts in all areas and its area of application is not restricted to regions or sectors. The application is assessed on the basis of objectives and non-discriminating criteria without tax authorities being given discriminating powers.
The information from the Danish authorities shows that the scheme is used in more than 150 sectors, by small and medium-sized businesses and by large businesses in the private and public sectors. The reason for the concentration in the office equipment, software and fuel sectors is that salaries are especially high in these sectors. In the correspondence from the Commission regarding the control of state aid and the reduction in employer costs, the Commission writes: “Salaries in the chemical, oil refining, office machinery and IT industries are on average twice as high as salaries in the textile industry and about three times higher than salaries in the footwear and clothing industry and hotel and catering industry. Schemes aimed at the low-paid will therefore have a much greater effect in the latter sectors than in those first mentioned without actually constituting state aid.” In contrast, schemes aimed at the high-paid will have a considerably greater effect in sectors with high salaries but this still does not constitute state aid.”
38, Dr Plender cited that decision as showing that a mere propensity for a measure to favour one sector rather than another cannot amount to selectivity. I agree. The lack of uniformity in the practical effects of the Danish measure (as between different sectors) arose not from any selectivity but simply because that is ‘how things are’. The position is the same with IR 35, except that there the claimants face the fbrther difficulty of a measure which has a propensity to disadvantage more workers in some sectors than in others.
Lunu Poly and Ferring
39. The judge rightly devoted some time to considering the decision of this court in Lunn l-°oly [1999] EuLR 653. It is an important decision which calls for examination in some detail. It was a direct challenge to the validity of domestic primary legislation, that is section 21 of the Finance Act 1997, which amended section 51 of the Finance Act 1994 by introducing new differential rates of insurance premiums tax (IPT). The original uniform rate of 2.5 per cent was replaced by a standard rate of 4 per cent and a higher rate of 17.5 per cent, the higher rate being charged on premiums for travel insurance charged by tour operators or travel agents. The lower rate was payable on travel insurance arranged by anyone else. Lunn Poly (a large travel agent and part of the Thomson Group, which included tour operators) obtained a declaration from the Divisional Court that the new differential rates were unlawful state aid contrary to Article 87 (then Article 92).
Ju4gment : Approved by the court mr handling down (subject to Profeonional contractorn’ Group and nun v — comminninern of
editorial corrections) Inland Revenue
40, The fiscal and economic background to the case was that insurance premiums were exempt from value added tax (under Article I 3B(a) of the Sixth Directive, 77/388/EEC) but Member States were free (under Article 33) to impose tax on insurance contracts, so long as the tax was not a turnover tax. The standard rate of value added tax in the United Kingdom at that time was the current rate of 17.5 per cent. The economic background was that there was fierce competition between tour operators, resulting in low margins on package holidays for both operators and agents. However the convenience of being able to arrange and pay for travel insurance at the same time enabled them to obtain a higher margin on related travel insurance. This point was developed in affidavit evidence on behalf of the Commissioners, who attacked it as a form of tax avoidance which justified the new differential rates in order to correct the anomaly.
41. The Court of Appeal followed the Divisional Court in rejecting this analysis as not being established on the evidence. Lord Woolf said that the approach of the Commissioners’ deponent was ‘logically indefensible’. He continued (at p.664):
“All he has succeeded in demonstrating is that the demand for travel insurance is highly price inelastic. This enables travel agents, in particular, to charge their customers a premium which they should find uncompetitive. They do not do so because they are guided by factors other than price when making their purchasing decision on insurance. Having come to this conclusion, there is no loss of tax which provides an objective justification for the discriminatory rate of tax imposed on tour operators and agents providing insurance. The higher rate contrary to the stand adopted by the commissioners cannot be objective1y/ust~ied as an anti-tax avoidance measure.”
42. Once the court had reached that conclusion the differential rates were inevitably a form of state aid, since it was obvious that the imposition of the higher rates of IPT on travel agents and tour operators conf