Government wins IR35 high court battle as judge urges reform

One-man bands lose IR35 tax fight

Phillip Inman

Guardian

Tuesday April 3, 2001

The government yesterday won a high court battle with computer and engineering contractors who claimed that tax rules known as IR35 undermined their businesses and forced them to work abroad.

The inland revenue said that in the new tax year starting on Thursday it would press ahead with implementation of the rules, designed to clamp down on one-person companies avoiding tax and national insurance contributions.

Mr Justice Burton said the contractors had failed to argue that ministers singled them out for special tax treatment in contravention of European free trade laws and the Human Rights Act.

The judge ruled that ending what he saw as a tax advantage in the UK was not an infringement of human rights or a limit on the transfer of business from one European country to another.

He added that the case highlighted many flaws in the tax rules, which he had been confusing and in some respects "inflexible". He said reforms to the IR35 rules were necessary and issued guidance on how they might be applied.

The 11,000-strong Professional Contractors' Group, which brought the legal challenge, claimed that the judge's comments gave them some hope that the inland revenue would consider a review of the tax rules.

"The judgment contains a detailed and what we would say is a damning critique of IR35, and the judge has issued binding guidance which effectively rewrites the IR35 rulebook," said Gareth Williams, the chairman.

The inland revenue said it would examine the judgment and consider all the points made by the judge. A spokesman said the agency's intention was to press ahead with the new regime in the coming tax year.

"The government is glad that the court has confirmed that the IR35 legislation is not contrary to EU and human rights law and the uncertainty caused by the case can now come to an end. The legislation was necessary to assure fair taxation of all workers whether or not they use a limited company to arrange their contracts."

The revenue reviewed the tax situation of one-person companies shortly after the election of the Labour government in 1997. It concluded that thousands of contractors in industries such as IT and engineering had been advised by their accountants to switch from full time employment to limited company status to depress their tax bills.

Contractors would pay themselves a salary equivalent to their personal allowance, a salary to their spouse and the remainder in dividends, allowing them to avoid paying national insurance contributions. The revenue argued that in many cases contractors worked for one employer and should be on the payroll.

The PCG denied the practice was widespread among the estimated 100,000 contractors operating in the UK and claimed the revenue's response was heavy handed. It argued that thousands of key workers had been driven abroad by the prospect of paying tax at a rate of 50%.

Mr Justice Burton agreed that the government appeared to have assumed, "without any adequate research," that all small service companies fell within the category of disguised employment. Evidence showed that by no means all contractors fell into that category.