IR35 survives legal challenge as Portillo pledges repeal

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IR35 tax case fails

By Jenny Parks

A CONTROVERSIAL tax regime aimed at ending the tax breaks enjoyed by individuals working on long-term contracts but operating through their own companies survived a major legal challenge today.

The tax, IR35, which came into force last year, reclassified people operating as companies as employees, who are liable to pay tax and national insurance.

The Inland Revenue believes that many one-person service companies are often set up in order to avoid taxes levied on normal companies.

But the 11,000-strong Professional Contractors Group, which brought the case, said the system was incompatible with European free trade laws and the Human Rights Act.

The PCG sought court orders effectively striking down the new measures as "liable to cause significant and damaging distortions of competition and movement of businesses and workers in relation to the UK knowledge-based contracting industries".

Critics of the regime claim that up to 90,000 small companies in "knowledge-based" fields such as IT, architecture and business and management consultancy could be affected.

There were other warnings that the tax could drive many IT contractors away from the City of London and to Frankfurt, where working tax conditions are more favourable.

The Conservatives dismissed IR35 as "another stealth tax" and have pledged to abolish it if they win the next election.

Shadow Chancellor Michael Portillo leapt on the ruling today. He said: "Parts of this ruling will come as a personal blow to Gordon Brown.

"In establishing the facts surrounding the case, the judge said that Gordon Brown’s new tax had created uncertainty for contractors who can’t know how much tax and national insurance they would have to pay on a particular contract."

He added: "Labour like talking about the new economy, but their stealth taxes have undermined it. Conservatives will support enterprise by repealing IR35 and instigating targeted anti-avoidance legislation."

The PCG today claimed the judge's ruling amounted to a victory for them in that it would force the Revenue to change its approach.

Mr Justice Burton said the Inland Revenue's approach to IR35 had been confusing and in some respects "inflexible" and he issued guidelines on how it should be enforced.

The judge accepted that some contractors might leave the country because of IR35, which might also deter others from coming here from abroad. He said it was "just arguable" that the regime would therefore restrict freedom of movement between European Union member states.

But the Government had shown that IR35 was justified for the purposes of combating tax avoidance and increasing, or avoiding the diminution of, tax revenue.

PCG Chairman, Gareth Williams, said the judgement amounted to a "damning critique" which would force the Inland Revenue to effectively "re-write the IR35 rulebook".

He added: "The Inland Revenue's definition of self-employment has been blown wide open. They will now have to look not only at a particular contract but the full circumstances, which includes the history of the particular contractor, to get the full picture as to whether they are genuinely in business.

"We think this is a significant step forward from our point of view."

The PCG was refused leave to appeal, but can still seek leave from the Court of Appeal.