Up to 90,000 could be forced out of business or the country, court told

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IT specialists, accountants, doctors and actors will be affected by the result of litigation seeking to define long-term contractors and employees. Ian Cowie and Nina Montagu-Smith report

THE Inland Revenue is attempting to tighten its grasp on our pay packets by an obscure rule change which is being contested in the High Court.

The devil's in the detail: the line between employed and self-employed is very fine.

Hundreds of thousands of people who are regarded as self-employed may lose the right to receive payment before tax is deducted from what they earn - and be forced to pay higher National Insurance Contributions. They would also have to satisfy tougher tests for allowable expenses if the taxman triumphs.

Fortunately, they can take steps now to protect their position, whatever the court decides in the case of the Professional Contractors' Group versus the Inland Revenue. Our table Employed or self-employed? sets out the key tests you must satisfy to get paid before the Revenue grabs its share.

The taxmen claim they simply want a "level playing field" which is fair to all. Oh, and the chance to boost the tax we pay by another £400 million or so. Accountants argue that this is the latest stage in the Revenue's campaign to bring more of us under the Pay As You Earn (PAYE) regime, which is easy to collect and difficult to avoid.

An unlikely combination of information technology specialists, actors and doctors will find themselves among those affected by the result of litigation about IR35. This is the name of the rule change which would redefine long-term contractors as employees.

Gerald Barling QC, representing the contractors, told the High Court this week that if the Inland Revenue is allowed to impose IR35, up to 90,000 self-employed people would be "forced out of business or out of the country". He told Mr Justice Burton that many of the companies which pay these contractors had no wish to add them to their staff, as that would confer rights to holiday and sickness pay, pension scheme membership, redundancy rights and add to administrative costs.

From the contractor's point of view, they pay tax twice a year instead of each month and - where payments pass through their own companies as dividends - do not need to deduct employer's National Insurance Contributions, which are levied at 12.2 per cent with no upper limit. Mr Barling said the legislation was "as misconceived as it is wide-reaching" and would hurt "precisely the businesses which successive Governments have purported to encourage".

Colin Ives, a partner at accountants Smith & Williamson, pointed out how uncertainty about the legal position creates immediate administrative and cashflow problems for many self-employed people. He said: "The ongoing judicial review may not be decided until very close to or after the due date for payment of PAYE and National Insurance Contributions on April 19. So, this year at least, many thousands of contractors would have little time to comply with the new rules.

"In practice, affected contractors will still have to decide what PAYE and National Insurance Contributions liabilities to pay for this tax year within the next month. The trouble is that the Revenue may not always agree and where the Revenue's view finally prevails, and sums due have not been paid by April 19, there will be interest and possibly penalties to pay as well.

"Different personal service company contractors provide their services in different ways, so each needs to consider how the new rules this tax year affect them. Many medical staff, for example, providing services through agencies will be caught by the rules, but to take another example, some information technology people contracted to do very specific tasks may well escape."

John Whiting of accountants PricewaterhouseCoopers said: "Working out whether you are an employee or are self-employed is pretty easy at each end of the spectrum, but there is a lot of fuzzy ground in the middle. If you want to be classed as self-employed, then are you really carrying on a business?

"Is there a prospect of you making losses? What is your relationship with the person hiring you - can they tell you what to do, where and when? Do you have to come yourself or can you send a substitute? How are you paid - by the week or month, or for the task?

"Self-employed people should have a proper contract drawn up stipulating that it is possible to send substitutes and so on, in order to prove that they are properly self-employed to the Revenue later on. It is important to remember that Customs & Excise will also take an interest.

"If you are really a business then you should register for value added tax (VAT). However, I have seen a very sad case in the past where a client was classed as self-employed by Customs & Excise and had to pay VAT, but was classed as employed by the Revenue and had to pay National Insurance Contributions as well."

Martin Donn, a partner at accountants Blick Rothenberg, said: "IR35 could lead to all individuals being taxed under PAYE, which might affect many small businesses, mainly in the service industries, which are taxed as self-employed, paying tax twice a year in January and July.

"This would increase their costs and reduce their cash flow as payments would be made monthly or perhaps quarterly. It might then also lead to a redefinition of those expenses liable for tax purposes as the restrictions are far greater for the employed than the self-employed."

Patricia Mock, of the accountancy firm Andersen, said: "The Revenue has always been keen to clamp down on people being classed as self-employed partly to increase its own cashflow but mostly for National Insurance reasons. The Government wants to rein in the situation when someone leaves the office on Friday as an employee and comes back on Monday as a consultant.

"There are no hard and fast rules: it all depends on the facts of each case. One thing worth bearing in mind, though, is that it is up to the Revenue to challenge your method of paying your tax."

-- David Hopkins

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