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Monday, 2 April, 2001, 13:40 GMT 14:40 UK
Q&A: IR35 - a tax on enterprise?

After a two-year struggle, the government has won the legal battle over the controversial IR35. Or has it?

BBC News Online examines the history, and future, of a taxing initiative.

IR35 - that's a strange name for a tax?

First, IR35 is not strictly a tax. It is a set of guidelines directing how contractors should be treated, for tax purposes, by the firms which employ them.

As for the name, 'IR' actually stands for Inland Revenue and '35' for the number of the press release in which the initiative was announced in March 1999.

If that title sound a bit opaque, you can always use the official version, which goes something along the lines of "anti-avoidance legislation on the provision of services through intermediaries such as personal service companies".

What does that mean?

The government proposed IR35 as a means of tackling the unscrupulous use of companies by contractors.

If hired as a contractor, rather than a salaried employee, a worker is paid without the need for employment levies such as national insurance to be deducted from pay.

So the worker gains a higher income, and as a company can also write off business expenses against tax and, the Inland Revenue maintains, "gains an unfair advantage over other employees".

While Chancellor Gordon Brown has recognised that contractors are typically hired in good faith, he has sought to close the loophole where someone "could leave work as an employee on a Friday, only to return the following Monday to do exactly the same job as a... consultant paying substantially reduced tax and national insurance".

The Inland Revenue believes the measure, introduced last April, will boost tax takings by 350m a year.

Sounds fair enough. So what's the catch?

The problem lies in defining who is, and who is working as a 'genuine' consultant and who is in what taxmen call "disguised employment".

While the scheme is largely designed to catch-out the lone operator who switches from employee to contractor overnight, protesters claim the way IR35 has been drawn up leaves it discriminating in favour of large consultancies.

They say the measure constitutes a breach of the human rights act, as it discourages contractors from setting up in the UK.

And the measure leaves UK consultants at a disadvantage to Continental competitors, so infringing EU laws governing free movement between member states.

What have these IT consultants done?

While the battle over IR35 has been portrayed as one between IT experts and the government, the measure also affects consultants in sectors such as architecture, engineering and accountancy.

The contest has focused on IT as this is one sector which the government has said it is keen to nurture - yet which, protesters claim, will suffer a brain drain as IR35 drives experts from the country.

Opposition has been led by an organisation called the Professional Contractors' Group, which in October won court permission to challenge IR35 at a judicial review.

It was the finding of that High Court review which was announced on Monday.

So who won?

The High Court rejected claims that IR35 was incompatible with Human Rights and EU free trade legislation.

But the PCG has gained comfort from a ruling which contains criticisms, nonetheless, about the way in which IR35 was introduced, and recommends some modifications to the way the scheme is run.

The Inland Revenue should, for instance, look at the history of a contract, rather than just its current operation, in determining its status under IR35, the High Court said.

What now?

The full implications of Monday's ruling will become more clear after it is examined in detail by both sides.

Whatever, there is always the possibility of appeal.

While the High Court refused the PCG leave to appeal, the group, which has previously sworn to fight IR35 to the bitter end, can still seek leave from the Court of Appeal to take its case further.

And if the Conservatives win the next General Election expected on 7 June, they have pledged to repeal the rule.

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See also:

02 Apr 01 | Business
IR35 tax challenge fails
16 Feb 01 | Business
Tories pledge to scrap IR35 tax
10 Oct 00 | Business
Court to review tax law
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