R (Professional Contractors Group Ltd) v Commissioners of Inland Revenue

JurisdictionEngland & Wales
JudgeLord Justice Robert Walker,Lord Justice Dyson,Lord Justice Auld
Judgment Date21 December 2001
Neutral Citation[2001] EWCA Civ 1945
Docket NumberCase No: C/2001/0895
CourtCourt of Appeal (Civil Division)
Date21 December 2001
Professional Contractors' Group and Ors
Commissioners of Inland Revenue

[2001] EWCA Civ 1945


Lord Justice Auld

Lord Justice Robert Walker and

Lord Justice Dyson

Case No: C/2001/0895






Mr Gerald Barling 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 the respondents)

Lord Justice Robert Walker



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 individuals by the use of what are loosely called service companies.


Employees are liable to income tax on their earnings under Schedule E, and they and their employers have to pay National Insurance contributions ("NIC") on the Class 1 (employed) basis. Taxation under Schedule E has several well-known disadvantages as compared with the taxation (under Schedule D Case I 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 be 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.


On 9 March 1999, which was Budget Day, the Inl and Revenue published (among numerous other press releases) one designated IR 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.

The Government is going to bring forward legislation to tackle this sort of avoidance. The Inl and 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."


The expression IR 35 has come to be used, and has been used in this litigation, as a shorth and 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 1999 ("the 1999 Act") and the Social Security Contributions (Intermediaries) Regulations 2000 ("the Regulations").


In June 2000 three claimants (the appellants in this court) sought permission to apply for judicial review of the lawfulness of IR 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 IR 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.


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 IR 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."


Both sides put in a volume of written evidence and full and 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 LJ on 16 May 2001.


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 IR 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 IR 35 legislation


As a matter of parliamentary procedure the enactment of the IR 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 h and, and the 2000 Act, on the other h and. 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.


Between the publication of IR 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 ab and onment 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.


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 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."


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 IR 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 Taxes) v Lorimer [1994] 1 WLR 209).


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...

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