Government plans to replace controversial contractor tax law

That law, which is named after the Inland Revenue press release which announced it, was created to combat what the then-Government saw as a growing problem of contractors using limited companies to avoid paying tax and national insurance.

The law ensures that when a contractor is employed by a company he is due to pay tax and national insurance as an employee, even when he is working via a limited company. The Government established the law because it believed companies were being set up to disguise basic employment relationships.

The law has been unpopular with IT contractors in particular who claim that it acts as a barrier to business and catches in its definitions companies and workers who are not exploiting any tax loophole.

The current Government has said in its Programme for Government, though, that IR35 will be examined and replaced with a law that is friendlier to small businesses.

"We will review IR35, as part of a wholesale review of all small business taxation, and seek to replace it with simpler measures that prevent tax avoidance but do not place undue administrative burdens or uncertainty on the self-employed, or restrict labour market flexibility," said the Programme.

Lobby group the Professional Contractors Group (PCG) was formed specifically to oppose IR35. Its managing director John Brazier welcomed the announcement. "We are delighted that the new Coalition Government made this commitment to review IR35 as a priority only days after taking power," he said.

"For the last 10 years PCG has campaigned for honesty and fairness when dealing with the UK’s 1.4 million contractors and freelance workers. With the end of the iniquitous IR35 we have the opportunity to achieve fairness," he said.

PCG's chairman said that the group had lobbied the Conservative and Liberal Democrat parties on the issue.

"Over the last few months the PCG team has had a series of meetings with the Conservative and the Liberal Democrat shadow front bench teams. We are delighted our message was heard and action taken," said Chris Bryce. "Freelancing is a growing and valuable part of the UK economy. We are delighted that at last we have a Government that appreciates this.”

An IT contractor lost a High Court case two years ago when contesting the application of IR35 and faced a £99,000 tax bill as a result. Jon Bessel was an IT systems tester and worked almost exclusively for motoring organisation AA for three years, providing his services via his company, Dragonfly Consulting.

The High Court found, though, that Bessel was effectively an employee of AA during this time because the control, appraisal and assessment of his work undertaken by AA manager's was like that undertaken in relation to an employee.

The fact that AA and Bessel defined themselves as two companies dealing with each other was irrelevant in the light of the facts of the actual relationship, the Court said.

The PCG said last year that it had collected figures that demonstrated that the law was a failure. It used a freedom of information request to find out that the tax brought in just £1.5 million a year rather than a projected £220m a year. This showed that the law has "not lived up to the Government's expectations," it said.

Her Majesty's Revenue and Customs (HMRC) argued instead that the low tax take indicated that the law was working and that workers were not using companies to mask their employment status because of the existence of the law.