The Budget, IR35 and e-commerce

Gordon Brown's March Budget promised much to promote Britain as an e-business friendly economy, but will the measures introduced...

Gordon Brown's March Budget promised much to promote Britain as an e-business friendly economy, but will the measures introduced be undone by the much-reviled IR35 tax policy?

It may have been a long time coming but the government has finally introduced some real measures to help companies get up to speed with e-commerce. Britain lags well behind the United States as far as the Internet economy is concerned and in March's Budget statement, Gordon Brown revealed a set of policies directly aimed at stimulating web-based commerce.

Since then, a mini-backlash has begun, many saying that the measures do not go far enough and actually do very little to promote e-commerce. On top of this there is the IR35 tax policy - which came into being on 6 April 2000 - which threatens to do far more damage to Britain's chances of being at the forefront of e-commerce than these policies could ever be of help. So, has the government got it right, or is it just the same old offering with a New Labour garnish on top?

The measures revealed in the Budget statement were announced with great bravado. "This Budget is built on the realities of the new economy," boomed Chancellor Gordon Brown. "We will meet and master a new tide of unprecedented technological change by continuing to remove the old barriers to business investment and by continuing to expand employment opportunities for hard working families."

So what did this entail? In essence, there were three major announcements that were directly aimed at promoting e-commerce, with a few little bonuses thrown in to whet the public's appetite for online transactions.

The most significant of these perhaps was the announcement that, for the next three years, any IT-related equipment purchased by any small- to medium-sized company can be written off against tax in one year. This allows established companies that have been looking to set up an online operation to have fewer worries about the costs involved in doing so. It also aims to increase the number of Internet start-ups in Britain by removing one significant cost barrier.

The Chancellor also announced that the maximum number of people in a company who could benefit from tax-friendly stock options of up to £100,000 would be increased from the 10 announced in the November pre-Budget statement, to 15. This is aimed at encouraging start-ups who may promise large stock options to valuable employees at a time when high salaries are not available. All these shareholders will now come under the lower 10 per cent capital gains tax rate. Of this move, Brown said: "Our measures are the biggest boost for employee shareholding our country has seen."

To address the problem with skills shortage in vital IT areas in Britain, the Chancellor introduced new regulations in relation to obtaining work visas for "highly skilled" non-EU citizens needed by IT companies. Workers within the EU do not currently need visas to work in Britain, or anywhere else within the European Union for that matter. The new law promises to make it easier to get hold of skilled IT workers from the USA or anywhere else in the world.

Besides the main measures announced, the Chancellor also introduced incentives to encourage the UK population to use the web for more than just surfing. If you now file a tax and VAT return over the Internet, there will be a £100 discount on the bill. If the same is done for the working families tax credit, the bill will be reduced by another £50.

All these measures were given much attention by the government and the media alike; some termed it the e-Budget. But will the actions taken by the government actually live up to their promise? Some believe that if you look at the measures closely, they actually can mean very little, and could mean even less depending on some of the details, which have yet to appear.

Take writing off IT equipment against tax, for instance. It is a fair enough measure for those established profit-making businesses, who will receive the benefits of being able to mark off the costs against the tax levied on its profits. For the loss-making start-up, however, the move has virtually no effect on them. Since they make no profits, they effectively pay no tax anyway. This may even make them feel that the government has given the established companies an advantage. If a start-up is in direct competition with a bricks and mortar company that then receives this tax write-off boost, it could be felt that the established company then has an advantage over the start-up, due to better branding and infrastructure.

Of course, it is still unclear as to the details of what exactly will be covered by this tax write-off. If you are an Internet-based start-up, it could be argued that everything you have is a vital IT part of the business. It may be that a separate company is used to host the web services. Would these costs be taken into consideration? All this is yet to be made clear, meaning there is still a large degree of uncertainty in people's minds over what to do and how to do it. It has also been mentioned that before the announcement, capital equipment was written off over four years; so the benefits of the new rules may not be that ground-breaking.

The increase in the number of people who benefit from lower capital gains tax on stock options is much less uncertain than writing IT equipment off against tax, as the details had already been finalised and it is only the number of people who will benefit that has changed. But still, the effectiveness of this method in promoting entrepreneurial activity could still be called into question. An extra five people being given tax benefits on stock options is not necessarily going to encourage e-commerce activity; the most important employees are already likely to be covered.

If this is to be used as an alternative to paying high wages, it should be noted that there are few Internet companies making large profits. In fact, after the recent episode with lastminute.com and Microsoft, technology stocks are not looking as attractive as they once were. This makes the stock options incentive less appealing to prospective members of a company.

The relaxation of visa rules could also have little effect in stimulating highly skilled workers to enter the country. Currently, there are other tax-related factors, such as IR35, which may discourage these people from wanting to work in the UK. In fact, IR35 may cause more problems than all the measures being introduced will solve.

IR35 - so named as it was introduced as press release number 35 from the Inland Revenue - covers the area of personal service provision. It was first mentioned in March 1999, but came into effect in April 2000. It was introduced to try and close a loophole that meant many people were paying considerably less tax than the government believed they should be. The theory was that someone could leave his or her job as an employee on a Friday, return to work the next Monday as an indirectly engaged consultant, doing the same job but paying significantly less tax and National Insurance due to the advantages of the corporate tax structure.

With the introduction of IR35, contractors who work for significant periods with the same company may be considered by the Inland Revenue to be employees of the company, and be taxed as such. This has caused consternation among the IT sector as it relies heavily on long-term contractors. In fact, certain details of IR35 relate specifically to IT contractors, the Inland Revenue believing that many are employed through agencies on standard contracts. The implementation of IR35 could cause many contractors to lose up to a quarter of their net income on additional taxes imposed.

The matter has caused so much upset that the Professional Contractors Group (PCG) is now challenging the government under European law in order to get the legislation removed. The PCG was set up specifically to campaign against IR35, and with the legislation now in place, this could be the last throw of the 8,000-strong group's dice. Gareth Williams, PCG chairman, says: "IR35 makes independent consultants pay more tax and National Insurance than their competitors - the large international consultancies - for doing the same work on the same terms, and in fact, more tax than any other sector of business. It is unfair and disproportionate."

The PCG also cites the government's own assessment of IR35's impact, which states that 66,000 small businesses, primarily in the knowledge-based sector, would close. Also, while affected contractors would be treated like employees for tax purposes, they would not receive the benefits associated with being a permanent employee, such as holiday and sick pay.

While the government is making so much noise about promoting e-commerce, it seems strange that it would implement measures that are bound to stifle the growth of the industry in Britain. Even stranger then that the measures introduced are, at best, unclear as to how much they will help the UK e-conomy. Some analysts have estimated that the measures will only cost the government around £5m to £10m in lost revenue, therefore surmising that the real benefits to companies cannot be that large.

New Labour has positioned itself as the party for new technology, but like so many other aspects of Labour policy at the moment, there seems to be far more style than substance. While it is welcomed that the government has recognised the importance that the Internet could have on boosting the UK economy, it needs to back this up with stronger incentives before people will start believing that the UK can get anywhere near the United States as a technological nation.

Paul Grant

This was last published in April 2000

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