What Tax Schemes Are HMRC Targeting with the Loan Charge?

April 1, 2019

On 20th June 2012, then Prime Minister David Cameron took time out of his day to criticise the tax affairs of popular comedian Jimmy Carr. While it might not have felt like it at the time, Cameron’s statement marked the start of a tax avoidance revolution.

"I think some of these schemes – and I think particularly of the Jimmy Carr scheme – I have had time to read about and I just think this is completely wrong,” said Cameron. “He is taking the money from [ticket sales] and he, as far as I can see, is putting all of that into some very dodgy tax avoidance schemes.”

Cameron was speaking just days after an investigation from The Times had revealed Carr was part of K2, a Jersey-based tax avoidance scheme. The report alleged Carr had stashed £3.3 million in the scheme, paying just one percent tax to HMRC. (For reference, if Carr had taken the entire £3.3 million as regular income, he would have paid approximately 47 percent tax.)

The Times investigation spread like wildfire. Within a couple of days, the isolated criticism in The Times had grown into full-blown public outrage. Partly driven by the media furore and partly by pressure from the Treasury, HMRC announced it would investigate how to tackle K2 and other aggressive—albeit legal—tax avoidance schemes. Later that year, in December, the UK Government announced a new power to help HMRC to tackle schemes like K2: the General Anti-Abuse Rule (GAAR).

HMRC had some success with GAAR but even after seven years, they're still fighting against tax avoidance schemes.

Later this month, HMRC will gain yet another power to fight against tax avoidance: the loan charge.

As we’ve written about fairly extensively, the loan charge will allow HMRC to levy £3.2 billion in new taxes on historic loans that they believe were disguised remuneration. When the loan charge comes into effect in April, thousands of individuals will face a tax bill of tens or hundreds of thousands of pounds.

In this article, we’ll briefly recap what the loan charge is and then we’ll discuss the specific tax avoidance schemes most likely to be caught out.

 

 

What is the loan charge?

Two years ago, the government introduced the Finance (No. 2) Act 2017. Among other things, it included a new power called the loan charge. The loan charge was specifically designed to help HMRC tackle a common form of tax avoidance: disguised remuneration.

Most disguised remuneration schemes work by issuing interest-free, non-repayable loans to scheme users. Because the money is issued as a loan and not as income, the recipient pays no income tax or National Insurance Contributions (NICs).

The new loan charge allows HMRC to apply retrospective taxes on any loan issued since 1999 that they believe was actually disguised remuneration. Effectively, it lets HMRC roll back the clock and tax loans as if they had been regular income.

While accountants offered a wide range of disguised remuneration schemes, three were far more popular than others: Employee Benefit Trusts (EBTs), Employer Financed Retirement Benefit Schemes (EFRBS) and Contractor Loan Schemes. In the next few sections, we'll take a deep dive on each scheme, discussing how each one worked and what scheme users can do if they're caught out by the new loan charge.

 

Employee Benefit Trusts (EBT)

Employee Benefit Trusts (EBTs) are designed to provide a company’s employees or directors with specific benefits like loans, shares, pensions, accident benefits or healthcare. However, since EBTs arrived in the 1980s, they have increasingly been used for tax avoidance purposes.

The most high-profile example of EBT usage comes from Glasgow-based football team, Rangers. Between 2001 and 2010, Rangers used EBTs to pay its players and employees approximately £47 million. In 2010, HMRC challenged their use of EBTs, taking them to court over unpaid income tax and NICs. The dispute rolled on for seven years before the Supreme Court finally ruled in HMRC’s favour in 2017, which seemed to put an end to the story. But the loan charge risks opening old wounds as HMRC can now pursue individual Ranger’s employees who benefited from EBTs.

In the next section, we’ll see how a company could have used an EBT to significantly reduce an employee's tax liability.

 

How does it work?

Let’s say an IT consultant called Jennifer is hired by a company called Acadesk. Normally, Acadesk would pay Jennifer directly and she would pay income tax and NICs on her earnings. However, Acadesk's accountant recommends they use an EBT to reduce Jennifer's tax liability and increase her take-home pay.

With an EBT, Acadesk doesn’t pay Jennifer's monthly salary directly to her. Instead, it pays the full amount to the EBT and Jennifer then ‘borrows’ the money (minus the EBT’s fees) from the trust via an interest-free loan. Jennifer and the EBT administrators have an agreement that the loan will never be written off or repaid.

Since Jennifer receives the money as a loan and not income, it is not subject to income tax or NICs.

 

What does HMRC say?

HMRC has been fighting against EBTs for some years now. In its Business Income Manual, HMRC says that typical avoidance uses of general-purpose EBTs include:

  • payment of bonuses via an offshore trust in an attempt to avoid employers’ NICs,
  • payment of remuneration by way of loans, which may be written off before they become repayable,
  • making loans in depreciating currency such as Turkish Lira from which the borrower may make a foreign exchange gain before the loan becomes repayable,
  • creating an offshore ‘moneybox’ for director/shareholders of close companies, with the aim of avoiding Inheritance Tax on value transferred out of the company through contributions to the EBT,
  • allowing employees to use assets (such as cars) owned by the EBT, the costs of acquiring which would be capital expenditure if they were owned by the employing company,
  • providing benefits in the form of shares (not in the employing company) whose values can most easily be manipulated before or after they are transferred from the EBT to employees or directors.

As you can see, HMRC believes EBTs facilitate a huge amount of tax evasion. If you have used an EBT scheme since 1999, HMRC will likely pursue you for unpaid taxes on outstanding loans.

However, it’s worth stating that the new loan charge can only target EBTs that have been used for the purpose bolded above: disguising remuneration as loans.

 

What can you do?

Despite a strong backlash from the House of Lords and sustained pressure from public lobbying groups, HMRC has refused to delay or amend the loan charge. Barring an unexpected U-turn, HMRC will introduce the loan charge on 5th April 2019 and apply £3.2 billion in new taxes.

Individuals who have used an EBT have two real options, which I have detailed below.

  • Negotiate a settlement: HMRC has issued two deadlines for settlement—31st May 2018 and 30th September 2018—but is still receptive to individuals coming forward to negotiate. However, with just a few days left until the official implementation date, you may struggle to arrange and sign a settlement agreement in time. Individuals who have not secured a settlement by 5th April may be charged extra penalties.
  • Pay the loan charge: If you have outstanding loans deemed disguised remuneration on 5th April 2019, HMRC will apply the loan charge. You then have until 31st January 2020 to make the payment.

Some people suggest fighting back against HMRC—either individually or as part of a collective like the Loan Charge Action Group—but I fear it may be too late for this as we are now only days away from the introduction of the loan charge.

Others recommend exploring professional negligence claims against the advisers who recommended the schemes in the first place. While you might be able to successfully claim against an adviser, your immediate concern should be HMRC who can (and will) make you bankrupt over unpaid historic taxes.

If you are facing an unaffordable retrospective tax bill, get in touch with our team for free initial advice. Click here to speak to one of our team members today.

 

Employer Financed Retirement Benefit Schemes (EFRBS)

Employer Financed Retirement Benefit Schemes (EFRBS) are unregistered pension schemes that offer a range of retirement benefits to their members. They were originally introduced to help employers compensate employees who had maxed out their earnings cap in occupational pension schemes and to allow people to pay into a pension scheme while working abroad.

However, accountants quickly realised EFRBS could also be used to facilitate disguised remuneration too.

Perhaps the most famous example of an EFRBS was the Jersey-based K2 scheme we discussed at the start of the article. In June 2012, The Times published a report into K2, revealing that many high-earning Brits were using the scheme, including comedian Jimmy Carr. In the next section, we’ll look at how K2 worked in practice.

 

How does it work?

Consider an engineering firm called Fitec. One of their project engineers James hears about K2 and persuades the company's management to let him join the scheme. James quits his job at Fitec and accepts a new job at K2, an off-shore company registered in Jersey. K2 pays James a very small salary and then seconds (hires out) him to his original employer, Fitec.

K2 then invoices Fitec for James’ work. Once K2 receives the money from Fitec, the scheme transfer the money to an EFRBS. Every month, James ‘borrows’ money from the EFRBS in the form of an interest-free, non-repayable loan. Since the money is a loan and not income, James doesn’t pay any income tax or NICs.

"These structures work so long as everyone agrees that the loan is repayable … but that's where the smoke and mirrors come in,” wrote an anonymous tax expert in The Guardian. “There is a nod and a wink that the pension scheme will never ask for the money back, and the loan stays in place for perpetuity, until the person dies. At death, it disappears. The trustees of the pension scheme meet and agree to write it off."

As you can see, the actual disguised remuneration process works in a similar way to the EBT schemes discussed above. All that changes is the vehicle used to deliver the loan.

 

What does HMRC say?

Unlike EBTs, which became virtually synonymous with tax avoidance, EFRBS are still used for legitimate purposes. HMRC’s Employment Income Manual provides a short section that defines their red line for EFRBS.

“Broadly speaking, if third-party arrangements are used to provide what is in substance a reward or recognition, or a loan - in connection with the employee’s current, former, or future employment - then an Income Tax charge arises.” [Employment Income Manual]

Simply put, if an EFRBS has been used to pay remuneration via loans, HMRC considers this an example of disguised remuneration and will apply the new loan charge.

 

What can you do?

Our advice for individuals who have previously used EFRBS schemes is identical to our advice for EBT scheme users: negotiate a settlement or pay the loan charge. I have detailed both options below.

  • Negotiate a settlement: While both HMRC's deadlines for settlement have passed, they are still open to individuals coming forward. However, with just a few days to go until the 5th April loan charge deadline, it’s unlikely that you will be able to get a settlement agreement in place by then.
  • Pay the loan charge: If you have outstanding loans on 5th April 2019 and HMRC deems them disguised remuneration, you will receive a retrospective tax bill. You then have until 31st January 2020 to pay the debt.

Again, while some people suggest fighting back or exploring professional negligence claims against the scheme operator, most individuals will have a more pressing concern: HMRC.

Individuals and businesses have become complacent after dealing with toothless powers like the Advanced Payment Notice (APN). In days gone by, if you ignored an APN from HMRC, it would go away eventually. But times have changed. If you ignore HMRC’s demands for payment under the new loan charge, they will bankrupt you.

If you are facing an unaffordable retrospective tax bill, get in touch with our team for free, initial advice. Click here to speak to one of our team members immediately.

 

Contractor Loan Schemes

The third main type of scheme targeted by HMRC’s new loan charge power is the contractor loan scheme. Unlike the other two schemes, which use preexisting vehicles to mitigate tax, contractor loan schemes were set up specifically to exploit taxation loopholes. These schemes actively targeted self-employed individuals, promising astronomical take-home pay rates—typically as high as 90 or 95 percent.

Contractor loan schemes work by paying contractors a small portion of their pay directly and the remainder as an interest-free loan via a third-party company. The first, small portion is subject to income tax and NICs but the second, larger portion is tax-free.

Here’s how a typical contractor loan scheme works.

 

How does it work?

Imagine a financial consultant called Kevin who is hired by a company Fasteam to act as chief financial officer. Fasteam offers Kevin a salary of £120,000 for a one-year contract. To sweeten the deal, Fasteam offers to pay Kevin through a contractor loan scheme to increase his take-home pay from around 60 percent to approximately 90 percent.

Every month, Fasteam pays Kevin a small salary of £2,000. Since this is taxable income, Kevin pays a negligible amount of income tax and NICs—roughly £190 in income tax and £150 in NICs per month.

Fasteam then pays the remaining £8,000 of Kevin’s salary to a third-party company based off-shore. The third-party then takes a small cut as payment—say 10 percent—and issues the rest to Kevin as an interest-free, non-repayable loan.

When the contract is over, Kevin will have earned £18,363 in regular taxable income and will have received £86,400 in non-taxable loans from the third-party. His total take-home pay will be £104,76387 percent of his total earnings.

Again, the actual disguised remuneration structure is very similar to both EBTs and EFRBS. Again, the key difference is the vehicle that delivers the loan, which in this case is a third-party company.

 

What does HMRC say?

HMRC’s view on Contractor Loan Schemes is the simplest of the three. In a spotlight on contractor tax, HMRC says:

Scheme promoters will tell you that the payment is non-taxable because it’s a loan, and does not count as income. In reality, you do not pay the loan back, so it’s no different to normal income and is taxable.

If you’re using one of these schemes and being paid this way, you’re highly likely to be avoiding tax. You could end up paying additional taxes, penalties and interest as well as a fee to the promoter.

As you can see, HMRC's view of contractor loan schemes is very black and white. If you have used a contractor loan scheme to reduce your tax liabilities, the loan charge will almost certainly apply and HMRC will pursue you for retrospective tax.

 

What can you do?

As with EBT and EFRBS schemes, your options are limited. HMRC is clear that it considers contractor loan schemes a type of disguised remuneration and will apply the loan charge to all outstanding loans on the 5th April 2019.

Individuals who have used contractor loan schemes have the same two options we have previously discussed.

  • Negotiate a settlement: It’s unlikely that you’ll be able to escape the loan charge if you’ve used a contractor loan scheme. While there isn’t much time left before the loan charge is implemented, you may be able to arrange a settlement if you are lucky.
  • Pay the loan charge: If you have outstanding loans deemed disguised remuneration on 5th April 2019, HMRC will apply the loan charge. You then have until 31st January 2020 to make the payment.

As we discussed before, some groups recommend fighting back against the loan charge. However, despite immense pressure, HMRC looks set to maintain course and introduce the loan charge in April. Even if you intend to challenge the loan charge, you still have to prepare for the effects of the loan charge. If you ignore HMRC’s demands for payment, they will make you bankrupt.

If you have already received a demand for payment from HMRC and believe that you can't afford it, get in touch with our team today for free, confidential advice.

 

How should you respond to the loan charge?

Although HMRC claims the average loan charge settlement will be around £13,000, their own data shows this is untrue. During a meeting of the Commons Treasury Committee, HMRC's head of counter-avoidance, Mary Aiston, revealed that HMRC has already settled 6,000 cases, bringing in a total of £1 billion.

These figures reveal an average settlement of £167,0001,182 percent higher than HMRC’s own estimate. A quick browse of business and financial forums shows many commenters are indeed facing six-figure tax bills and not the £13,000 claimed by HMRC.

If you receive a tax demand from HMRC that you cannot afford, it's essential that you take insolvency advice as soon as you can. At 180 Advisory Solutions, we have extensive experience dealing with personal and corporate debt and are prepared to support you through your negotiations with HMRC.

To speak to one of our team members immediately, click here to get in contact today. Our initial advice is free, confidential and no-obligation.

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