In Defence of the ‘Outstanding Loan’ Charge

The former Financial Secretary to the Treasury recently announced in a letter to MPs that “HMRC will not apply the Loan Charge to a tax year where (sic) an enquiry was closed on the basis of fully disclosed information.” I venture to suggest that this is misguided, both as a matter of law and as a matter of social policy.

There are two economic benefits of a loan enjoyed by the person to whom it is made:

(a) the value of the loan in the sense that the price being paid for it (in terms of the interest rate payable) is less than the market value of such credit on the same terms. One measure of this is the difference between the amount of interest actually paid, and the rate at which it would have been charged if the loan had been made on arm’s length/open-market terms. In the case of an employment-related loan the amount of such benefit is (broadly) charged to income tax by reference to the Official Rate of interest; and

(b) if it is not a ‘fixed term’ loan, that of the continuing forbearance of the lender in not calling for immediate repayment.

The latter is not taxed as ‘general earnings’ (under the benefits code) of the borrower, but there is no reason in law why Parliament should not have determined that such an ongoing benefit is properly to be the subject of a charge to income tax in much the same way that other profits or gains not obviously income in nature (such as, e.g. share option gains) have been brought within the charge to income tax, regardless of whether the loan was linked to an employment or a self-employed trading activity. This is, in effect, what Parliament has done in legislating to impose the Loan Charge as at 5 April 2019. The fact that the loan was made pursuant to arrangements made as far back as 1999 has no bearing on the fact that, if the loan has not been repaid, a benefit is still being enjoyed on a current daily basis.

It is said that it is wrong in principle, and/or as a matter of law, that a taxpayer should be at risk of a charge to tax on the benefit of an arrangement made many years ago and which was fully disclosed to HMRC in, or in respect of, the tax year in which it was entered into and which HMRC chose, for whatever reason, not to challenge. The existing legislation provides a balance between the obligations of a taxpayer to self-assess his or her income and gains, and the statutory time limits on HMRC’s power to enquire into a return or make a discovery. It is important that the courts uphold this balance, and they do so (see, for example, the recent decision of the Court of Appeal in Tooth v HMRC [2019] EWCA Civ 826). But the point is that income tax is charged on an annual basis and the need to maintain that balance in relation to historic earnings or benefits cannot be taken to restrict Parliament from deciding to impose a charge to tax on what is, in effect, a continuing current benefit enjoyed from day to day for so long as a creditor chooses not to call for immediate repayment of an open-ended loan.

The passage quoted above suggests that those individuals (typically contractors, not employees) who are continuing to enjoy the ongoing benefit of not having to repay loans made to them in lieu of payments of taxable income may avoid the Loan Charge if an enquiry was opened into their tax affairs in respect of the year in which the loan was made, or possibly a later year, and since closed, and the existence of the loan was then fully disclosed but not challenged by HMRC. By contrast, those who were not the subject of such an enquiry will not avoid the Loan Charge. If correct, this will mean that individuals who continue to benefit from outstanding unpaid loans will now be taxed differently according to whether or not HMRC happened to have opened, and since closed, an enquiry in respect of an earlier year. Looked at from the point of view of the millions of taxpayers who have not enjoyed the benefit of receiving profits of their employment or trading activities in the form of loans, this would surely be seen as unfair discrimination in favour of those who have ‘shouted loudest’ yet benefitted at the expense of all other taxpayers.

It is certainly the case that HMRC should have acted sooner to put an end to the egregious tax planning arrangements and to the activities of those advisers who promoted such structures and profited handsomely from doing so. Ministers are properly to be criticised for having failed to do so. There was a strong case for action to have been taken long before 2011 to impose charges to tax on such loans as if they were earnings, or, as appropriate, trading income, of the recipients and taxed accordingly – in the case of employees, by imposing the charge primarily upon the employer, not the employee. The decision of the Supreme Court in the Glasgow Rangers’ case was too late in the day to stop the use of EBT loan arrangements.

It was asserted that, at least in relation to employment-related arrangements, if (per the Supreme Court in Glasgow Rangers) contributions to the trust which made the loans were properly to be taxed as income of the employee at that time, no further charge should arise on the basis that the loan by the trustee was merely an application of the employee’s earnings. The government moved to head off such arguments by making clear, in what is now s554A (5A) to(5C) ITEPA 2003, that the use of such ‘re-directed earnings’ does not obviate the application of the disguised remuneration rules (including the Loan Charge) to loans made out of such taxable earnings. (The Loan Charge applies in relation to individuals who are not employees by reason of the arrangements having fallen within s 23A ITTOIA 2005 and Schedule 12 F(No.2)A 2017.) In any event, the idea that HMRC is entitled to challenge a loan arrangement only within a limited period after the tax year in which it was entered into ignores the fact that, for so long as the loan remains outstanding, that arrangement in itself affords a distinct and ongoing benefit which is a legitimate target of the government in seeking to ensure that all taxpayers are dealt with fairly.

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