The government has announced that the changes to IR35 due to come into effect in relation to work done on or after 6th April 2020 will, as part of the response to Covid-19, be put back until 6th April 2021. The announcement is to be found here: https://www.gov.uk/government/news/off-payroll-working-rules-reforms-postponed-until-2021
As a member of the working party that put together the EMI scheme which was originally legislated for in Sched 24, FA 2000, I very much welcome the government’s announcement, as part of the Budget today (11th March 2020), that it intends to “review the EMI scheme to ensure it provides support for high-growth companies to recruit and retain the best talent so they can scale up effectively, and examine whether more companies should be able to access the scheme.”
Coupled with the consultation on changes to the tax treatment of ‘hedge funds’, there may now be an opportunity to persuade the government of the need to extend eligibility to employees of companies under the control of private equity. Hopefully the existing statutory limits and other eligibility requirements will be examined with a view to broadening the scope of what has proved to be a remarkably popular and successful scheme allowing companies to attract and retain the best talent at the early, high-risk, stage of their development.
That said, the announcement of an immediate restriction, to £1 million, of the lifetime allowance for Entrepreneurs’ Relief will come as a disappointment to those holding EMI share options over valuable shares in the most successful qualifying companies.
The government has today published a House of Commons Library Briefing Paper (No. 4369) on the topic of “Retrospective Taxation” which describes, inter alia, the practices which successive Parliaments have adopted in relation to the enactment of tax legislation having retrospective effect.
The paper may be found here: https://researchbriefings.parliament.uk/ResearchBriefing/Summary/SN04369
The paper makes reference to the decision of the High Court in the case of Cartref & Others v HMRC  WEHC 3382 (Admin), which was the subject of an earlier post. The High Court ruled that the Loan Charge is compatible with human rights.
Following most of the recommendations of Sir Amyas Morse in his report, issued on 20th December 2019, on the policy behind the Loan Charge and its implementation, the government immediately announced changes to the Loan Charge and its enforcement, some of which require legislation to be included in the Finance Act 2020.
- Reduction in scope of the Loan Charge.
The principle change is that the Loan Charge will not apply to (a) loans made before 9 December 2010 or (b) to any loans made before 6 April 2016 if the scheme was fully disclosed to HMRC but they did not open an enquiry or raise an assessment.
However, this does not mean that liability for a general earnings charge on ‘re-directed earnings’ in the form of contributions to a trust used to fund the loans is being set aside. It was made clear that HMRC will continue to pursue such liabilities to income tax and NICs through open enquiries and discovery assessments and, as necessary, litigation. The HM Treasury paper issued in response to the Loan Charge Review indicated (at 2.9 and 2.12) that HMRC would publish updated settlement terms for all taxpayers in this position. Guidance published by HMRC on 20th December by HMRC states that, in the case of those who made full disclosure by 5 April 2019 and are in settlement negotiations:
- if the position is unaffected by the changes, settlement may be finalised in the normal way;
- otherwise, HMRC will re-calculate settlement terms if either: (a) they relate to any loans made before 9 December 2010 (but presumably only if the relevant year(s) in which contributions were made are ‘unprotected’ so that HMRC is out of time to recover the tax) or (b) they relate to loans made before 6 April 2016 and the use of the loan scheme was fully disclosed to HMRC but they took no action to open an enquiry.
In these cases, the taxpayer may choose to settle (presumably under the 2017 settlement terms, subject to any changes to be announced) all years up to and including 2015/16 if there is an open enquiry or assessment, and any tax due for 2016/17 and later years, whether or not there is an open enquiry or assessment. A choice is offered: a taxpayer may instead settle only those years to which the Loan Charge still applies (so as to prevent it applying). In this event, the tax covered by any open enquiry or assessment will need to be finalised in due course by separate settlement or litigation.
So far as the self-assessment return due on 31 January 2020 was concerned, this can be submitted either:
(a) by that date with a best estimate of the balance outstanding on loans to which the Loan Charge applies (i.e. loans made on or after 9 December 2010 or before 6 April 2016 if, but only if, the scheme was fully disclosed to HMRC and no enquiry was opened). This estimate can be amended up to 30 September 2020 without penalty – and, if settlement is reached before then, the estimate can be reduced to nil. Tax due on the Loan Charge (only) may be ‘stood over’ until that date.
(b) submit the 2018/19 SAR by 30 September 2020. Provided that a ‘time to pay’ arrangement is agreed by then any late filing or late payment penalties will be waived. Again, if settlement is reached by then, there will be no Loan Charge to report.
In the case of returns filed after 30 September 2020, HMRC would consider waiving late filing and late payment fees on a case-by-case basis. Likewise, decisions on whether to charge inaccuracy penalties would be made on a similar basis.
- What of those who have already settled?
HMRC will refund voluntary restitution payments (i.e. amounts on which no late payment interest has been charged) made under settlements reached since March 2016 if the Loan Charge no longer applies either because the loan was pre-9 December 2010 or pre-6 April 2016 and, although fully disclosed, no action was taken by HMRC (e.g. by opening an enquiry). Refunds cannot be made until legislation has been enacted. Clearly there will be additional complexity if the settlement included other taxes such as inheritance tax. How this interaction with other taxes will be dealt with has yet to be determined, HMRC simply stating at this stage that details will be published in 2020 (not “early 2020”).
Those already paying off settled liabilities under a payment plan should continue to do so and await contact from HMRC after the necessary legislation is passed.
- Spreading the cost of paying the Loan Charge over 3 years
This recommendation was accepted and will presumably be legislated for in 2020. It is estimated that about 21,000 individuals could be affected by this.
- Recovery of the tax due
The government has accepted the recommendation that individuals subject to the Loan Charge (as distinct form any earlier ‘re-directed earnings’ or other disguised remuneration charge) should only be asked to pay up to half their disposable income each year and a reasonable proportion of their liquid assets. No one should be put in the position of having to sell their home or use their existing pension pot to pay the loan charge.
The government did not accept the recommendation that those individual taxpayers with income of less than £30,000 in 2017-18 should be released from liability to pay any balance remaining unpaid after 10 years as this would, it was said, treat tax avoiders more favourably than other individuals with tax debts and reduces the incentive to pay off the debt.
The government partially accepted the recommendation that individuals with income in 2017-18 of between £30,000 and £50,000 should be offered the same payment terms as those who opted to settle rather than pay the Loan Charge. Only if they have no disposable assets will taxpayers earning less then £50,000 be automatically entitled to a minimum 5-year payment plan or, if less than £30,000, a minimum 7-year plan.
- Other recommendations
The government has accepted, or partially accepted a number of other recommendations made by Sir Amyas, including:
- that the government review future policy on interest rates within the tax system and report by 31 July 2020;
- that HMRC fund an external body to provide independent advice to lower income taxpayers on debt management.
HMRC has already announced that it will publish the Income & Expenditure form used to work out disposable income and how it is used to create ‘time to pay’ arrangements, and that it will refer taxpayers to a debt advice charity if evidence suggests they need time to pay in excess of 5 years. It will also accept Single Financial statements completed by an individual with a debt charity as proof of affordability; stop, until a significant change in circumstances, recovery action if there is no ability to pay; and not seek to bankrupt those who have engaged with HMRC and are solely unable to pay the loan Charge.
- that HMRC must communicate regularly with those who have open enquiries; report to Parliament on its implementation of the changes to the loan charge; improve staff training and set higher expectations of performance during interactions with the public.
- Proposals to further tackle tax avoidance
The government will announce in the 2020 Budget further action to tackle large scale tax avoidance involving disguised remuneration. To reduce the scope for the marketing of tax avoidance schemes, the government will:
- ensure that HMRC can more effectively issue stop notices to promoters of schemes that do not work;
- Prevent avoidance of obligations under the Promoters of Tax Avoidance Scheme (“POTAS”) rules by using corporate entity structures;
- Ensure HMRC can obtain information as soon as an abusive scheme is identified and that enabler penalties bite immediately a scheme has been defeated at tribunal;
- Ensure that HMRC can take decisive action if promoters fail to provide information; and
- Make further changes to the POTAS regime to ensure it operates effectively and that the GAAR can be used to counteract partnerships as intended.
More generally, HMRC communication must be improved. For example, PAYE RTI information should be used to enable communication with taxpayers suspected of engaging in tax avoidance.
Further details will be given in the 2020 Budget.
- Inheritance tax charges associated with EBT loan schemes
No announcement has been made about any changes to HMRC’s current approach of seeking ‘10-yearly’ and/or ‘exit’ charges to inheritance tax, if appropriate, when a discretionary trust has been used. The suggestion, mentioned at 2 above, of further details of the interaction with other taxes being published at some point in 2020 gives rise to the hope that a more pragmatic approach will be taken and that there might be substantive changes to the inheritance tax regime as it applies to trusts used solely to provide taxable loans.
 Reference is made elsewhere to further guidance and draft legislation being published in early 2020.
Whilst awaiting the recommendations of Sir Amyas Morse, it should not be forgotten that challenges to the Loan Charge are also being mounted in the courts. This week, the High Court (Lady Justice Cockerill) heard a ‘rolled-up’ application (i.e. it was both a ‘permission hearing’ and a trial of the substantive application) for judicial review by corporate participants (and their shareholder/directors) in an arrangement (not notified under DOTAS) which involved loans made to directors by a third party and which, so HMRC assert, come within the ‘close company’ gateway in s554AA ITEPA 2003. The application was made on the grounds that the Loan Charge is incompatible with the applicants’ human rights, although it was recognised that such a declaration cannot strike down domestic primary legislation. In particular, its retroactive effect and the fact that it obviates any opportunity to challenge a Reg 72/81 determination in respect of the earlier funding or making of a loan are, it is asserted, incompatible with Article 6 (right to a fair trial) and Art 1 of the First Protocol (“A1P1”), i.e. the right to peaceful enjoyment of possessions, as set out in the Convention on Rights and Freedoms as enshrined in UK law by the Human Rights Act 1998.
Judgement was reserved.
It is important to appreciate that this application was made in relation to a particular arrangement under which, as a first step, a loan was made by a third party to the director of a close company who then loaned that sum to the company which used it to make a contribution to an LLP which traded in film rights. An accounting valuation of the film rights produced a trading loss in the LLP which was attributed to its member companies. They then set the loss against their trading profits. This allowed the director/shareholder loans to be repaid free of income tax. HMRC was of the view that, as the first loan made to the director was outstanding at 5th April 2019, it was caught by the Loan Charge.
The fact that the loan in these cases was funded by a third party meant that the principle laid down by the Supreme Court in the Glasgow Rangers case (that a contribution by the employer to fund a loan was itself a payment of taxable earnings) did not apply. This leaves open the possibility that other applicants whose loans come through the ‘employee gateway’ in s554A may have a stronger case on the basis that the Loan Charge effectively denied employees the right to challenge a Reg 81 determination on what was, according to the Supreme Court, a liability which had already arisen (on the funding of the trust) before the F(No.2)A 2017 was passed – being a liability on the same amount – and on which PAYE had not been accounted for by the employer but for which HMRC were now out of time to assess the income tax on the employee.
In the present application, it was argued that, insofar as HMRC could have asserted that the loans made in 2010 and 2013 were ‘earnings’, the court should consider the combined effect of the 2011 disguised remuneration legislation (“DR”) and the Loan Charge (“LC”), taken together with the changes made by FA 2018 (which rendered nugatory any assertion that the earlier incidence of tax on such earlier earnings took the loans outside the scope of the DR legislation and the LC). Overall, this deprived the applicants of the right to argue before a tribunal that assessments to such earlier liabilities were out of time. The LC, coupled with the 2018 changes introducing the close company DR charges, would also result in double taxation because it was anticipated that HMRC would issue APNs and PPNs, having already issued Follower Notices (given on the basis that a decision of the Court of Appeal had struck down the efficacy of the film rights trading partnership scheme). Under the DR rules, the LC is not suspended if an accelerated payment is made in respect of an earlier liability which overlaps with an amount to which which the LC applies – see s554Z5 (11). Relief from double taxation is afforded by ss554Z11F, but only insofar as there is an overlap. In the present case, APNs had not yet been issued but, in any event, if they would be to recover the disallowable trading losses, it would appear that there would be no overlap for the purposes of the DR rules in ss554Z11B – G.
HMRC argued that, as representations made in respect of the Follower Notices were still under consideration, the application was premature as that remedy should have been exhausted first.
To succeed in obtaining a declaration of incompatibility on Human Rights grounds the applicant must first establish that:
- there has been a decision of HMRC which is reviewable by the court. HMRC asserted that letters inviting the claimants to negotiate a settlement did not amount to ‘decisions’;
- the claimants are ‘victims’ of a human rights abuse. HMRC argued that individual claimants were not victims, as they were not primarily responsible for the LC tax which is to be accounted for by the company under PAYE;
- the claims are brought in time. Insofar as the challenge was to the LC legislation, it should have been brought within 3 months of the passing of the F(No.2)A 2017 on 16th November 2017;
- in relation to A1P1, the claimants had to have “possessions” which had been interfered with. HMRC asserted that, as their monetary possessions had been impressed with the liabilities to tax, it could not be said that they had been denied enjoyment of those possessions. This was particularly so if the money in question is enjoyed as a consequence of a tax avoidance scheme of which the full facts should have been disclosed. The APN/PPN regime was proportionate and perfectly compatible with A1P1.
The rights afforded by A1/P1 do not impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest or to secure the payment of taxes. Clearly, the State has a very wide margin within which it may exact taxes, particularly through primary legislation. Retrospective tax legislation is permitted provided it strikes a fair balance. It should be sufficiently accessible, precise and foreseeable and must carry out a legitimate aim in the public interest and be proportionate. If the LC and DR legislation do combine to amount to an interference with possessions, is it reasonable and proportionate?
It was pointed out that the style of drafting of the DR legislation is very different from that of other tax legislation in its use of vague terms such as “in essence” and “it is reasonable to suppose”. HMRC accepted that the wording of the DR legislation was intended to allow for the exercise of judgements on the part of HMRC officials in individual cases but made the point that such judgements were subject to the taxpayer’s right of appeal to the tribunal.
In their justification of the DR legislation, HMRC referred to the points made in the March 2019 Report by HM Treasury on time limits and the charge on DR loans. It was also stated on behalf of HMRC that if an enquiry into an earlier year had been closed on the basis that full disclosure had been made, then HMRC would not apply the LC. So far as the particular claimants were concerned, there was no unfairness and, in any event, to succeed in showing incompatibility, they had to show that the legislation would operate unfairly in all cases, not merely in their own cases. Where there are many claimants, they should apply for a group litigation order.
Much emphasis was placed by the claimants upon the effects of the LC upon individual taxpayers (and, indeed, the public gallery was filled with some 40-50 individuals personally affected), as highlighted in the Report of the Loan Charge All-Party Parliamentary Group in April 2019. HMRC pointed out that as the claimants challenge is to primary legislation, rather than to the practice of HMRC, it is not open to them to rely upon the views and opinions of an APPG (which, unlike a Select Committee, has no formal status but merely exercises a right of freedom of speech in Parliament) as these cannot, under Article 9 of the Bill of Rights, be used to impeach the will of Parliament. The claimants must, so it was said on behalf of HMRC, accept that the present government’s position on the LC is at odds with the findings of the APPG.
We await the judgement of the court.
 See s 4 Human Rights Act 1998
 By the insertion of ss554A(5A) – (5C)
 Degorce v HMRC  EWCA 1427
 See, for example, R (oao St Matthews (West) Ltd & others v HM Treasury & anther); sub. nom. R (oao APVCO 19 Ltd & others) v HM Treasury & another  EWCA Civ 648,  STC 2272
 See R (oao Rowe and others) v HMRC and R (oao Vital Nut Co Ltd and others) v HMRC  1 WLR 3039
 See a decision of the EuCt HR in MA & others v Finland  37 EHRR CD210 and a Commission Decision of 10 March 1981 approved in Lay Lay Co Ltd v Malta  ECHR 723.
 NKM v Hungary  STC 1104
 As in the Knibbs litigation in the Court of Appeal  EWCA Civ 1719
Returning from a few weeks holiday, I was looking forward to reading suggestions as to what Sir Amyas Morse might recommend to government which I assumed would be made by those senior members of the profession who, it might be argued, are responsible for bringing about the mess that has resulted in the misery of so many contractors and employees being faced with the Loan Charge. Instead, there is a deafening silence from that quarter. Short of calls from lobby groups for the total repeal of the Loan Charge – a move which is unlikely to be acceptable to any political party given the signal it would send to promoters of tax avoidance – I have yet to see any suggestions made as to what Sir Amyas Morse might recommend to government to be a fair and just solution. There is much comment on how HMRC and the government failed to act and have since sought to recover tax in a manner which circumvents, or undermines, the established checks and balances of the systems for recovery of tax by way of PAYE and self-assessment, but no positive suggestions as to how to address the issue.
So, given that I have previously defended the Loan Charge in principle (see earlier posts), here are my suggestions as to what actions the government and HMRC should now take to resolve the plight of those contractors and employees faced with disproportionate and unplanned for tax bills if either they choose to settle with HMRC on the terms offered, or face up to the Loan Charge and the dilemma of a further charge if the loans outstanding are released.
First, a line must be drawn to distinguish between (a) those cases in which the individual was knowingly participating in a tax avoidance arrangement and was in receipt of money for work done and on which he or she knew that PAYE tax had not been accounted for; and (b) those cases in which (typically) more modestly-remunerated contractors and employees were, in effect, made victims of the greed of others and obliged to accept payment for their services in the form of advances on loan under arrangements promoted to, and established by, their clients, or by an intermediary, as a condition of being given the paid work in the first place. This might also include those who can adduce evidence that they were persuaded to participate in such arrangements on the basis of clear professional advice that they were ‘acceptable’ to HMRC.
Where exactly that line is drawn may be contentious, and there will doubtless be dispute as to the side on which a particular taxpayer should fall.
Those within (b) should then be treated, for all tax purposes, as if the arrangements were, so far as they and HMRC were concerned, a ‘sham’ (whether or not that is strictly correct as a matter of law), HMRC accepting settlements on the basis that the amounts actually received by such individuals were payments of earnings received in the years in which the loans were advanced. This then leaves the question of whether such amounts received should be treated as either (i) having been received net of PAYE tax, on the assumption that the ‘employer’ had deducted and withheld tax and NICs on the grossed-up amounts of such payments (so entitling the individual to a credit for the PAYE tax which should have been deducted from the grossed-up payments) or (ii) as gross payments on which the employee is liable to tax. However, given that, in many cases, HMRC will not be in a position to make a Reg 72 or Reg 81 direction (making the employee primarily liable for the tax) and will in any event be out of time for recovering the tax from the employee, the pragmatic solution may be for the government to accept – on a concessionary and ‘without prejudice’ basis – that such payments be treated as having been net amounts (per(i) above). HMRC should then accept, notwithstanding that ss 554(5A) – (5C) ITEPA 2003 provides otherwise, that the ‘disguised remuneration’ rules and the Loan Charge have no further application in these cases. Insofar as HMRC is in time to recover the PAYE tax and NICs from the ‘employer’, they should make every effort to do so, but if they are now out of time for doing so or for making a discovery assessment, HM Treasury should accept that this is the price to be paid for failure to have acted within the normal time limits and in the proper manner. Of itself, this is not a complete solution as the trustee (or other loan creditor) may well take the view that the arrangement is not a ‘sham’ and, so far as they are concerned, the loan remains outstanding unpaid. However, the issue then becomes one between the individual and the trustee, rather than between the individual and HMRC.
In these situations, HMRC should also accept that the inheritance tax rules relating to 10-yearly charges (under s64 IhTA 1984) and ‘exit’ charges (under s 65 and s72 of that Act) are of no application. This being on the working presumption that amounts advanced to the individual were payments of earnings for duties performed and so both they and the funds applied in payment are, and have at all relevant times been, outside the scope of the inheritance tax rules.
Whilst such an approach should be capable of justification as being an exercise of HMRC’s residual powers of ‘care and management’, I accept that it might be considered to ‘fly in the face’ of the current position under case law (particularly the Glasgow Rangers case) and the ‘disguised remuneration’ legislation as it stands. Legislative change would go a long way to provide certainty and remove the risk of challenge, but may be far down the list of this government’s priorities.
For those within (a), it is more difficult to see on what basis the current rules should be relaxed or repealed. However, one unfairness in the current system is the punitive effect of a combination of the Loan Charge, the further charge(s) arising on a release of a loan, and the complex rules (in ss554Z11(B)-(G)) affording relief from ‘double taxation’ when a given sum has been the subject of multiple unpaid charges to income tax (such as the original earnings charge on the amount contributed to the trust, any advance on loan made post 2010, any earlier writing off of the loan, the Loan Charge itself, and a charge on a subsequent release of the loan). I have suggested that those rules (which were rewritten in 2017) need to be revisited by Parliament so that, in effect, if the Loan Charge bites, earlier occasions of charge for which HMRC is out of time to recover the tax from any and every party are then ignored altogether in determining any amounts of tax outstanding.
What follows is an edited version of my submission to Sir Amyas Morse, who is leading the review ordered by the Prime Minister into the Loan Charge. The Review is due to be completed by November 2019. The closing date for submissions is 30th September 2019.
Advice on the use of EBT loan schemes
Contrary to the assertions made by many others, in the period from c 1992 – 2010, it was neither the ‘received wisdom’ nor the standard practice of all professional advisers, that clients should consider making use of EBT loan arrangements as a ‘legitimate’ means of avoiding, or reducing liability to, income tax and NICs on what would otherwise fall to be charged to tax as payments of earnings.
Broadly, the opinion which I and my team consistently held and gave – long before the Glasgow Rangers case was litigated – was that consideration given by an employer, or, in ‘IR35-type’ situations, by the client, was properly to be treated and taxed as earnings, and that the fact that it was agreed that some or all of that money be received by way of loan from a trust did not alter the character of such earnings. I am aware that this was also the view of many independent advisers and some counsel. Nevertheless, the views reported to have been expressed by certain QCs [lending credence to EBT loan arrangements] appeared to carry disproportionate weight with those advisers seeking an opportunity to profit from the promotion of such arrangements.
The final decision of the Supreme Court in the Glasgow Rangers case was wholly consistent with the opinions I and my team had given over many years, and for which we had come in for some criticism for being too conservative.
How should the government have addressed the abusive use of EBTs?
It was open to the government in and before 2010 to have structured the DR rules on the basis that any company putting funds beyond the reach of creditors by (for example) making a contribution to an employees’ trust, should be subject to an immediate charge to tax at, say, 40% on the amount (or even the grossed-up amount) of that contribution, on a basis which is similar to that of the charge to tax on ‘loans to participators’ under s455 CTA 2010. Credit could then have been given to the company against any subsequent obligation to account for PAYE tax on payments and benefits made out of the trust. This would have been relatively straightforward to legislate for and to enforce. It would have ensured that HM Treasury received tax on amounts earmarked for the provision of benefits, whether by way of loans or otherwise, at the earlier time when the company contributed the funds to the trustees.
It therefore came as a surprise to me when, in 2010, I was first shown a draft of the DR rules and invited to comment upon them. When I asked why they effectively imposed charges on the individual employees, rather than upon the employer, I was told by HMRC officials that this was a direct consequence of a Ministerial decision that the new levy should be structured as a charge on employees, not as a fresh ‘tax on business’. Much of the complexity of the DR rules appear to stem from this early policy decision.
The relationship between the Loan Charge and the earlier ‘re-directed earnings’ charge
On the basis of the Supreme Court decision in the Glasgow Rangers case, PAYE tax was due when an employer made a contribution to an EBT to fund the provision of loans to employees. Clearly, that did not happen in relation to the arrangements under review. HMRC is, in many instances, now out of time to raise assessments on employers under the PAYE regulations.
Tax due under the Loan Charge, if not accounted for by the employer under PAYE, may be recovered from the employee following the making by HMRC of a Reg 80 determination (as the Loan Charge is a ‘notional payment’ per ss710 and 695A ITEPA 2003). In many cases, the employer will have ceased to exist or will not have the cash to be able to account for the charge and so, in effect, HMRC is now able to recover the Loan Charge tax from the individuals, whereas HMRC could not otherwise have collected the PAYE tax originally due on the contributions first made to the trust. This has been put forward as justifying criticism of the Loan Charge as having circumvented the established safeguards and balance as between the right of HMRC to collect tax, and the entitlement of the employee to finality and certainty as to the basis upon which, assuming full disclosure has been made, he or she may rest content that the tax treatment of monies received as consideration for work done has been settled. In my view, this argument is misconceived.
Justification for the Loan Charge
The arrangements typically entered into with employees and IR35-type contractors are all based upon the premise that, once a loan has been extended to an individual, it will remain outstanding until after the death of the debtor when – so it is argued – the loan may be released, and or repaid and then the trust assets appointed by the trustees in favour of the deceased’s dependants in a tax-efficient manner. Meanwhile, the benefit of such a loan falls to be taxed annually as a benefit-in-kind under Chapter 7, Part 2, ITEPA 2003. It is asserted by many that as the tax point was the original making of a contribution to the EBT, so if and insofar as the tax then due cannot, for the reasons summarised above, be collected, that should be an end to the matter.
However, this ignores the quite distinct benefit (which is not expressly brought into charge under those ‘beneficial loan’ provisions) of the decision of the trustee creditor, made from day to day, not to call for immediate repayment of the loan. Most people would accept that being allowed to defer repayment of an outstanding loan is itself a benefit, and one which is distinct from that of having been made the loan (otherwise than on a fixed-term basis), in the first place – the latter having been brought into charge by the ‘beneficial loan provisions’.
I see no reason why the government should not have imposed a one-off charge to tax on the amounts outstanding, having given due warning that it intended to do so and plenty of opportunity for participants to choose to either (a) to reach a voluntary settlement with HMRC of the earlier charge on re-directed earnings, or (b) effect repayment and seek a pay-out from the trustees, or arrange with the trustees for the loan to be written off (so that, in either such case, an immediate charge arises under the disguised remuneration – “DR” – rules). The settlement terms offered by HMRC were, looked at objectively, relatively fair and reasonable – albeit that they have varied over the years.
What is unfair about the Loan Charge?
For many lower-paid employees and contractors, the imposition of an immediate charge to income tax on the entirety of an amount which, in effect, represents income spread over up to 20 years or so – and therefore, in many cases, at a higher effective rate of tax – is a crippling financial burden. This is particularly so in those cases in which the individuals were effectively obliged to accept the arrangements either in the mistaken belief that they were acceptable to HMRC or because the profitable engagement under which they were obliged to accept payment in the form of such arrangements was offered on a ‘take it or leave it’ basis. In these situations, the burden of payment should be spread over a period which broadly equates to that over which the relevant employments/engagements were held.
Who is to blame for the situation?
Whilst the government, HMT and HMRC should all have acted sooner – and as far back as the early 1990s – to address the growing practice of ‘payment by loans’, it is surely only right that the greatest criticism should be directed at those who promoted such arrangements and profited from their adoption through fees and commissions (so that, in many cases, the perceived economic benefits of the arrangements were shared by the ‘client/employers’ and the promoters/advisers rather than by the individual participants). Of course, many such promoters have quietly ‘melted away’. The more reputable offshore trustee organisations have striven to offload their trusteeships of such EBTs to smaller trustee organisations, many of which (in my experience) have inadequate detailed knowledge of UK trust and tax laws. Many substitute UK trustee organisations in the UK are unregulated
In particular, I would hope that the Review will shine the spotlight on those QCs who allowed their Opinions (whether right or wrong in their views as to the law) to be used to lend credence to the promotion of such arrangements. Likewise, those accounting firms – including the major UK firms – who chose to advise positively in favour of, or failed to counsel against, the adoption of such arrangements should also attract criticism.
Those closely-owned companies and owner-managed businesses which entered into such marketed arrangements should also be the subject of criticism.
HMRC is to blame for not acting sooner and for not seeking to secure a ‘Glasgow Rangers’ – type decision of the courts much earlier than it did. HMRC was clearly warned, but officers sat on their hands.
For the reason given above, former Treasury Ministers are to blame for directing that the recovery of tax through the DR rules be structured as a charge on individuals, not on employers, thus giving rise to unnecessary complexity in the legislation (some 60+ pages of detailed provisions having been added to the statute book).
HMRC is to blame for the lack of consistency in its procedures for securing settlement from employers and employees. There have been at least 3 distinct regimes over the years (including the Lichtenstein Disclosure Facility) under which employers and employees have been encouraged to settle their tax liabilities.
HMRC should have consulted outside of HMT/HMRC as to the most effective manner in which to engage in settlement discussions and made clearer from the outset the basis on which HMRC would expect to settle.
There has been confusion and an inconsistency of approach in relation to the inheritance tax aspects of settlements, with no clear exposition from HMRC as to how they will seek to impose charges to IhT under sections 64, 72 and/or 65 IhTA 1984. In this respect, much turns on the detailed structuring of the trust arrangements and whether (for example) use has been made of sub-trusts or sub-funds and whether or not the trusts involved are, or have at some time been, within the scope of s86 IhTA 1984. In many cases neither the promoters or the trustees are familiar with the detailed provisions of the Inheritance Tax Act and have failed to appreciate the actual and potential charges which arise in relation to the EBT loan arrangements. Ministers and HMRC might have succeeded in collecting more tax through settlements had they made a policy decision (or legislated) from the outset to treat all such arrangements in relation to which a ‘Glasgow Rangers-style’ charge applies – and regardless of the nuances of the drafting of trust documentation – as outside the scope of the charges to IhT and thereby encouraging more engagement with employers and individuals.
Is the Loan Charge an appropriate response to the tax avoidance behaviour in question?
For the reason I have described, and in particular the fact that participants have, until the Loan Charge, continued to benefit from a failure on the part of the creditor to call for immediate repayment of a loan – a current and continuing benefit which is not charged to tax under the ‘beneficial loan’ provisions – the Loan Charge is a perfectly fair, reasonable and proportionate response and necessary to bring to an end to such arrangements and to the unfairness as between those employees who suffered PAYE tax and NICs on the full amount of their earnings and those who have not.
My colleague in Chambers, Keith Gordon, has asserted (in Tax Journal 27 Sept 2019) that “In substance, the loan charge is a tax on the loans made in earlier years…” and that it is wrong in principle to impose a charge on something which should have been brought into charge years ago, but for which HMRC is now out of time for doing so. I disagree. This ignores the ongoing and continuing benefit of the creditor determining from day to day that an open-ended loan need not be repaid. It is that distinct, and real, economic benefit at which the Loan Charge is (presumably), or should be, properly directed. Income tax is an annual tax and there is no reason in principle why a government should not determine to levy a tax on an employment-related benefit which accrues on an on-going basis.
Have the changes announced by the government in advance of, and since, the Loan Charge came into effect addressed any legitimate concerns raised about the impact on individuals, including affordability for those affected?
No, not the legitimate concerns noted below.
Whilst the Loan Charge is PAYE earnings, provision has been made which allows HMRC to collect the tax directly from the individual if it is not promptly accounted for by the employer or if, as in many cases, the employer has ceased to exist. The effect of imposing in a single tax year a charge on amounts which represent earnings accrued over many years is unfair, given the failures on the part of HMRC/HMT and government to have taken action sooner and therefore allowed many promoters and individuals to believe(wrongly) that such arrangements were legitimate and acceptable to HMRC. Whilst the Loan Charge itself is, for the reason given above, perfectly fair, there is a legitimate concern as to the manner in which the tax is collected.
In particular, the announcement by the Financial Secretary 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” is surely misguided. Why should those who happen to be in that situation receive more favourable treatment than those who, for whatever reason, were not the subject of an enquiry? If the policy reason for the Loan Charge is to tax the ongoing benefit (see above), the fact that such benefit has been enjoyed by all participants (regardless of whether an enquiry has been opened and closed), means that this policy applies in an arbitrary and unfair manner – possibly to the advantage of those whose other tax planning activities prompted the enquiry in the first place.
A legitimate concern relates to the manner in which HMRC has dealt with settlement negotiations. HMRC staff assigned to dealing with individuals, companies and their advisers have clearly not had sufficient training, and/or general knowledge of the relevant (complex) tax laws, or of how to understand company accounts, so as to be able to engage effectively and address technical questions arising. The advice received from more senior technical staff has on occasions fallen short of the standard to be expected and, particularly in the early days of settlements, showed a lack of consistency.
What should now be done?
I would respectfully suggest that consideration be given to recommending that government:
- should not suspend the Loan Charge, as this would result in thousands of individuals having benefitted unfairly – when compared with the millions of employees and contractors who have duly accounted for tax on their earnings and profits – from having entered into such arrangements, whether they did so voluntarily or having been obliged to do so as a condition of securing work. It cannot be right that individuals who continue to benefit from egregious tax planning should be relieved of liability on what is an ongoing and continuing benefit (of not having to repay the loan) by reason only of the passage of time since the arrangements were first entered into. Further, given the number of settlements already reached, the idea of suspending or revoking the Loan Charge at this stage would mean that a substantial amount of work would be needed to make refunds and compensation payments to those who have already chosen to settle;
- withdraw the policy statement of the Financial Secretary (referred to above) on the basis that it is arbitrary and unfair in its application;
- direct HMRC to allow, in those cases in which the tax cannot be collected from the employer under PAYE, individuals with modest means (regardless of their current annual earnings) to have the benefit of much extended periods for payment so that the period equates broadly with that over which the loans were successively made. In this regard, I would suggest that the threshold below which such an extended facility be offered to individuals be set at, say, current annual income of £150,000 or capital assets (excluding house and pension) of less than £250,000;
- direct HMRC to devote greater resource to training the front-line staff charged with reaching settlements with companies and individuals to allow for direct and meaningful engagement with advisers;
- direct HMRC to consult in future more widely outside of government/HMT/HMRC when seeking to address issues such as an actual or potential haemorrhaging of tax through the development of new techniques. HMRC should be more trustful of the views and opinions of individuals with recognised experience and expertise, whilst clearly taking care to avoid those who have been responsible for giving opinions which support egregious tax planning. In my experience there is a genuine willingness on the part of many able and gifted advisers to make a positive contribution to addressing such issues. The idea that anyone outside of HMRC is likely to undermine the government’s efforts is misconceived. I would point to the success of the SIP/EMI legislation which was (for the first time) put together by a team recruited from outside of HMT/HMRC and has well stood the test of time.
David Pett Temple Tax Chambers