A Judicial Review of the Loan Charge

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[1]. 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[2] (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[3] 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.[4] 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.[5]

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.[6] It should be sufficiently accessible, precise and foreseeable and must carry out a legitimate aim in the public interest and be proportionate.[7] 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.[8] 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.[9]

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.[10] 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.

David Pett

[1] See s 4 Human Rights Act 1998

[2] By the insertion of ss554A(5A) – (5C)

[3] Degorce v HMRC [2017] EWCA 1427

[4] 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 [2015] EWCA Civ 648, [2015] STC 2272

[5] See R (oao Rowe and others) v HMRC and R (oao Vital Nut Co Ltd and others) v HMRC [2018] 1 WLR 3039

[6] See a decision of the EuCt HR in MA & others v Finland [2003] 37 EHRR CD210 and a Commission Decision of 10 March 1981 approved in Lay Lay Co Ltd v Malta [2013] ECHR 723.

[7] NKM v Hungary [2013] STC 1104

[8] https://www.gov.uk/government/publications/report-on-time-limits-and-the-disguised-remuneration-loan-charge

[9] As in the Knibbs litigation in the Court of Appeal [2019] EWCA Civ 1719

[10] http://www.loanchargeappg.co.uk/wp-content/uploads/2019/05/Loan-Charge-Inquiry-Report-April-2019-FINAL.pdf

The Loan Charge – So What Should Be Recommended to Government?

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.

David Pett

Independent Review of the Loan Charge: Submission Made

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                                              

 

 

 

Briefing Note on ‘the Loan Charge’

In response to concerted pressure from MPs and lobby groups, and in fulfilment of a promise made by Boris Johnson to Parliament, the government has asked Sir Amyas Morse (former Head of the National Audit Office) to conduct a review, to be completed by November 2019, into whether the ‘Loan Charge’, “as it applies to individuals who have directly entered into disguised remuneration schemes, is an appropriate response to the tax avoidance behaviour in question”. To understand what this is all about, read on….

  1. Many relatively low-paid employees and contractors have been lured into providing their personal services to clients, including government departments, on the basis that, each year, the individual worker would receive minimum wage payments, subject to income tax and NICs under PAYE, and the balance of the consideration for their services being made up of loans – typically advanced by the trustees of an offshore trust funded directly or indirectly by the client . The loans were generally represented to be ‘open-ended’, that is, there was no expectation that the worker would be required to repay the loan for many years, if at all. (Broadly, it was anticipated that the loan would be released, free of tax, after the worker’s death.) The loan element was – so it was represented – not “earnings”, and therefore not subject to deduction of income tax and NICs under PAYE.
  2. Such arrangements were widely promoted by accountants and other tax advisers in the period from c 1993 until (at least) 2010. They were adopted by a wide range of employers/engagers, both small and large, including government departments.
  3. In many cases the legitimacy of the arrangement was represented by promoters and advisers to be in reliance upon the written Opinions of well-known Q.C.s. Whilst never formally ‘approving’ such arrangements, HMRC were slow to challenge them or respond to disclosures of their intended use or open enquiries into returns which made full disclosure of them.
  4. The practice of having third-party trustees make such loans to employees and directors was effectively stopped when, in 2011, the ‘disguised remuneration’ rules (in Part 7A, ITEPA 2003) were introduced. It is understood that Ministers insisted that this legislation be framed as imposing a charge on individual employees, rather than as a levy on the employer funding the arrangement. Similar rules relating to workers who were not employees or directors took effect from 6 April 2017.
  5. In 2017, the Supreme Court (in the “Glasgow Rangers” case) ultimately held that payments for or in respect of an employee’s services which are re-directed with the consent or acquiescence of the employee to a third party (such as trustees) nevertheless fall to be taxed as payments of earnings subject to deduction of tax and NICs under PAYE.
  6. The disguised remuneration rules did not, of themselves, bring into charge to income tax the benefit enjoyed by employees and workers of having existing pre-2011 loans remain outstanding, and employers/clients, and individual taxpayers, were showing an obvious reluctance to come forward and agree settlements with HMRC, accepting that the amounts outstanding were properly to be taxed as earnings or profits of a trade.
  7. Accordingly, the government introduced a ‘one-off’ charge to income tax (and NICs) on (broadly) the aggregate amount of loans outstanding as at 5 April 2019 (“the Loan Charge”). The charge applies to all loans made as far back as 1999 in circumstances which, if such a loan was now made, would fall within the scope of the ‘disguised remuneration’ charges introduced in relation to employees and directors, in 2011 and, for certain other workers and close company participants, in 2017.
  8. Criticism of the Loan Charge has been voiced on the basis that:

(a) It is perceived as ‘retrospective’ in effect, as it applies to loan arrangements made as far back as 1999.

However, the charge is levied on the current, ongoing, benefit to an individual of the lender failing to call for repayment of the loan, that being a benefit which accrues daily for so long as it remains unpaid. The charge did not apply in relation to a loan if it had been repaid in cash before 6 April 2019.

(b) The Loan Charge imposes an immediate charge to income tax (and NICs), on a single occasion, on amounts which represent the aggregation of income accrued over up to 20 years. A reporting obligation must be satisfied by 30 September. The tax, if not accounted for under PAYE, must be accounted for by self-assessment, with the deadline for submission of SA Returns being 31st January 2020 (and an earlier deadline of 5 October for paper returns).

Whilst HMRC has offered deferred payment terms to those individuals with gross annual earnings of less than £50,000, the burden on many individuals to fund the tax is very substantial and it has been reported that, in extreme cases, individual taxpayers have been driven to suicide as a consequence.

(c) In most cases, the burden of the charge falls on the individual, rather than upon the employer or client who, typically, stood to benefit from the arrangement as it meant that the net cost of the arrangement was reduced below that of paying earnings in cash, principally because of the saving of employers’ 13.8 % NICs.

Whilst extant employers are primarily liable to account for tax under the Loan Charge, in the case of those which have ceased to exist, or are no longer the PAYE employer, HMRC is exercising power to recover the tax directly from the individual.

(d) In reality, many individual participants benefitted only marginally, in terms of net ‘cash in hand’, as much of the perceived ‘savings’ were taken by the promoters/advisers in fees. Many lower-paid employees and contractors had little or no choice as to whether to participate in such arrangements as the employer/intermediary/client made such participation a condition of securing the paid employment/engagement.

(e) So far as many individual participants were concerned, it was represented to them that such arrangements were ‘legitimate’ and ‘acceptable’ to HMRC, and this understanding was reinforced by the fact that HMRC did not in fact challenge such arrangements even when the full circumstances were disclosed to them, either by way of formal ‘up-front’ ‘disclosures [by the promoters] of a tax avoidance scheme’, or in response to enquiries opened into an individual’s self-assessment return.

(f) Those who in fact gained most from such arrangements (as implemented in relation to relatively low-paid workers), namely the promoters and advisers, have effectively avoided sanctions. It is not possible, under existing laws, for HMRC to secure recovery, from the promoter/adviser, of the tax now due from an individual participant.

(g) Whilst HMRC has, until recently, offered, to both employers and individuals, ‘settlement opportunities’ which would allow an individual to avoid the Loan Charge by the employer or employee agreeing to account for tax on the loans as if they were earnings of the relevant years, the tactics used by HMRC to ‘persuade’ taxpayers – particularly individuals – to reach settlement agreements have been strongly criticised as “strong-armed”.

 

David Pett, Temple Tax Chambers                                                            11 September 2019

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.

How Far Will the Courts Go to Rectify a Tax Statute?

Once upon a time, taxpayers and their advisers could take at face value the wording of a tax statute and ensure with certainty that matters were within, or outside, the clear words of a charging provision. It is, after all, widely accepted that “a subject is only to be taxed on clear words, not on any ‘intendment’ or on the ‘equity’ of an Act” (per Lord Wilberforce in WT Ramsay v IRC [1982] AC 300 (known as ‘the clear words principle’).  So, if the wording is clear, the taxpayer is at liberty to ‘work around’ it, or so arrange matters as to fall within an exemption, or outside a charge, as he or she pleases.  If the clear words produce an unintended effect, that should surely be recognised as the ‘fault’ or consequence of the efforts of the legislative draftsman or of Parliament. Not now, it seems. If the clear words allow taxpayers to frustrate what the courts infer to be the presumed policy intent of the legislation, the courts will readily seek to apply an interpretation which rectifies the shortcoming in the drafting and imposes a charge in the manner in which it is presumed to have been intended. How far can the courts be expected to go in presuming to rectify the faults of Parliament?

In the UBS/Deutsche Bank case (UBS AG and Deutsche Bank Group Services (UK) Ltd v HMRC [2016] UKSC 13), which came before the Supreme Court in 2016, the court was required to consider if the deliberately constructed rights of securities in a special-purpose company meant that the securities were, or were not, “restricted securities”. The statutory definition of a security which is “restricted” (in s 423 ITEPA 2003 (as amended)) is clear and unambiguous. The terms of the securities in question were carefully crafted so that they fell within that definition and would therefore be exempt from tax on acquisition. If they were so restricted (by being subject to a short-term risk of forfeiture), the taxpayer companies would have succeeded in avoiding many millions of PAYE tax on bankers’ bonuses. However, the Court held that the reference, in s423, to “any contract agreement, arrangement or condition which makes provision to which any of ss(2) to (4) applies” is properly to be construed as being limited to provision having a business or commercial purpose, and not to commercially irrelevant conditions whose only purpose is the obtaining of the exemption, notwithstanding that the legislation makes no reference to such a requirement. The court took it upon itself to presume an intention of Parliament, namely that securities will not be taken to fall within the clear and prescriptive definition in the statute if taxpayers would thereby succeed in gaining exemption from tax notwithstanding a lack of commercial purpose. Of course, had the provisions included, as a requirement for such exemption, a ‘purpose test’, the need to have imposed this extra-statutory requirement would not have arisen. Parliament was surely at fault for having failed to do so.

It had been hoped (by the author, at least) that this was the ‘high water-mark’ of moves by the judiciary to correct errors in, or seek to avoid unintended consequences of, the drafting of tax statutes. Surely, if Parliament fails to ‘cover all bases’, the citizen is  – and, in a democracy governed by the rule of law, should be – at liberty to order his or her affairs so as to conform to the letter of the law, albeit with a consequence which might be widely regarded as egregious, selfish and anti-social. Not so, it seems.

The recent judgement of the Supreme Court in Hancock v HMRC ([2019] UKSC 24) is a further example of the court making every effort to avoid taxpayers enjoying the benefit of having relied upon the most obvious interpretation of what are, in this case, clear words in the Taxation of Chargeable Gains Act 1992 (“TCGA”). Here, the taxpayers had taken advantage of the fact that s116(1)(b) TCGA 1992 (which, if it applied meant that a conversion of securities into other securities would qualify for ‘rollover relief’ and therefore defer, but on a later disposal result in, a charge to tax) makes clear reference to two situations: where the original shares consist of or include a QCB and the new holding would not; or where the original shares would not and the new holding would consist of or include a QCB. In the appellant’s situation (deliberately engineered), the original shares included QCBs and the new holding into which they were converted was solely of QCBs, so – it was argued – neither limb of s116(1)(b) applied and, in consequence, the later disposal of the new holding of QCBs should have been exempt from CGT by reason of s115 TCGA 1992.

One response to such an opportunistic move by the taxpayers could have been for HMRC to accept that there is a lacuna in the drafting of TCGA 1992 and arrange for it to be rectified at the next available opportunity to do so, leaving the taxpayers to deal with the opprobrium to be heaped upon them for successfully avoiding tax.

Should government and the courts not accept that such shortcomings are the responsibility of Parliament to correct, not for the justices to do so? As Lady Arden has demonstrated, that is not the view of the Supreme Court: “…the Appellants’ interpretation result would be inexplicable in terms of the policy expressed in these provisions, which is to enable all relevant reorganisations to benefit from the same rollover relief [and not for some only to be treated differently so as to enable a subsequent disposal to be treated as exempt from CGT]”.

To ensure the taxpayers were liable for tax on the gain realised by them, Lady Arden adopted the reasoning of the Court of Appeal that “it is clear that the intention of Parliament was that each security converted into a QCB should be viewed as a separate conversion (which amounts to the same thing as regarding the conversion…as consisting of two conversions, one of QCBs and one of non QCBs).” On that basis, the taxpayers triggered a chargeable gain when the rolled-over securities were disposed of. Further, and because s132 states that sections 127-131 shall apply “with any necessary adaptations” to conversions as they apply in relation to a reorganisation (i.e. providing for there to be a ‘rollover’ not involving a disposal, with the new securities being treated as the same asset acquired as the old securities were acquired), the ‘clear words principle’ was, in Lady Arden’s judgement, observed.

This is subtly different from applying the principle in Luke v IRC [1963] AC 557. That enables a court to adopt a “strained interpretation [of a statute] in place of one which would be contrary to the clear intention of Parliament, although this is limited to, for example, situations in which there is not simply some inconsistency with evident parliamentary intention but some clear contradiction with it – and the intention must be clearly found in the wording of the legislation”.

Of course, and with due respect to her ladyship, in the absence of an express statement of policy in the statute itself (which is not something normally to be found in a taxing statute – perhaps the nearest one comes to a declaration of intent is, for example, s527 ITEPA in relation to EMI options), the policy intention of HMRC and/or Parliament can only ever be inferred from the effect of the words of the Act. Drawing such an inference inevitably involves an element of subjective judgement as to which informed judges may, not unreasonably, differ in their opinions. This is surely what underlay the ‘clear words principle’ – that, and the broader notion that the citizen should not be deprived of his assets without Parliament having clearly stated the basis on which it is to be done.

If, had the appellants in Hancock been correct, the way would have been opened for relatively easy tax avoidance, the answer is surely that this is the price worth paying for ensuring that the citizen is only deprived of his wealth by the clearly expressed will of Parliament – not by what a court might infer to be the broad intention of Parliament (rather than that of HMRC and/or government) which, if the provisions were not fully debated, may not be clear.

When Is a Share, or Share Option, “Employment-Related” so as to Come Within the Scope of the Charging Provisions of Part 7, ITEPA 2003?

It has long been understood that the charges to income tax on employment-related securities apply to shares, or a share option, acquired by a person if the right or opportunity to do so is available “by reason of” an office or employment (see ss421B(1) and 471(1) ITEPA). However, when re-enacted in 2003, the legislation further extended the scope of Part 7 by providing that a right or opportunity to acquire shares, or options, is deemed to be available by reason of an office or employment if it is made available by a person’s employer or by a person connected with a person’s employer (e.g. another company in the same group). These ‘deeming provisions’, in ss421B(3) and 471(3), are not easy to interpret and apply, not least because the definition of “employer” – which refers to the (office or) employment  by reason of which the opportunity is available – appears to produce a circular analysis.

As Charles Hellier pointed out in his decision in Steven Price ([2013] UKFTT 297 (TC)), the sections cannot be construed literally, as that would mean that shares or options acquired pursuant to an opportunity made available to an individual by someone who happened to be an employer of another person,  would be caught by the deeming provisions, and that is absurd.

If the answer is that, for the deeming provisions to apply, the provision by a company of an opportunity under which the shares or options are acquired must be linked to an office or employment by the individual with the same , or a connected company, then this would appear to be no different from the test of whether the shares or options have been acquired pursuant to an opportunity made available “by reason of” an employment. Further, if Parliament had intended that an option granted to a person who is, or has been, an officer or employee, is invariably to be treated as an employment-related securities option (regardless of the fact that it is not ‘by reason of such office or employment’), the legislation would simply have said so. But it does not.

Of course, if the opportunity was in fact made available by a person or persons other than the company with which the individual has an office or employment (or a connected company), the deeming provisions cannot apply. So, if for example, on investigation, it is the shareholders, or one or more of them, who make the opportunity available, not the company itself, then, provided the acquisition is not “by reason of” an office or employment, the shares or options will fall outside the scope of Part 7.

A recent decision by Dr Heidi Poon (best known for having delivered the minority judgement in the Glasgow Rangers case in the First Tier Tribunal – ultimately substantially upheld by the Supreme Court) in the case of Vermilion Holdings Ltd v HMRC ([2019] UKFTT 0203 (TC)) has looked again at the scope of these deeming provisions. An individual investor held options to subscribe for shares in the company. He subsequently became a director and, in his capacity as an investor, was party to the negotiation of a reconstruction and refinancing deemed necessary to save the business of the company. In short, in was decided that his option terms should be amended so as to reduce his proportional entitlement on exercise of the option, relative to that of other investors (including himself). Rather than amend the terms of the existing option, it was decided, for commercial reasons, to cancel the original option and grant a fresh option on new terms. The new option was clearly not granted “by reason of employment”, but as it was granted by the company of which the individual was then a director, HMRC asserted that the deeming provision of s471(3) applied. Clearly it would be unfair if the individual were, in this situation, to find himself chargeable to income tax and NICs, rather than capital gains tax as would be the case with any other investor in the same position who happened not to be a director.

At the end of a long judgement, Dr Poon holds in favour of the company (the appeal having been brought by the company in response to a Reg 80 determination in relation to the PAYE income tax and a s8 decision in relation to the associated NICs), apparently on the basis that “[the individual’s] right to acquire the 2007 option was not ‘made available’ by Vermilion as his ‘employer’” (para 141). Expressed in these terms, the decision is clear and straightforward – and hardly justifies some 15+ pages of analysis. However, I say “apparently”, as this is stated to be an alternative ground: the principal ground being that “The ambit of the deeming provision should be limited where the artificial assumption is at variance with the factual reason that gave rise to the right to acquire the option” (para 140). This leads us into difficult territory, suggesting as it does that, even if the opportunity to acquire the option is provided by the company, the deeming provision does not apply if  (a) that right or opportunity was not available by reason of the individual’s office or employment and (b) the acquisition was not pursuant to an opportunity which was so available.

Charles Hellier earlier gave the example of a bank offering options to all customers, some of whom are employees of the bank. He suggested the need for an investigation in such cases into whether a link exists between the employment and the opportunity. If the opportunity under which an option is acquired is not the same as the opportunity offered to an employee, the deeming provision does not apply. This may work if the opportunity is afforded to a number of individuals, some only of whom happen to be employees or directors, but the position is not so clear if the opportunity is offered to only a single individual who happens to be an employee or director. Can the link with the office or employment be so easily broken?

What if (for example) an employed shareholder is given the opportunity to acquire shares made available by operation of the articles of association requiring a leaver to offer their shares for sale to all remaining shareholders on a pro-rata basis? If an opportunity to acquire shares is offered to all shareholders, only some of whom are directors or employees, it is easy to see that the opportunity is acquired qua shareholder and that there is no link between the acquisition of the shares and an individual’s office or employment with the company. Here, the “artificial assumption”, that the acquisition is by reason of employment, is at variance with the factual reason which gave rise to the right or opportunity to acquire the shares.

However, the opportunity to acquire the shares is made available by the employer (through the operation of its articles), and prima facie therefore the deeming provisions would appear to apply. Put another way, if they are not to apply in such a case, Parliament’s presumed intention of extending the scope of Part 7 may be rendered ineffective.

That said, the decisions in both Steven Price and Vermilion would appear to support the conclusion that the deeming provisions do not apply if:

  • the opportunity to make the acquisition is not by reason of an office or employment; and
  • although that opportunity is made available by the employer company, there is no causal link between the acquisition of the shares or option and the office or employment held by the individual.

The difficulty remains that, if the deeming provisions are not to apply in relation to such an acquisition by a director or employee, in what circumstances are they intended to apply? When is an acquisition from the employer made pursuant to an opportunity afforded by the employer which is not by reason of that office or employment, but is linked to the office or employment with that employer (so as to fall within the deeming)?

We are left in a situation in which unless, as in Vermilion, the opportunity to acquire shares or an option is not in fact made available by the employer of the individual concerned, the scope and application of the deeming provisions remains unclear.

…………………………………………………………

5 May 2019