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