Contractors who have engaged in disguised remuneration schemes over the past two decades have little time left to avoid potentially huge tax penalties, as the April deadline for the 2019 Loan Charge approaches.
Billed by HMRC as ‘a charge on outstanding loan balances’, the retrospective tax charge looks set to have disastrous consequences for contractors, many of whom engaged in tax avoidance schemes to avoid perceived excessive taxation at the hands of IR35.
The Loan Charge grants HMRC license to punish contractors retrospectively for loan agreements dating back to 1999. As such, it has been heavily criticised by experts, who have described it as a disproportionate response to an issue which is partly HMRC’s own making.
What is the 2019 Loan Charge?
In the Finance Act (No 2) 2017, Government introduced aggressive measures to tackle the use of disguised remuneration loan schemes, known as the 2019 Loan Charge.
The charge targets remuneration by way of a third-party loan, the most common being the Employee Benefit Trust (EBT). Here, an employer would pay into an EBT and receive a tax deduction, with funds paid out to employees as non-taxable loans which were to be left outstanding indefinitely.
Rules had already been introduced within the Finance Act 2011 to ensure that EBT loans were taxed as employment income. This tax charge didn’t apply to loans made before the 2011 Finance Act, meaning those loans were safe for the time being.
However, when the Loan Charge was introduced in 2017, it granted HMRC power to look back almost 20 years over the tax affairs of those involved. This is far more than the four-year enquiry window that HMRC is granted to raise a standard discovery assessment, and predictably has had a devastating impact.
Such retrospection stomps all over the absolute necessity of certainty within taxation that enquiry windows provide. Considering the emphasis that the Organisation for Economic Co-operation and Development (OECD) places on such certainty, it will be interesting to hear its response on the matter of the Loan Charge.
The Loan Charge is not limited to EBTs. HMRC can investigate and apply a charge to any third-party loan which is found to have been set up with the intention of benefitting an employee, and which was entered into on or after 6 April 1999.
Whatever portion of the loan is still outstanding by the 5 April 2019 deadline will be subject to the charge. Taxpayers have until then to make repayments to reduce or negate their Loan Charge, which must be paid in cash only.
The legislation was obviously geared towards motivating those in receipt of these loans to repay them before the Loan Charge takes effect, to mitigate their impact and show that their loans were not disguised remuneration.
Who and what is to blame for the 2019 Loan Charge?
The Loan Charge is a means of tackling loan schemes. For many, initial involvement seems to have been driven by IR35. The Loan Charge encompasses disguised remuneration loans entered into throughout the existence of IR35, which Manley notes sparked an uptick in scheme usage:
IR35 was the beginning of the situation that we find ourselves in today. Many limited company contractors joined these schemes to avoid breaking IR35 rules, and the majority of contractors caught in this charade were sold these structures as protection against IR35 by advisors.
HMRC has been quick to condemn those involved as large-scale tax avoiders. Manley continues. But what it has failed to acknowledge is that, due to the fees paid to promoters, contractors often received a very similar amount in net pay to what they were previously receiving through their limited company prior to IR35.
Manley adds that, for the majority, tax avoidance wasn’t the main motivation, as the relatively modest savings made would suggest. Instead, the key driver for most was escaping punitive taxation at the hands of IR35, which imposed both employment taxes and employer’s National Insurance (NI) upon affected contractors. This results in an effective tax rate far more than that paid by an employee.
HMRC’s failure to tackle loan schemes and close loopholes has also inevitably contributed to the introduction of the Loan Charge. Remarkably, despite schemes being displayed on individual tax returns and Disclosure of Tax Avoidance Schemes (DOTAS) numbers declared, HMRC failed to open an enquiry into many cases.
The enquiries that the taxman had opened yielded nothing, as HMRC spent so much time unsuccessfully trying to convince the courts that loans were taxable. HMRC simply had no way of lawfully collecting tax where it had issued a closure notice. To get around this inconvenience, it did nothing until eventually conceiving the Loan Charge as a means of cleaning up its mess.