Sarah Laing points out that HMRC is challenging certain tax avoidance arrangements sometimes used by ‘one man band’ companies in particular.
Contractors and freelancers may be aware of schemes often referred to as ‘contractor loan schemes’ or ‘remuneration trusts’ which claim to avoid income tax by paying participants in the form of loans. This article outlines the arrangement and highlights reasons why such arrangements should be avoided.
How does the scheme operate?
In a contractor loans scheme, an individual is paid in the form of a loan from a trust or company, sometimes referred to as a remuneration trust. The payment is not made directly by the engaging company, and will be diverted through a chain of companies, trusts or partnerships.
Scheme promoters have claimed that payments are non-taxable, because they are just loans and don’t count as income. However, since the loan is not paid back, the payments are to be treated as normal income and should be taxed accordingly. Those who use such schemes are highly likely to be regarded by HMRC as participating in tax avoidance arrangements, and this could result in additional taxes, penalties and interest becoming due.
In their guidance on the use of contractor loan schemes, HMRC specifically refer to the case of Boyle v HMRC  UKFTT 723 (TC), where the taxpayer’s appeals against discovery assessments and/or closure notices in respect of a scheme for ‘soft currency loans’ from his employer, an Isle of Man company, failed. The tribunal determined that the loans were not genuine and the money paid to Mr Boyle as loans was ‘in substance and reality income from his employment’ and therefore taxable.
HMRC on the attack!
The first point to note is that all contractor loans schemes must be declared to HMRC. Once declared, the scheme promoter receives a scheme reference number, which must be passed on to all users of the scheme. So, if you are using a contractor loans scheme and you don’t show the correct scheme reference number on your tax return, you will be charged additional penalties. Note that HMRC also challenge undisclosed schemes, which means that even if a scheme hasn’t been declared, you may still need to pay additional tax, penalties and interest if you’ve used it.
Broadly, HMRC never ‘approves’ schemes, so the reality is that the reference number merely identifies users, which in turn, prompts HMRC to investigate it! It is also worth noting here that HMRC wins around 80% of avoidance cases that taxpayers take to court, and many more users choose to settle their affairs before that stage.
It is highly likely that an individual using a scheme will receive an ‘accelerated payment notice’ (APN) from HMRC, requesting them to pay tax and NIC ‘up front’, whilst the scheme is being investigated. The APN will only cover the tax or NICs advantage relating to the specific avoidance scheme covered by the APN. The amount shown may not be the final liability agreed, which may be larger or smaller than the amount of the APN. It will not include any interest, penalties or other tax that may be due in the year. Therefore, when the enquiry or appeal is finalised, there may be additional amounts to pay.
HMRC points out that it may contact a scheme user’s clients to check their position relating to the contract. This may put vital working relationships at risk. HMRC may also seek information held by mortgage providers and other creditors about loans from schemes. If the level of income on your tax return is lower than the income disclosed on a mortgage application, HMRC may seek penalties.
If the loan was paid through a trust, inheritance tax may also be payable, either immediately or at some stage in the future.
HMRC strongly advises anyone using a scheme to withdraw from it and settle their tax affairs. There is a contractor loans helpline (0300 534 226) for anyone requiring further assistance.
This article was first printed in Tax Insider in September 2016.