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Why it’s time to end Offshore and Contractor Loan Schemes?


There have been many creative schemes promoted to contractors, entertainers and sports stars, basically using a limited company to make loans to connected parties to avoid tax.

HMRC have been attacking these schemes for years, for example the Boyle case

Philip Boyle v HMRC [TC03103] 2013

On the 16th September HMRC published Spotlight 26: Contractor Loan Schemes – Too good to be true

Contractors and freelancers are bombarded by promoters who make claims that they can help individuals take home as much as 80% to 90% of their income. Sounds too good to be true, that’s because it is.

So why is this considered to be tax avoidance? These promoters use schemes to reduce the amount of tax you pay on your income by making payments which purport to be ‘loans’ from a trust or a company. Normally, a contractor would receive the contract income directly and pay tax on it. These arrangements artificially divert the income through a chain of companies, trusts or partnerships and pay the contractor in the form of a ‘loan’. The ‘loans’ are claimed to be non-taxable because they don’t form part of a contractor’s income. However, in reality the ‘loans’ aren’t repaid and the money is used by the contractor as if it were his or her income.

HM Revenue and Customs (HMRC) view is that these schemes don’t work and strongly advises any contractor or freelancer who has used such a scheme to withdraw and settle their tax affairs. People who settle with HMRC avoid the costs of investigation and litigation and minimise interest and penalty charges on the tax which should have been paid.

Don’t be fooled by promoter websites..

The promoters’ websites and promotional literature claim that they are fully compliant and are HMRC approved. HMRC doesn’t view these arrangements as compliant and never approves any schemes.

Contractor loan schemes, of the sort described above, must be declared under the Disclosure of Tax Avoidance legislation. The promoter is required to pass the scheme reference number (SRN) to all the users who must put this on their tax return. A failure to show the correct SRN on your tax return will lead to additional penalty charges.

Don’t be tempted, HMRC are closing in on unpaid tax, they will find you!

HMRC aims to raise further £5bn in tax revenue

Thanks to

Her Majesty’s Revenue & Customs (“HMRC”) are seeking new powers as follows:

1. Advance Payment – basically in any dispute between HMRC and a tax payer HMRC would be able to assess what tax they believe is due and require the tax payer to pay this as a sort of ‘refundable deposit’ until such time as the dispute is resolved through arbitration or court. Perhaps more importantly, if granted, these powers will be applied retrospectively.

Given that at the current time there are unresolved cases going back ten years or more and that once HMRC has the tax payers’ money there will be even less incentive for them to come to a resolution then this is essentially HMRC to act as judge, jury, and executioner. Isn’t this simply a ‘guilty until proven innocent’ treatment of tax payers?

2. Direct Debit – where HMRC believe that the tax payer owes them money then they will be able to simply take money directly from the tax payer’s bank account. As I understand it there will be further powers to obtain previous bank statements and this will no doubt lead to further tax investigations.

The legislation which will encapsulate these powers is currently going through Parliament, and despite opposition from lobby groups and committee members alike, HMRC seem intent upon pushing this legislation through with a view to achieving Royal ascent in mid July 2014.

Of course, should HMRC gain these powers they will hit the easy targets first i.e. those who have ‘played by the rules’ and properly disclosed everything through DOTAS, and those who operate proper business bank accounts, so it will do nothing to address those who have hidden their activities from HMRC and those who operate in the black ‘cash-in-hand’ economy.

Whilst the general public may have little sympathy for people who ‘don’t pay their fair share of tax’ (if there is such as thing – see Did Jimmy Carr just use the wrong vehicle?) we have to remember that tax avoidance is entirely legal as it simply takes the rules and regulations enacted in law and uses these to reduce a tax payer’s liability.

The new powers will do nothing to tackle tax evasion, which is illegal, and so it is no surprise that spokesmen for HMRC, and representatives for HM Government, have sought to blur the lines between legal avoidance and illegal evasion in recent times. We can be equally sure that HMRC will not be tackling the multi-nationals like Google and Starbucks who have made recent headlines with their tax affairs, and so it will (as ever) be small firms that will bear the brunt of any HMRC action.

What we shall no doubt see is an increase in non-DOTAS schemes being made available to tax payers by providers of such schemes, and I fear beyond that we shall see a rise in business insolvencies and loss of jobs, all of which will run contrary to HMRC’s aim to raise further tax revenues.

Paul Driscoll is a Chartered Management Accountant, a director of Central Accounting Limited, Cura Business Consulting Limited, Hudman Limited, and AJ Tensile Fabrications Limited, and is a board level adviser to a variety of other businesses.

Tax Planning v’s GAAR and the “Double Reasonableness Test” – Will GAAR stop tax avoidance abuse?

UK tax return form

The general anti abuse rule (GAAR) has now been adopted by many advisers in the UK.

The GAAR will apply to Corporation Tax (and amounts treated as Corporation Tax), Income Tax, Capital Gains Tax, Petroleum Revenue Tax, Inheritance Tax, Stamp Duty Land Tax, and the annual tax on enveloped dwellings.

Heather Self, Pinsent Mason commented.  “Many of the examples are complex and contrived – we need more examples of ‘normal’ tax planning, to help show where the boundary will lie.”

The key changes to the legislation relate to the “double reasonableness test”. Nearly all the respondents to the consultation expressed concern about this test. The stated purpose of the GAAR is to counteract “tax advantages” arising from “tax arrangements” that are “abusive”. The tests of “tax advantage” and “abusive” both use concepts of reasonableness and this has been referred to as the “double reasonableness test”.

Accountancy Age reported on the 3rd April 2013:

A LACK OF CLEAR DEFINITION within the incoming General Anti-Abuse Rule is likely to cause “considerable uncertainty”, advisers have warned.

The GAAR, designed to catch and prevent contrived tax avoidance schemes, was included in the 2013 Finance Bill and will take effect once it has received Royal assent in July, although many practitioners have been treating it as if it came in on 1 April.

Chair of the House of Lords committee on the Finance Bill Lord MacGregor said : “There is a misconception that GAAR will mean the likes of Starbucks and Amazon will be slapped with massive tax bills.

“This is wrong and the government needs to explain that to the public. GAAR is narrowly defined and will only impact on the most abusive of tax avoidance.”

There are other concerns too….

The Institute of Chartered Accountants in England and Wales (ICAEW) has reiterated its criticisms of draft legislation for a General Anti-Avoidance Rule, claiming that the proposed GAAR is confusing and that it could be in breach of international obligations by overriding double taxation treaties.

The ICAEW draws attention to Article 27 of the Vienna Convention, which the UK signed in 1971 and which states that “a party may not invoke the provisions of its internal law as justification for its failure to perform a treaty.” ICAEW argues that the GAAR may therefore be unlawful, particularly in the case of around 100 agreements with non-OECD countries.

HMRC will be monitoring for GAAR by:

  1. Reviewing DOTAS (Disclosure of Tax Avoidance Schemes) for abusive schemes, in general DOTAS are reported by the scheme promoter or scheme user – HMRC have a number schemes under the spot light
  2. Intelligence via other sources or disclosure
  3. Records of successfully litigated or settled by agreement GAAR cases
  4. Regular communication with taxpayers and their advisers

DOTAS penalties fall into three categories:

  • Disclosure penalties: apply to failure to disclose a scheme. There are variations in cases where a Tribunal has issued a disclosure order.
  • Information penalties: apply to other failures to comply with DOTAS.
  • User penalties: apply to failure by a scheme user to report a Scheme Reference Number (SRN) to HMRC.

In all cases apart from user penalties (which are up to £1,000) the initial and daily penalty is determined by a Tribunal and could be up to £5,000 per day.

Its important to note:

Tax avoidance is not the same as tax planning. Tax planning involves using tax reliefs for the purpose for which they were intended. For example, claiming tax relief on capital investment, saving in a tax-exempt ISA or saving for retirement by making contributions to a pension scheme are all legitimate forms of tax planning.

So will GAAR work? does it need to be clarified so that we can understand it? I am sure we all agree that everyone should pay their fair share of tax but is GAAR the best way to achieve this?

Did Jimmy Carr just use the wrong vehicle?

Thanks to

A year on from when comedian Jimmy Carr apologised for using a legal tax avoidance scheme which enabled him to pay as little as 1% tax on his earnings, and with GAAR upon us, tax avoidance has rarely been out of the news headines.

Prime Minister David Cameron stated that “… some of these schemes we have seen are quite frankly morally wrong”, and Danny Alexander, chief secretary to the Treasury, suggested that tax avoiders are the “… moral equivalent of benefit cheats”.

Whether you feel that David Cameron has the moral high ground given the alleged source of his family’s wealth, and whether you feel he was right to name Jimmy Carr in this way, are discussions for another day, but what the comedian had done was entirely legal, so what is the real problem here?

Do we really think that the tax system is a level playing field and that there is a ‘right amount of tax’ we should be paying, and that everyone on similar earnings pays the same amount of tax?

Well think again, because it just ain’t so!

Let’s take for example three fictional friends in the 2012-13 tax year, each of whom receive an income of £25,000.

Tom works for an employer and receives a salary each month from which tax and Class 1 National Insurance is deducted under PAYE; from his £25,000 earnings he might expect to see £19,532 in his pocket, and additionally, the employer has had to pay a further £2,417 for the privilege of employing him.

Dick is a self-employed plumber and his £25,000 income has been calculated from the sales less the expenses of running his business; he would expect to see £19,917.65 in his pocket at the end of the year having paid the tax, and both Class 2 and Class 4 National Insurance due under ‘self assessment’.

Harry didn’t work during the year but was fortunate enough to sell an antique that had been ‘kicking around’ at home for years; after paying Capital Gains Tax he would expect his £25,000 income to be reduced to a net £22,408.

At these modest income levels even relatively small variations can be significant and whilst we can argue about the relative merits of whether the working men and women in the UK should be paying tax at a higher rate than those who can live off the proceeds of asset sales, the central issue here is that because the tax system creates such disparities it is a racing certainty that those who are having to pay tax will, if they are able, seek to arrange their affairs in such a way that they minimise their tax liability.

And it doesn’t stop there.

I have clients who have more than one source of income and because of the way the tax system is arranged into ‘schedules’ it is not automatic that income from once source can be offset against losses from another source, so there have been years in which the client has no overall income, or even a ‘net loss’, but will still be liable for tax on the income from a particular source.

I think we would have to conclude that HM Revenue and Customs are not so much on the side of fairness and equity as that of maximising tax receipts. Indeed in a recent informal conversation a retired tax inspector noted that the “… tax rules are complicated …”, and when HMRC uses those rules to maximise tax collections they are said to be “… applying the law …”, but when a taxpayer uses those same rules to minimise the tax he or she pays, they are said to be “… tax cheats …”, “… tax avoiders …”, or worse.

In Ayrshire Pullman Motor Services & Ritchie v IR Commrs (1929) 14 TC 754, Lord Clyde stated that ‘no man is under the smallest obligation, moral or other, to arrange his legal relations to his business as to enable the Inland Revenue to put the largest shovel into his stores’.

This was endorsed by Lord Tomlin in IR Commrs v Duke of Westminster [1936] 19 TC 490, in which he stated that ‘every man is entitled if he can, to order his affairs so that the tax attaching under the appropriate acts is less than it would otherwise be’.

There has been a good deal of legislation and case law in the intervening period but today we have a whole industry which has grown up around legally minimising the tax their clients need to pay, with HM Revenue and Customs playing catch up and introducing ever more and complex legislation to plug the loopholes that the legislation itself creates.

Anecdotally I believe there is evidence that as tax rates increase so do the number of taxpayers seeking help to minimise their tax liability, and that again would not be a great surprise to me if found to be true. It seems to me that the only real beneficiaries are the ranks of lawyers on both sides.

So how do we halt the madness?

The Office of Tax Simplification has identified various areas ripe for reform, but in my view at least this amounts to ‘tinkering round the edges’, and in the meantime, the 2012 Finance Bill has added almost 700 pages of legislation.

Perhaps we should look at real simplification such as a flat rate tax for all income in a period, from whatever source, with a few (very few) exemptions such as the profit on the sale of one’s family home?

Yes, I know that immediately we introduce exemptions and exceptions there will be opportunities for those seeking to avoid tax, but if the system is seen to be ‘simple’, and more importantly ‘fair’, my belief is that the incentive for avoidance will all but evaporate, and at the very least we might see a reduction in the cost of collecting tax.

Time for real change?

Paul Driscoll is a Chartered Management Accountant, a director of Central Accounting Limited, Cura Business Consulting Limited, Hudman Limited, and AJ Tensile Fabrications Limited, and is a board level adviser to a variety of other businesses.

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