Why is the loan charge needed?

‍

I explored in an earlier piece the fact that HMRC’s recognition and reaction to the use of what they describe as a disguised remuneration scheme was inconsistent.

‍

Some users of such arrangements had an enquiry notice or a discovery assessment for every year they took value from the scheme. Others had notices for some years and not others. Some had no notices at all.

‍

This was a situation that would be exposed in a Tribunal should any of those taxpayers dispute the matter there. Whilst a Tribunal is not there to decide if it is fair that one taxpayer should pay tax but another not, simply because of an administrative or systemic error in HMRC, almost certainly the point would have been made.

‍

The “solution” arrived at was to persuade Parliament that the usual taxpayer protections requiring HMRC to act within a given time deadline should be put aside. Instead, regardless of whether an enquiry notice or discovery assessment was in place, the tax year would be deemed to be available for amendment.

‍

This ensured that all taxpayers would be treated the same but also had the chilling effect of overriding taxpayer protections (and collecting the maximum amount of tax).

‍

The original iteration of the legislation on the loan charge included all untaxed payments from April 1999 to April 2019 – 20 years. The Morse review reduced that period to December 2010 to April 2019 on the grounds that HMRC’s position was unclear until the legislation in Part 7A arrived.

‍

There is a case for saying that the position is still unclear.

‍

One of HMRC’s original justifications for the loan charge was to “draw a line” under their efforts to outlaw all forms of abuse involving disguised remuneration. Quite how a retrospective or retroactive tax charge could change future behaviours is unclear. There have been fewer mentions of this “reason” in recent years.

‍

How does the loan charge work?

‍

The tax charge is calculated by aggregating all the untaxed payments received between 9 December 2010 and 5 April 2019 and adding that value to your 2018/19 taxable income.

‍

The tax reliefs and tax bands applicable to 2018/19 are part of the calculation.

‍

It is not the case that the aggregate value of the loans is taxed entirely at the highest rate of tax.

‍

A short example:

‍

Assume that a scheme was used which included untaxed payments being made of:

‍

2011/12 = £25,000
2012/13 = £30,000

‍

Assume that your taxable income in 2018/19 was £40,000.

‍

Your original 2018/19 tax position is:

‍

Income                                 40,000
Less Personal Allowance    11,850
Taxable income                   28,150
Taxable at 20%                    28,150
Tax due                                5,630

‍

Post-loan charge calculation is:

‍

Income                                  40,000
Add loans                              55,000
Total income                         95,000
Less Personal Allowance     11,850
Taxable income                    83,150
Taxable at 20%                    34,500
Taxable at 40%                    48,650
Tax due                                 26,360
Less paid (above)                  5,630
Loan charge                         20,730

‍

This completes step one of the calculation.

‍

Unless you qualify for the Residual Tax Concession (this example does – see below), it is then necessary to calculate the tax that would have been due had the loans been taxed in the year of receipt.

‍

Interest on the unpaid tax from each year is calculated and added to the tax due.

‍

The loan charge paid in 2018/19 (due on 30 September 2020) is then applied against that tax and interest due in each earlier year (see below as to some uncertainty as to how this is done).

‍

If the loan charge is less than the tax and interest due in each earlier year, further tax/interest is payable.

‍

If the loan charge exceeds the tax and interest due in earlier years, it is not refundable.

‍

This completes step two of the calculation.

‍

The Residual Tax Concession

‍

Where the average untaxed payments, calculated by aggregating all the payments and dividing by the number of years a scheme was used, are less than £75,000, step 2 of the calculation is not required.

‍

Instead, the liability is the loan charge in 2018/19 (plus interest if it is paid after 30 September 2020).

‍

In the above example, the average untaxed payment value is:

‍

£(25,000 + 30,000) / 2 = £27,500.

‍

Note that if these values had been £80,000 and £85,000 but the final payment of perhaps just a few hundred pounds was in the third year (2013/14), then the calculation is:

‍

£(80,000 + 85,000) / 3 = £55,000

‍

and the concession still applies.

‍

Interest charges

‍

If tax is paid late, interest is charged. In most instances, tax is due on 31 January of the year following the end of the tax year. So a liability for 2011/12 is due 31 January 2013.

‍

Interest would be calculated from that date to the date of payment. The rate of interest varies according to the Bank of England base rate plus 2.5% for periods prior to 5 April 2025 and plus 4% after that.

‍

The loan charge due date for interest purposes is 30 September 2020, as it was extended because of the Morse report delivery date (December 2019).

‍

In practice, HMRC seems to be inconsistent in terms of charging interest from earlier years.

‍

Allocating the loan charge against earlier years

‍

If it is the case that the residual tax concession is not applicable, then it is necessary to calculate how much of the loan charge is allocated to each earlier year.

‍

Opinions and practice vary here.

‍

HMRC seems to favour a method which looks at the total tax due in each earlier year as a percentage of the total tax due in earlier years and then allocates that percentage of the loan charge against the liability.

‍

For example, if the 2011/12 tax liability was 20% of the total earlier years’ liability, then 20% of the loan charge is allocated against that tax.

‍

In practice, this leaves a liability for the earlier year which attracts interest.

‍

We are of the view that the loan charge should be used to fully cover each year, starting with the earliest, so that if the loan charge is insufficient to cover the entire liability, it is a later year that has an outstanding balance. That, of course, means interest starts from a later date.

‍

There is no consistency in HMRC as to which method is accepted or used.

‍

Open or closed years

‍

An open year is one in which HMRC has opened an enquiry or issued a discovery assessment within the permitted time deadlines.

‍

A closed year is one which has no such notice or assessment and where it is now too late to issue such a notice/assessment.

‍

Generally, the deadline for opening an enquiry is 12 months after submission of the tax return for that year. A discovery assessment is usually up to 4 years after the end of the tax year. This can be extended to six years if the taxpayer has been careless or 20 years if there has been deliberate action to hide or misrepresent income. There is also a twelve-year deadline where there are “offshore” issues involved.

‍

Space is too short here to examine the legal and judicial definitions of the above, and professional advice should be sought in every instance.

‍

The above deadlines are there to protect taxpayers from HMRC being able to have unlimited retrospective access to making adjustments to tax they think is due.

‍

Except that for the loan charge all these protections are ignored, and all the untaxed payments are taxed in 2018/19.

‍

Some practical consequences

‍

For many taxpayers, even those paying only the basic rate in the earlier years, the effect of adding the total amount of untaxed payments to 2018/19 is usually to expose some “income” to the higher (40%) or even additional (45%) tax rates.

‍

Double limited schemes

‍

These are disguised remuneration schemes which involve, in some fashion, a wholly owned company of the contractor. Money may (or may not) pass through this company. HMRC tends to see this company as the “employer” and issues PAYE assessments (Reg 80s) to them (whilst saying that they cannot do this to UK promoters, agencies and end clients).

‍

The Reg 80s will often include the aggregate of the untaxed payments made over the earlier years.

‍

There is considerable doubt as to whether this is what the loan charge intended or whether it is a valid treatment based on general principles. This is an untested (in Tribunal) area.

‍

The defences

‍

To be honest, not many.

‍

It is thought that if the untaxed payments in earlier years should have, in fact, been taxed - especially if PAYE would have applied - then the loan charge, depending as it does on the definition of disguised remuneration found in Part 7A ITEPA, should not be applicable, as the money has already been (or should have been) taxed. This is an untested position.

‍

More HMRC confusion

‍

Part of the process of preparing taxpayers for settlement is a letter from HMRC to each individual indicating whether their scheme qualifies for the McCann settlement terms or not.

‍

WTT has seen letters that claim, for example, a scheme called Edge (later Redstone) does not qualify for the settlement.

‍

The assumption is that this is because it does not meet the definitions in Sch 11 of Finance (No 2) Act 2017. Those definitions are based on the disguised remuneration rules in Part 7A ITEPA.

‍

If a scheme is not within the loan charge because it fails the definition, how can it be disguised remuneration (whose definition it shares)? Again, an untested position.

‍

WTT is trying to clarify why some schemes (including Edge) are said to be outside the new settlement but, to date, has not had any response from HMRC.

‍

Further reading

‍

There has recently been a book published on the loan charge. One of the authors is a barrister WTT has used for several years and who is as expert as it comes in this space:

‍

https://www.claritaxbooks.com/product/disguised-remuneration/

‍

Author: Graham Webber – Director of Tax

‍

‍