Loan Charge Independent Review – History & Introduction
So the loan charge independent review is out.
The last Friday before Christmas, and on a day where significant Brexit matters were being decided upon in Parliament, was deemed to be a good enough day to bury the news.
However, undoubtedly, the report represented very good news for a proportion of people affected under the legislation. We have a number of clients who were performing cartwheels. This is because all of their loans were made pre-December 2010 and their schemes were not under enquiry in any other way. Others will have had a lessening of their predicament with some loans falling out of account…
However, other than the Government offering more flexible terms relating to repayment of loan charge liabilities, for the many it was (to coin Liam Gallagher) ‘as you were’.
Sir Amyas Morse Loan Charge Report – In Context
No one can doubt that the loan charge independent review, conducted by Sir Amyas Morse (“SAM”) is a proper piece of work. He has also undoubtedly interpreted the review’s terms of reference quite widely. This, in itself is important. My own firm’s submission made clear our view that any proper consideration of the proportionality of the loan charge first required an understanding of the 20 years or so of legislation and case law in this area. Happily, SAM has followed this approach and dedicates the first section of his report to laying out the context.
The key areas covered in this article on the loan charge independent review are:
- Removal of loans from the loan charge where taken out before 9 December 2010 (“Loan charge – the look back”);
- Removal of loans taken out after this date that are unprotected (“Post 2010 unprotected years”)
- Was the loan charge necessary and what is the future?
Loan Charge History – the ‘look back’
I make no apology for skipping straight to this issue.
Personally, it was this element that brought me to the loan charge and, amongst other things, motivated me to write my evidence to the Finance Bill Committee back in October 2017. Sadly, the issues have not evolved a great deal since then. What was wrong at the outset, remains wrong today.
However, first rate campaigning by the Loan Charge Action Group (“LCAG”) and others have slowly brought around an initially sceptical mass of Parliamentarians and the press.
It is interesting that SAM had no problem cutting through whether the provisions are retrospective or retroactive (an issue which seemed to bog down many tax advisers). This was a distinction for which SAM had little time. He was more interested in the fact that these were measures that had the potential to open up old, settled tax liabilities. As such, he agreed that these were measures that should be subject to greater scrutiny.
20 year ‘look back’ reduced
Originally, the loan charge looked back up to 20 years. However, following his review, the key headline is that SAM’s recommendation is:
“that the LC should not apply to loans entered in to by either individuals or employers before 9thDecember 2010”
Further, the Government has accepted this recommendation. These changes will need to be actioned through primary legislation. More on this below.
The date of 9 December is not an arbitrary one. It is the date that Part 7A of ITEPA 2003 was first effective. The measures are colloquially referred to as the “Disguised Remuneration” legislation but perhaps more properly ‘Income Provided Through Third Parties’.
In our own submission to SAM we raised the use of this date as an alternative option. As such, you might think we are happy with this concession.
This was suggested as a compromise – based on the fact that we felt this report would always have to find a compromise. However, it is a compromise with several flaws. Indeed, SAM’s reasoning, perhaps unwittingly, draws out the problems with this compromise.
Clearly, Part 7A represented the final nails in the coffin for the traditional EBT route – in other words, where the employer contributes to a trust and the trustees make loans to an employee.
In addition, it also meant that anyone who advised on these employment related schemes should be on notice that the Government, having gone to the effort of producing the legislation, would likely be very interested in their activities going forward. As a result, many who had been involved in this space vacated it and went to do something else.
But not everybody.
Some promoters took time to consider what new variations they could come up with (or, perhaps more accurately, waited for Counsel to contact them with their new ideas!) It could be seen as the next stage in an ongoing game of cat and mouse between the Government and promoters.
For instance, I am aware of at least 3 different general variations of loan schemes that were in circulation after December 2010. All supposedly designed to mitigate the introduction of Part 7A. These could broadly summarised as:
- Do the same things, but broadly in a different order – leaving the employee owing a debt to the trust as per under the original scheme;
- The scheme is based on the workers being in a partnership and, as such, no employee / employer link; and
- Split contracts arrangements, where the director gets most of his bunce in the scheme as a self-employed person (again, no employee / employer link)
Of course, SAM may have been aware of these new ‘strains’ of the loan scheme virus. It may simply be that he does not care and has simply has taken a purposive approach to the new legislation.
However, I don’t think this is the case and my view is that it does not seem to be a valid approach for all of these schemes. In paragraph 4.14 of SAM’s report states that:
“the effect of the announcements and 2011 legislation was that it became legally clear that a tax charge would arise on income paid to employees through a third party from 9 December 2010” [my underlining]
The first of the successor schemes sketched out above would clearly be vulnerable if Part 7A was construed widely and, as we have seen, would also be vulnerable to GAAR in any event. However, new legislation was introduced to counteract such schemes by explicit changes to Part 7A that took effect from April 2017.
The second scheme did not involve any employee / employer link as required by the law, a fact acknowledged by SAM in 4.14. This type of scheme also required a fix (and an extensive one at that) by bringing in a number of entirely new sections in to ITTOIA 2005 in April 2017 to extend the limits of Part 7A beyond employees and employers. So for some users of these schemes it is only the combination of the new ITTOIA 2005 provisions and the loan charge that opens up the possibility of a liability.
The third, again relying on the lack of the employment nexus which SAM’s quote shows was required under Part 7A, required a new section in Part 7A which took effect from April 2018.
I am not saying I believe these schemes worked. Indeed, as I say, I believe the first was perhaps was too clever for its own good and I could not see it getting a sympathetic hearing from any Court.
However, it demonstrates that, although the law may have been clear in relation to the old schemes, it clearly also had a number of holes in it. It was clear at the time that Part 7A only applied to employer / employee relationships.
As such, it is at least arguable that Part 7A did not apply to the self-employed schemes that emerged after December 2010 (albeit HMRC could argue over other issues such as status and commerciality)
HMRC had three options in relation to these schemes:
- Challenge them under Part 7A on the basis that they do not / did not circumnavigate Part 7A at all or failed on other existing law;
- If the schemes were not notified under DOTAS and HMRC argue they were notifiable then challenge them on that basis. If successful, HMRC could issue APNS; [Note, I have subsequently had a conversation with barrister Keith Gordon via social media. He has pointed out, and I agree, what appears to be a hole in the DOTAS / APN patchwork. If a scheme is forced in to disclosure it appears that the legislation does not allow for an APN to be issued. Whether a Court (I suppose under a JR if HMRC issued an APN) would support such a limitation is a different matter!]
- From 2013, challenge them under GAAR for being contrived and artificial even if they do, technically, escape Part 7A.
It is true that some variations of these schemes have been counter-acted under GAAR (and we will come to that shortly) but this is not indicative as to whether they were ‘clearly’ within Part 7A.
In fact, you might argue it says quite the opposite. If the law was clear and Part 7A applied then HMRC would have simply litigated the scheme on the basis it was covered by the existing tax rules. Penalties would have been applied accordingly.
Failure to Notify – DOTAS
A further ingredient in the loan charge stew is that of the Disclosure of Tax Avoidance Schemes (“DOTAS”) legislation.
DOTAS, and the failure to notify under DOTAS, is not mere administrative garnish. SAM’s report implies (based on HMRC’s figures) that much of the unprotected years in relation to loan charge schemes are as a result of failure to notify under DOTAS.
DOTAS does not just merely give HMRC important knowledge in relation to the scheme and its users (each user would need to add a serial number to their tax return all but rubber-stamping their return for enquiry).
In addition, from 2014 onwards, it meant that HMRC could issue Accelerated Payment Notices (”APNS”) to scheme users asking them to ‘pay now, argue later’. This, unsurprisingly, changed the landscape for marketed tax avoidance.
However, in order to be able to issue an APN, it is necessary that an enquiry is in progress or there is some other open appeal. This would impede HMRC’s ability to use APN’s where a scheme was not disclosed.
Perhaps a small, narrow amendment could be made to the APN rules in this regard, rather than the broader brush approach provided by even the amended loan charge?
Falling Foul of GAAR
Finally, we have GAAR.
As stated in the report, several schemes have fallen foul of GAAR over the last few years. My view is GAAR has not been used enough in relation to these schemes.
Even if one accepts that the self-employed and close company ‘worked’ (prior to the Governments recent patches to Part 7A bringing them in the net for DR and LC) then one certainly can challenge their commerciality.
Realistically, why would someone really commute 80% of their guaranteed income for the opportunity to get a loan instead?
Why would they do this? This, for me, is the question to be asked.
I think most people know the answer and one would have expected the GAAR advisory panel to have spent less time thumb twiddling. Further, of course, APNS can be issued on the back of a GAAR panel ruling. Again, providing the fire power (from 2013) for HMRC to collect the disputed tax.
Post 2010 Protected Years
The second recommendation in this area is that:
“taxpayers who made reasonable disclosure of their scheme usage, but for whom the relevant year is unprotected, should not have unprotected years included in the scope of the loan charge.”
My view is that this should not be relevant as I believe that HMRC should only be able to use existing powers (which are extensive) to investigate and challenge schemes.
On the face of it, someone who has reached the disclosure threshold and HMRC is now out of time regarding discovery seems a sensible one.
However, the threshold is high and likely to have to have been a very explicit disclosure. I would suspect that this is likely to involve the scheme having to have been disclosed under DOTAS.
In practice, 99% of such cases are likely to have resulted in an enquiry anyway.
So this might be more of a technical concession than one that will benefit a large number of scheme users.
Summary & The Future of the Loan Charge
My view is that, although the halving of the retrospective element is welcome, this is only half a job and only loans taken out since the consultation in 2016 should be within the LC.
In other words, the retrospective element should be removed in full.
Campaigners should not, and I am sure will not, give up following SAM’s suggested revisions. The changes outlined clearly require primary legislation and therefore will require further scrutiny as they pass through the chamber.
This means that the door remains ajar for further potential changes.
However, regardless of where the line is eventually drawn in the sand, that will not be the end of the matter.
For many historic cases HMRC will still be able to:
- Carry on investigating open enquiries – I note there will be another HMRC crack team assigned to this. This is welcome and perhaps a long stop date should be applied by which all historic cases should be closed;
- Use discovery powers where still ‘in time’;
- Intervene more in respect of DOTAS – and issue APNS where appropriate;
- Use GAAR more effectively for any loans that have been taken out since 2013. Adjustment may need to be made to the transitional provisions to allow this
Was the loan charge necessary and what should we do?
SAM sets out that “there was a need for a new policy” and “I support the loan charge”.
But these do not necessarily follow.
I agree with the need for a new approach. If we all concur that loan charge schemes are undesirable then there clearly needs to be a policy to stop them.
But this ‘need’ stems from a failure of existing legislation as set out above and in SAM’s report.
Part 7A was ineffective as has been demonstrated by the various Elastoplast’s that the Government has had to stick on it.
SAM’s report sets out that there is still a healthy market for ‘loan schemes’. Indeed, it is true that there is both supply, and seemingly a demand, for these arrangements.
But again, from what I have seen, these are not schemes that pay income through third parties as per traditional schemes. They are broadly umbrella schemes that pay someone, say, 20% as PAYE and the balance as, let’s say, a loan.
But this loan is direct from the employer so, on the face of it, Part 7A is not relevant as this legislation explicitly does not apply to direct loans.
As stated above, in my opinion, the best way to attack these is through the commerciality. In the cold light of day, why would anyone sign up to commute the majority of their salary as a loan? As such, GAAR must raise its ugly head more and more on these schemes.
I have always said, including to a Counter Avoidance Officer, that there is one simple method of curtailing loan charge promotion. That is to make promoters potentially personally responsible for the PAYE in a similar manner to the Managed Service Company (“MSC”) legislation.
Believe me, MSC transfer of liability is the one thing of which Promoters are scared.
The depressing point is that the Government’s response to the report promises a host of ‘further measures’ to ‘tackle promoters of avoidance schemes’.
I don’t agree at all that this is the correct approach.
Instead, I would suggest that the Government instead looks at my small but significant change first?
We have prepared separate notes on the new administration and payment terms offered by the Government following the report.
We have also prepared a ‘cut out and keep’ side by side comparison of the loan charge independent review and the Government’s response.
If you have any queries or comments in relation to the loan charge independent review, or the loan charge at all, then please get in touch.