Is the public programmed to despise tax avoidance and its promoters and subscribers? It is after all “morally repugnant”! Fuelled by the global financial downturn and fight against crime and terrorism, both government and media have brought tax avoidance to the forefront of people’s minds.
However, as the summer approaches and people head off on their holidays, who is going to refuse the duty free shop? The reality is that almost everyone wants to maximise their income and/or wealth. Of course making use of the duty free shop (up to the statutory limits and for personal use) when returning from holiday is perfectly legitimate tax planning.
Anyway, this week, I wanted to take a closer look at the contractor loan schemes and the Contractor Loan Settlement Opportunity (CLSO), which is due to close in just over a month on the 30 June 2015. Whilst writing this, it struck me how much contractor solutions had advanced and become so complicated that even what should be simple definitions have become blurred.
What is a contractor loan scheme?
A contractor loan scheme is broadly a tax avoidance arrangement whereby contractors have received loans or similar reward from a non-UK employer in place of all or part of their earnings.
Is the definition wide enough?
Is HMRC’s use of the term non-UK employer correct? Perhaps entity or person would have been better suited. Contractors are not always clearly employees and often a contractor loan or similar reward will not be made as part of an employment relationship, although in essence there may be a strong indication that loaned funds or similar rewards are connected to or akin to an employment relationship. The guidance wording does suggest to limit the number of individuals affected perhaps intentionally. However, the CLSO does have some limited wider application if you read on.
A contractor loan scheme is any scheme that allows a contractor to enter into arrangements where they provide services under a contract of employment and/or a contract for services with an employer or entity and received a substantial portion of what might be considered “in the real world” to actually be their earnings in the form of loans or other rewards.
A reality check?
The schemes vary in complexity and may use rapidly depreciating currencies or other convoluted methods of reducing the loan repayable or similar reward to zero. The not so complicated or not thought through so well schemes, mean that technically a contractor may have an outstanding loan with trustees. The trustees would be legally entitled to pursue that loan with the full force of the law. It is doubtful that many beneficiaries of such trusts realise the debt they are in! When challenged, are they going to say “but I earned that money”, potentially blowing the scheme completely out of the water as a sham.
There are a myriad of schemes whose aim is to reduce a contractor’s tax liability by removing what would be earnings from the scope of UK taxation. To be clear; if it is too good to be true, it usually is! Maybe, all professionals and contractors should be aware of their market worth in their industry. They should also be smart enough to be aware that HMRC have access to this information and a very sophisticated system (Connect) to analyse risk. It seems obvious that something is amiss when an individual receives funds akin to their market worth with taxable income equal to a fraction of that worth, while maintaining the same or an improved lifestyle.
Who would settle for significantly less earnings than they could rightly achieve for the same role anywhere else? This is not to ridicule the professional contractors out there; we’re more in awe of the promoters who win their trust and convince them that their scheme works unless all the risks are highlighted.
So, exactly what is a contractor?
A contractor is defined in the Oxford English Dictionary as “a person or firm that undertakes a contract to provide materials or labour to perform a service or do a job”.
The Oxford English Dictionary definition suggests an element of a business activity and to define a contractor in tax terms, it is certainly true in this day and age that one would need to look closely at the badges of trade and employment status tests to come to a conclusion in what can be a complicated area.
One thing that becomes clear whilst sipping a Starbucks and researching Google on an Apple iPad bought from Amazon: a business should always seek to maximise its profits and tax mitigation often plays a big part of this. The entrepreneurial nature of the concept of contracting indicates that a person will have an eye on ways of maximising profit unlike a traditional employee who may simply perform their duties within the terms of their contract.
Contractors typically provide their skill and perhaps the “tools of their trade” where applicable to an end client. A contractor may be self employed, employed on short term contracts, operating via a business entity (such as a limited company or partnership), or any combination of the aforementioned; think Medical Consultant who is employed by the NHS and also practising privately.
In their guidance HMRC suggest a person can be both employed and otherwise engaged with the same business. On the face of it the NHS and private consultation can be regarded as two separate sources of income. What HMRC don’t accept is where the remuneration for one role is artificially reduced, as supported by their dislike of split contracts.
With the ever evolving tax landscape and eternal quest to maximise tax efficiency, the definition of contractor has become somewhat clouded. The term contractor in the context of a contractor loan scheme and the CLSO can include individuals who appear on face value to be regular employees.
In many situations, there will be at least one intermediary business providing a service akin to that of an agent. An agent is defined in the Oxford English Dictionary as “a person or company that provides a particular service, typically one that involves organising transactions between two other parties”.
For many years, providers of employment, business or tax schemes have promoted schemes that seek to maximise a contractor’s income for a fee. Where such parties services contain an element tax advice, HMRC could regard them as a tax agent and within the penalties regime for dishonest agents.
Anyway, in summary the definition of contractor appears to have widened to potentially include anyone who is not in long term full time employment and who provides services to an end client where one or more intermediaries are involved.
How has legislation developed?
Where there is a need to consider whether someone is really an employee, tax schemes have been prevalent. The development and complexity of IR35, host employer, and managed service company legislation for example stands testament to this.
HMRC have frequently challenged loans from Employee Benefit Trusts (EBT) as well as contractor loan schemes and similar arrangements. Many of HMRC’s successful challenges were made under the transfer of assets abroad legislation contained within section 720 et seq of the Income Taxes Act 2007 (ITA 2007).
As the prevalence and complexity of the schemes advanced, HMRC recognised that specific anti avoidance rules were required and issued the disguised remuneration legislation on 9 December 2010. The legislation applied from 6 April 2011 with anti-forestalling provisions applying from 9 December 2010. There were significant changes from the original draft to the final legislation.
Promoters somewhat predictably sought to remove an employment relationship in order to circumvent the disguised employment relationship rules and this has subsequently caused some confusion as to whether the CLSO applies in some circumstances.
HMRC first issued a spotlight on contractor loan schemes in September 2013 after winning the Boyle vs HMRC  TC03103 case in which, Mr Boyle, an IT contractor received a basic salary and loans in various currencies which realised currency exchange gains. The defence’s argument was that the currency gains were not in any way earnings. The First Tier Tribunal (FTT) concluded that the exchange gains were actually the defendants disguised earnings. Despite the availability of the disguised remuneration rules, HMRC’s case relied on the transfer of assets abroad legislation.
HMRC have taken steps to plug further gaps in tax planning around what are regarded as employment relationships, with changes to taxation of partnerships and changes to loans to participator rules.
As the anti avoidance legislation developed, so did the complexity of the schemes. The penny obviously dropped for the developers and promoters of EBT schemes and the various permutations that followed; the tax planning made available to the upper tier of the skilled professionals was wheeled out en masse to almost anybody by an increasing number of promoters.
HMRC simply had to do something and their general policy on tackling tax avoidance has certainly proved effective and raised awareness of what is and is not acceptable tax planning. Given that it is possible to find any number of tax solutions for contractors on the web, is it enough?
So, what is the CLSO?
The CLSO gives those involved in schemes which, in essence, disguise some or all of their income as loans or other rewards, the chance to settle their affairs and bring their tax affairs up to date.
The CLSO was first announced by HMRC on 24 July 2014 and applies to arrangements affecting tax returns up to 5 April 2011 (from April 2011, the disguised remuneration rules came into force and it may be that HMRC believe they can effectively deal with the majority of contractor loan scheme arrangements under that legislation).
Initially the opportunity was only open until 9 January 2015 but was subsequently extended to 30 June 2015 on 18 December 2014. HMRC cited overwhelming enquiries, confusion about how it would operate amongst the reasons for the extension.
An individual will have until 30 September 2015 to make a disclosure and offer of payment once they have notified HMRC by 30 June 2015.
Individuals who have been involved in a contractor loan scheme up until April 5 2011 can use the CLSO unless they are:
- subject to HMRC’s criminal investigation policy
- subject to civil investigation of fraud procedure
- a UK employer who has used an Employee Benefit Trust and should be using the employee benefits trust settlement opportunity
The CLSO may mean that the taxpayer just settles on the tax due with interest, completing avoiding any penalties. This will depend on the facts of the case. Penalties can be up to 200% of the tax where overseas entities are involved, so anyone at risk should seriously consider the opportunity.
It is also important to note that HMRC’s guidance indicates that contractors within the CLSO may be able to bring their affairs up to date for slightly different arrangements used in later periods:
Enquiries for different arrangements
If you receive an enquiry notice relating to a different arrangement you’ve used after the tax year ending 5 April 2011 then you can ask HMRC to discuss paying the tax to resolve these years too. HMRC may not be able to settle on the same basis as the earlier years but this will depend on how you used the arrangements and the law in place at the time.
In our experience, HMRC welcome giving contractors the opportunity to bring their tax affairs up to date where schemes that do not stack up commercially have been entered into. Anyone at risk should seriously consider taking up this opportunity.
Do I (or my client) need to take any action?
Many contractors would have received a letter regarding this settlement opportunity where HMRC are aware of specific providers of schemes. Where the promoters are still in operation and defending their scheme, individuals may be advised that they have not entered into such a scheme and are given limited responses to reply to HMRC.
Where an individual cannot categorically state that monies received either by way of loan, reward or any other method are not in any way, shape or form connected to their declared earnings, they should seriously consider the implementations of not cooperating with HMRC which include increased penalties and risk of prosecution.
Where an individual is comfortable that the scheme they have entered into technically works and they have not received undeclared or disguised income, they should still seek an independent review. Promoters may well believe that their scheme technically and legally works. However, the promoter may be out of funds (and business) to recompense the additional burden of tax and penalties suffered if the scheme is later judged to fail through the courts. For similar reasons, placing reliance on an insurance policy to protect from the additional taxes and penalties may not be a wise courses of action; the devil is in the detail and the small print on that policy is unlikely to be comfortable reading.
If an individual thinks they have received a letter by mistake or simply ignored it, they should contact us to discuss why they have received the letter and why HMRC might be mistaken. Similarly any accountants or business advisors who have clients who have entered into such schemes may wish to discuss individual cases. We recommend that anyone who wishes to enter into the CLSO should contact us in the first instance.
Once a settlement has been agreed with HMRC, a legally binding contract will be entered into. The contract won’t be binding on any third parties for any tax they might owe.
If an individual who used what is regarded as a contractor loan scheme decides not to take this opportunity or cannot come to an agreement with HMRC, they face legal action with the risk of additional penalties and interest.
Worries about the amount owed and affordability can also make individuals reluctant to come forward. However, repayment terms can be negotiated with HMRC as long as the settlement opportunity is taken before the deadline.
We are a team who are involved in representing individuals with HMRC enquiries where they have been involved in contractor loan schemes and similar arrangements.
As a firm of Chartered Tax Advisors and Tax Technicians, we provide tax advice and we always go to great lengths to highlight the risks of undertaking certain transactions or entering into certain arrangements. We interpret our professional guidelines and professional indemnity insurance as demanding this!
It constantly surprises us the number of people who enter into arrangements accepting them to be robust. We would question the promoters’ integrity and how far the media and HMRC go to increase public awareness of what is and what is not acceptable tax planning.
In almost every case where a contractor loan scheme or similar scheme has been entered into, the contractor has not had the benefit of an “eyes wide open” approach. They are almost certainly sold into a scheme that is “HMRC compliant” (to the point of indicating it is HMRC approved) and not made fully aware of the risks or even how the scheme they have joined works.
We welcome HMRC’s approach to tackle serial promoters of schemes that consistently fail. There will always be those who will seek to mitigate taxes through what are intended to be perfectly legitimate methods. Where a scheme or arrangement has a degree of uncertainty, we would simply suggest the tax payer retains enough money to pay the duties; like accidentally taking a suitcase full of perfume for personal use through the “nothing to declare” customs aisle on the way back from holiday. At best, you are going pay the duty or watch the goods get binned! However, at worst, you still do face prosecution.
The CLSO is a great opportunity for people to put right any tax irregularities with minimum cost and disruption to their lives.