Introduction – Disguised remuneration & the April 2019 loan charge
Of course, Se7en was a 1990’s shocker movie starring Brad Pitt, Morgan Freeman and Kevin Spacey (before he became US president, Frank Underwood). As you will recall, Kevin Spacey’s psychopathic ‘John Doe’ character gruesomely disposed of each of his various victims in a series of elaborate set pieces recreating each of the ‘seven deadly sins.’
Certainly, the amendments to Part 7A of ITEPA 2003, aka disguised remuneration rules, could have been one of the options for the set-piece based on the sin of ‘wrath’, rather than Spacey’s parting gift to Brad Pitt in the Californian desert.
Indeed, the Government, no doubt at the behest of HMRC, has decided that it has had enough of those who have historically taken part in remuneration schemes. As such, it will be applying a tax charge (the “April 2019 loan charge”) to any such loans outstanding as at 5 April 2019.
What is disguised remuneration?
Of course, where a Company pays salary or a bonus to an employee then that is subject to income tax and NICs through the PAYE system. The Company will also generally receive a corporation tax deduction for the payment on the assumption that the funds paid were wholly and exclusively for the purposes of the trade (which would usually be the case) and assuming other conditions are satisfied.
However, since time immemorial, devices have been used to provide reward and incentives to employees. Clearly, tax has been a key driver, even if other factors may also be in play.
Have you heard of Employee Benefit Trusts (“EBTs”)? I am sure you have, otherwise I can’t imagine you would be reading this (I acknowledge that anyone who has stumbled across this article after Googling ‘Brad Pitt’ will be sorely disappointed).
Of course, these were prolific devices through the 90’s and the 00’s and were used by all types of businesses – from scrap dealers, to City finance houses, to Premier League football clubs both north and south of the border.
It usually involved the business contributing funds to a Trustee who held the money or assets for the benefit of the employees and perhaps their relatives.
The Trustee would have discretion to provide certain benefits to the employee and / or his or her family. The contribution would receive a corporation tax deduction but, certainly prior to the Rangers decision which turned received wisdom on its head, because the funds were not put unreservedly at the disposal of the individual (ie they hadn’t got the use of the money) there was no income tax / NIC charge on the payment.
Subsequently, the Trustees may then have made a loan to the employee. A genuine loan made to an employee being capital in their hands and not subject to income tax and NICs as earnings. Where interest was not paid then there might be a benefit in kind charge payable.
Similarly, contractors have for many years used similar schemes where the fee paid by the end user for their services was paid to an intermediary. In turn, they usually receive a small salary or consultancy fee from the entity with the balance being paid in loans. Such a scheme might also provide additional considerations such as whether the agency, IR35 and Managed Service Company rules applied. These provisions are outside the scope of this article.
Corporation tax – Dextra Accessories and legislative amendments
Old Schedule E, which in pre-ITEPA 2003 times dealt with income from employment, changed several decades ago from an earnings basis of taxation to a receipts basis. As such, FA 1989, s 43 was introduced to smooth out any timing differences between the year in which the employer could receive a deduction for payments and the employee was taxable on the receipt.
If, following the introduction of these provisions, the accrued remuneration (technically called ‘relevant emoluments’) was not paid within 9 months of the end of the accounting period in which accrued, the new provisions meant that the associated corporation tax deduction would only arise in a year in which paid. This applied to ‘potential emoluments’ which were defined as ‘amounts or benefits … held by an intermediary [eg EBT Trustee], with a view to [them] becoming relevant emoluments’.
The implications of this legislation were discussed in the various instalments of Dextra Accessories. At first instance, in September 2003, it was found that contributions to an EBT were not ‘potential emoluments’ and therefore a corporation tax deduction was available immediately.
For obvious reasons, this decision set a hare racing. The law was changed mid appeal by the introduction of Schedule 24 to the Finance Act 2003. This provided that payments made by an employer ‘to another person to use for the provision of benefits to employees’ under a ‘trust, scheme or other arrangement for the benefit of persons who… include… employees’ are not deductible when they are made, unless they gave rise to an employment income tax charge and a liability to pay National Insurance.
However, the earlier ruling was overturned by the House of Lords (now the Supreme Court) who decided that a contribution to an EBT was a potential emolument if there was a realistic possibility that the sum may be used to pay emoluments.
That said, certain wheezes continued to operate under the new rules (Schedule 24 which, together with s43, ultimately became CTA 2009, s1288 et seq). For example, it was thought that even where any element of a payment suffered employment taxes the corresponding corporation tax deduction would be deductible in full. For example, where £100 was transferred on to the trust, and just £1 triggered a PAYE charge, both the taxable £1 and the other £99 were available for a deduction against corporation tax.
Other schemes utilised the exclusions which now exist in CTA 2009, s1290.
In summary, the legislation seeks to achieve a tax symmetry such that a Company making the contribution to the EBT could only receive a corporation tax relief as and when the EBT made a payment that gave rise to an income tax and NIC charge. Such a payment being termed a ‘qualifying benefit’ in the legislation.
It is interesting that the definition ‘qualifying benefit’ explicitly excludes loans. Why would this be the case? Could it be because the Government and HMRC believed that a loan from an EBT was not subject to tax like other ‘qualifying benefits’? In other words, no income tax means no corporation tax deduction.
I turn to this rhetorical question next.
Neither a borrower nor a lender be?
Despite ultimate success (eventually) on the corporation tax point in Dextra Accessories, HMRC had a more frustrating time in trying to argue that loans from EBTs were subject to PAYE.
They were unsuccessful on this point in Dextra Accessories and also failed to convince a court of the same in Sempra Metals. Indeed, even in the Rangers case HMRC failed to argue successfully that loans from EBTS were subject to PAYE (of course, we will deal with what the Supreme Court did rule shortly).
As mentioned above, it seems that this was recognised in the drafting of the corporation tax provisions discussed above. A CT deduction is not available as a loan cannot be a qualifying benefit because, it is assumed, the principal is capital and not taxable earnings (and not a qualifying benefit).
I say ‘principal’ because it is likely that the loan from the EBT would be treated as an ‘employer loan’. As such, any interest unpaid, or under paid, on the loan would be a taxable benefit. Indeed, in their own Manuals, HMRC seem to agree this position (as applies to pre FA 2011 loans).
In other words, the principal of the loan is not subject to PAYE or any other income tax charge and the quid pro quo being that the Company will not obtain a corporation tax deduction.
The employee will pay tax on any interest underpaid.
However, this position is clearly, at odds with HMRC’s Spotlight 5 [now withdrawn] which was published in August 2010 a few months before Part 7A was published.
Finance Act 2011 – the Government introduces the ‘disguised remuneration’ rules
As stated above, the Government and HMRC, had failed to obtain an authority in Court that a loan from such a structure was earnings and subject to PAYE.
It was not until December 2010 that the Government announced that it wanted to treat payments which had been made through third parties, by employers on behalf of employees, subject to PAYE. This was through the introduction of ITEPA 2003, Part 7A (via Finance Act 2011) and is often referred to as the ‘disguised remuneration’ rules.
Unsurprisingly, the rules picked up loans made by the third parties to an employee and sought to subject the amount to tax. Other payments and the use of assets would also be caught.
These rules applied to new arrangements and also would apply to new loans or ‘relevant steps’ made by existing schemes.
However, the rules did not attack existing loans from these schemes. As such, many schemes have essentially been locked in to a state of hibernation with substantial loans outstanding.
Of course, there was no suggestion that these rules should be backward facing and apply to any loans taken out since 1999.
For the reasons I will come to shortly, perhaps this is a time to make a distinction between:
- Pre FA2011 scheme loans; and
- Post FA2011 scheme loans
The latter category being designed to skirt through the gaps and deficiencies in the legislation.
HMRC and the Government go nuclear: enter April 2019 loan charge
Up to now, I have been somewhat critical of HMRC / Government. As far as I am concerned there was a logical balance between CT deductions and loans. Despite this, and the instructions in their own Manuals, HMRC certainly were not that happy about this situation and had various attempts in the Court to get such payments in the PAYE net. They lost so, as is their prerogative, they moved to have the law changed.
For most in the mainstream tax planning industry, if they were or had been involved in this type of planning, Part 7A meant the ‘game was up’.
If that really had been that then I do wonder whether we would be talking about these changes. However, for some, the game is never up and scheme providers produced new schemes that purported to circumnavigate Part 7A. For example, they might reorder the mechanics – such that the ‘loan’ was made first and the payments were made afterwards. Also, schemes that benefitted people in their capacities as non-employees also proliferated.
Indeed, in addition to the April 2019 loan charge, there are other provisions being, or already, introduced to address these successor schemes. However, these changes are outside the scope of this article.
Additionally, so-called contractor schemes have also proliferated, again arguing that they are outside of the Part 7A rules.
It is my view that it is these Post FA2011 schemes that have broken the metaphorical camel’s back.
To address these post FA2011, but also pre-2011, schemes they have introduced amendments to Part 7A which apply a PAYE charge to the full amount of any loan outstanding. It applies to all loans taken out since 1999.
For someone seeking to repay a loan going forward, only repayments in money count. As such, one cannot settle a relevant loan ‘in specie’.
This charge will crystallise on the amount outstanding on 5 April 2019 and will be payable in respect of the 2018/19 tax year.
We have done a full article on these new rules which can be found here [Link not yet active, sorry].
Clearly, this could potentially result in a staggering tax charge for taxpayers who have used schemes. Contractors who have used this type of arrangement might be the hardest hit of all especially where they have used arrangements for a decade or more (and many have).
Could it get any worse?
I am afraid it could!
At the moment, any PAYE charge that arises as a result of these measures would fall fairly and squarely on the employer. Other than in limited circumstances, it is unlikely that such a liability could be transferred to the individual.
In some cases, Companies may have come and gone over the years for various reasons – many totally unconnected with tax. In other cases, a Company might end up going out of business as a result of not being able to stump up the PAYE. In all cases, at least the taxpayer’s home would not be on the line.
However, HMRC has set out plans in a consultation document that it wants powers to be able to transfer the liability from the employer to the individual.
I am deeply troubled by this. Of course, HMRC will assert that they need this power other wise the new tax charge will be ineffective and people will just sink the Company in a cavalier fashion. Of course, this might be the case for a limited profile of private companies, and perhaps conduits used by providers of contractor companies, however for most businesses this is not going to be an attractive option at all. It will be a last resort.
Secondly, where does one draw the line. What if a Company was wound up ten years ago because the owner of the business has retired. Will he or she be chased for the money?
This is yet a further example of HMRC getting powers to make its life easier at the expense of taxpayers – even though it is well ahead in the balance of power. It is tantamount to piercing the corporate veil. Even for those with no direct ‘skin in the game’ it is perhaps worth noting that this is perhaps the thin end of the wedge in respect of tax and limited liability.
These powers are not set out in draft legislation however anyone involved in tax will understand that HMRC seemingly get their own way on whatever suggestions they come up with. This is due to the current lack of Parliamentary scrutiny of tax legislation. MPs should perhaps prepare themselves for meetings with many bankrupt (and worse) constituents.
Retrospective law – is that even legal?
Other than in the criminal field, retrospective law is not unlawful. That said, as retrospective legislation offends the rule of law, the presumption is that new legislation should not be retrospective.
Indeed, this is also true of tax legislation.
I have discussed retrospective legislation in some detail here.
To jump straight in, the tax provision I can see that is most analogous to the April 2019 loan charge is the Pre-Owned Assets Tax (POAT) introduced in 2005. Perhaps the April 2019 loan charge should be called the ‘Pre-loaned assets tax charge?’
This was a new, standalone income tax charge that was targeted at individuals who had already entered into ‘contrived’ Inheritance Tax (IHT) arrangements. These schemes essentially allowed them to remove assets from their estate for IHT purposes whilst retaining the ability to use the assets.
The income tax charge levied under these provisions operates in a similar way to the employee benefit in kind charges. In other words, a tax charge applies to a cash equivalent value of the benefit received.
By any normal definition of the term, POAT was a ‘retrospective tax’ as it applied to arrangements entered in to from 1986 onwards. Of course, HMRC and the Government argued that it was simply a new standalone tax being introduced and therefore was retroactive. Rather strangely, in the HM Treasury Budget Summary for 2004, the Treasury stated that it ‘is not retrospective as it will not take effect until April 2005’ seemingly missing the fact that the tax charge applied to transactions entered in to up to almost 20 years ago.
This explanation was not bought by most in the profession. However, the big surprise is that, as far as I am aware, this legislation was not challenged in the Court.
One assumes that this was because for impacted parties who would find unwinding arrangements difficult or too expensive, it was possible for an election to be made treating the assets as being back in to the estate for IHT purposes. In other words, it would just render the planning ineffective. For these people, there would be no real cost implications of the new rules other than fees paid and the fact that, on death, the asset would be subject to IHT.
Others would of course review the position and take steps based on a cost / benefit analysis.
Indeed, the Joint Committee on Human Rights made the following comments:
‘1.48 In our view, the imposition of the new tax by clause 84 and Schedule 15 cannot strictly be said to be retrospective. It imposes a prospective liability, from the tax year 2005-06, in respect of the value of benefits received during those years [my emphasis]. It is true that this imposes, in relation to certain arrangements, a tax which was not payable at the time that those arrangements were entered into, but that does not make the change retrospective. A retrospective provision would be one which levied the charge in respect of the benefit enjoyed in previous years [my emphasis]. Such a tax would require very careful scrutiny for compatibility with the requirement of accessibility and foreseeability.
‘Clause 84 imposes a prospective liability in respect of future benefits, and allows individuals who have already entered into arrangements whereby they have disposed of their assets to elect for them to be treated as part of their estate for inheritance tax purposes.’
Can parallels be drawn between the POAT legislation and the April 2019 loan charge? Of course, both apply a tax charge to arrangements entered in to, in both cases, up to the two decades ago.
However, there are fundamental differences to the operation and implications of these taxes.
Firstly, POAT only sought to tax the benefit of the use of the asset going forward on an annual basis. The quantum of the tax charges being relatively small. So, on a property asset of £500k one might be paying tax on the annual rental value of, say, £25k.
However, the loan charge is much blunter. Regardless of the length of time a loan arrangement has been in place (whether 5, 10 or 20 years) one is taxable on the full amount at one’s marginal rate of tax plus national insurance. As such, it is fairly arbitrary, converting a capital sum into income and, as such, is clearly taxing ‘benefits’ received or use of money provided in prior tax years.
This seems to be a highly relevant point as (see My Second Underlining above) the fact that charge only applied to future benefits persuaded the Joint Committee that the charge was not retrospective.
Secondly, with POAT, there was a simple way out for those economically impacted by the change. One could pay the income tax charge or one could elect for the asset to fall back in to the estate. With the latter, one being simply in the position that one would have been in had the planning not been entered in to in the first place (other than loss of fees).
However, with the loan charge, one has the following options:
- Repay the loan – this is likely to be very difficult for many as a bullet payment, or series of bullet payments, before April 2019 which might be financially impossible;
- Persuade the Trustees to write off the loan – this will result in income tax and NIC and potentially an IHT charge; and
- Pay the tax and leave the loan in place
Hobson’s choice seems a good deal.
However, this analysis has been largely superseded by the publication by the Government of their Protocol on unscheduled announcement of changes to tax law. So a comparison between the loan charge and POAT is, perhaps, of limited value.
This document was first published in March 2011 and set out, generally, the criteria under which tax changes would be announced other than at the Budget. However, for the purposes of this article, and in relation to retrospective tax legislation, it stated that:
‘The Protocol will explicitly recognise that changes to tax legislation where the change is effective from a date earlier than the date of announcement will be wholly exceptional’.
My previous article on retrospection provides the definitions of both ‘retrospective’ and ‘retroactive’ provisions. Although, it might seem like splitting hairs, the difference is important.
Ultimately, both are going to affect historic arrangements or transactions. However, retroactive rules apply to future benefits, income and gains whereas retrospective applies to benfits, income and gains enjoyed in the past.
One first has to get over whether a loan is a benefit, income or gains. Clearly, the traditional position is that the loan capital is not. Only the use of that money, without paying interest, would be a benefit.
However, let us say that the law has transmogrified the loan capital in to income. In this case, the loan (the income or benefit) has arisen in a previous year.
As such, the April 2019 loan charge ‘imposes (or increases) a tax charge on income earned, gains realised or transactions concluded at a time before the legislation was announced. This is, by definition, a retrospective tax law.
The corollary of this is that the Government could introduce a non-retrospective measure which charged to tax the use of the money going forward. However, they already do, through the benefit in kind provisions mentioned above.
So, if my view is correct, and the April 2019 loan charge is retrospective then ‘so what?’
Well, the Protocol states that legislation may be retrospective in ‘wholly exceptional’ circumstances. As I said in my earlier note, in cases such as Huitson and St Matthews, one can easily argue that the retrospectve changes were ‘wholly exceptional’.
However, in my view, it is difficult to see what ‘exceptional’ issue the proposed April 2019 loan charge addresses other than creating an exceptionally attractive windfall for HM Treasury. Indeed, one can state that for a long period of time EBTS and similar devices were wholly unexceptional.
Indeed, the argument that loans are subject to PAYE has been a nailed on loser for HMRC in the Courts. Secondly, as described above, the corporation tax rules seem to take account of this logical position.
Furthermore, HMRC changed the rules with effect from 2011. At this stage, they did not seek to apply Part 7A retrospectively. No measures were taken to clean up the old schemes. Part 7A was not positioned as a ‘re-clarification’ of tax law. It was clearly the introduction of new rules.
My view is therefore that:
- The loan charge is retrospective; and
- It is at odds with the Governments own protocol on these matters.
European Convention on Human Rights (“ECHR”)
Looking outside the Protocol, as the Protocol was stated as not binding on Parliament in the St Matthews case, one could also ask whether the charge is compatible with ECHR.
As discussed in my earlier note, there is no general prohibition on retrospective legislation within ECHR either.
Furthermore, as many tax scheme providers and users have found to their cost, the ECHR does not readily lend protection in matters of tax avoidance.
The key points, in respect of Article 1 of the First Protocol (“A1P1”) of the ECHR, which entitles someone to peaceful enjoyment of their possessions, are as follows
- Whether there is a possession;
- Whether the legislation is lawful; and
- Whether the legislation is proportionate
Both Huitson and St Matthews (cases discussed in my earlier note) both failed to get out of the blocks as there was no possession. Merely an arguable right to tax relief or that there was no tax to pay.
However, in the case of the April 2019 loan charge, there is a possession. There is cold hard cash at stake, each required to pay a tax charge which, until now, did not exist.
Of course, one would assume, that the legislation when it comes in will be passed in accordance with the law. As such, I do not propose to discuss this here.
Finally, and crucially, is the legislation proportionate? Does it properly strike the balance between the taxpayers impacted by the measure and the wider public at large. In the case of both Huitson and St Matthews, the circumstances of these tax avoidance schemes meant that the Court felt such a balance was fair.
I find it difficult to come to the same conclusions here. Even if one accepts that even a pre-2011 EBT was a tax avoidance structure, there appears to be no doubt about the tax position of a loan under the legislation at the time. They simply were not taxable. So, unlike the aforementioned cases, this cannot be described as the emergency re-clarification of the existing rules to prevent the haemorrhaging of tax (albeit, as I said earlier, the April 2019 loan charge will be a welcome windfall to the Treasury).
That said, ECHR gives the Government a ‘wide margin of appreciation’ in framing and implementing tax policy. The question is how wide?
Finally, will the Human Rights Act 1998, which incorporated ECHR in to UK law, still be left standing following Brexit?
Is there a case to discriminate?
One could reasonably take the view that the Part 7A rules were a line in the sand. HMRC didn’t like the old rules (and couldn’t win in Court) so they changed them. As such, this should have been a warning that enough was enough.
This would perhaps be analogous to the St Matthews SDLT case where planning was defeated by retrospective changes. This planning was devised after the Chancellor had already given clear notice that he would block any such schemes with such moves.
So, rather than applying to loans that have been taken out since 1999, a revised April 2019 loan charge could apply to those loans taken after Part 7A was introduced in 2011. This would still be extremely harsh in my view but at least would address the bigger risk takers.
Just a thought.
Are these changes already redundant?
Clearly, these proposals were announced prior to the decision in the Rangers. Why is this relevant? Well, the decision in Rangers would seem to go right to the heart of this issue.
Rangers featured the use of an EBT. The beneficiaries of the EBT were players and the executives of the club. As such they were employees, albeit well paid ones.
In respect of the players, various side agreements and correspondence with agents had ‘promised’ that players coming to the club would get an amount net of tax. This was made up of a salary payment (subject to PAYE in full) and also a contribution to the trust that could, and in all cases seemingly did, end up in a loan payment being made to the players by the Trustees.
Initially, at the First Tier Tribunal and Upper Tier Tribunal, HMRC had lost on the argument that the loans were taxable as earnings. Despite the fact that the arrangements were set out like a West Brom set piece.
However, at the Court of Sessions, and ultimately the Supreme Court, HMRC won on a different argument. That is, that the payments to the trust were actually just a diversion of earnings that had already crystallised. In other words, if one has a right to receive the earnings, requesting that the payments are made to a third party does not matter. They are earnings.
However, doesn’t the entire policy rationale basis for the April 2019 loan charge hinge on the fact that the arrangements entered in to are ‘disguised remuneration’. The correct argument that HMRC should be advancing is that the funds paid in to the scheme are a ‘redirection’ of earnings and the PAYE results from that leg of the scheme.
HMRC would also have the ability to issue a Follower Notice were applicable.
Perhaps it is easier for HMRC to have the April 2019 loan charge, who knows. However, surely it is correct that HMRC should be expected to collect tax through the existing legislation / legal authorities rather than lobbying for retrospective legislation?
Finally, let’s not forget, HMRC also has the GAAR at its disposal where schemes have been designed to navigate Part 7A. Indeed, a GAAR ruling was made recently in relation to a disguised remuneration scheme.
Summary – April 2019 loan charge
Of course, if you have ‘no skin in the game’ then you might shrug your shoulders and say ‘it serves them right’. Who wants to be an apologist for morally repugnant tax avoiders?
Indeed, there seems little support for people potentially impacted by the April 2019 loan charge and little push back against rules which will impose a life-changing tax liability which, in full anticipation that HMRC gets its own way, can also pierce the corporate veil. This is a slippery slope.
In my view, these new rules are pernicious, potentially unlawful (and certainly against the extra statutory protocol) and arguably unnecessary.
Is this likely to stop HMRC and the Government introducing them? Of course not. Parliament unfortunately, and understandably, will have little grasp of these complex issues. The second Finance Bill 2017 alone being in excess of 600 pages. This is one of the reasons why we have one of the worst tax codes in the world. It will not get better.
The result of these provisions may not quite be on par as serving up the lovely Gwynnie’s head in a cardboard box (sorry for the spoiler) but there will be some real pain as a result of these wrathful measures.
If you are affected by the April 2019 loan charge then please do not hesitate to get in touch.
Evidence to the Committee: Finance Bill 2017 Consultation
In October 2017, Enterprise Tax submitted evidence to the House of Commons Public Bill Committee in respect of the Finance Bill 2017, which you can view in full here.