Back Dated Tax Loans | Disguised Remuneration Rules

When the Chancellor Smiles It's time for tax payers to worry

Phillip Hammond Chancellor of the Exchequer

In the Budget 2016 the Chancellor included proposals to impose a retrospective tax charge on certain loans to contractors and employees, which remain outstanding on 5th April 2019. Not surprisingly, this proposed tax charge was seen by many as both unfair and retrospective.

Many things have changed in the world since then and both political and judicial decisions have been made that many observers feel would justify a review of the original plans. However, when the draft loan legislation was re-published on 13 July 2017, it looked virtually identical to the previous, much criticised, 2016 version.

Disguised remuneration

At the heart of the proposals are the complicated and deliberately punitive ‘disguised remuneration’ (DR) rules. These rules began to take effect from 9 December 2010 and were specifically designed to discourage payments being routed through third parties to avoid or at least defer any employment taxes.

The DR rules were widely drafted and, in almost all cases, contractor loans, loans to employees and employee benefit trusts (EBTs) taken out on or after 9 December 2010 were subject to immediate Income Tax and national insurance (NIC) charges.

The Budget 2016 proposals took the existing DR rules and expanded them further, to cover pre-2010 loans that remain in existence on 5 April 2019. Under the proposals, unless the borrower agrees a settlement with HMRC prior to this date, most outstanding loans will be taxable as earnings on 5 April 2019, creating a typical combined tax and NIC liability of a massive 61% of the loan value.

Repayment rules

The draft legislation includes a very wide definition of loan and a very narrow definition of repayment. In particular, for repayments after 16th March 2016 only “payments in money by the relevant person” will be treated as effective, so the transfer of an asset to satisfy a repayment obligation after that date will be ignored.

In cases where the expectation was that the borrower would die before the liability matures, the borrower’s estate will be worse off by both the repaid debt and the tax – a typical cash cost of 147% of the amount borrowed, with the possibility of the individual also picking up the employer’s NIC liability.

Settlement terms

The terms of the HMRC settlement agreements for employees and contractor loans are not generous and in essence, the taxpayer is required to accept that the full amount paid into the arrangement should have been taxed as earnings from day one. They must also accept that they are liable to settle the Income Tax and NIC that should have been paid, plus what amounts to a penalty, as HMRC will request interest on this ‘late paid’ tax and NIC.

There is however a crumb of comfort for Employee Benefit Trusts loans, where if the value of the trust has increased since its creation (eg due to investment growth), any settlement will now only cover the original contributions into the EBT.

Employees facing potential ruin

HMRC is not willing to change its settlement terms, even where the tax at stake is enough to result in financial ruin for the taxpayer. HMRC’s attitude is heavily influenced by its view that loan arrangements are abusive tax avoidance, and cracking down hard on affected taxpayers is a way to send a signal discouraging anyone from undertaking similar ‘tax planning’ in future.

Is it fair?

Ever since the proposed new charges were first made public they have been criticised. There is a widely-held view that the effect of the charge is retrospective and that its whole premise is unfair. The counter-argument is that although it affects loans taken out before the legislation was introduced in 2010, the charge can be eliminated by repaying the debt, so the taxpayer can choose what to do.

Successive governments have also considered that where tax planning is ‘abusive’, even the most draconian anti-avoidance rules are justified, as they’ve clear done in this case. However, the counter argument is that when these loans were taken out they were within the existing tax rules and as such, should not be considered ‘abusive’ tax avoidance.

Can anything be done?

It is, in theory, possible to seek judicial review to request the courts to overturn retrospective tax changes on the basis that the taxpayer had a legitimate expectation that they would not apply. It is also possible to take a case to the European Court of Human Rights on the basis that the legislation is a breach of the right to peaceful enjoyment of personal property.

Unfortunately, in practice the costs involved in making such a challenge are likely to be prohibitive. Also, even if the judicial review is successful, and the chances of that are very modest, it could well prove to be a pyrrhic victory unless affected taxpayers group together to share the costs of a test case.