Rebecca Smith’s husband faces a tax bill of more than £100,000 because of a decision the couple made 15 years ago. 

The IT contractor is one of an estimated 100,000 self-employed workers to be caught by the loan charge, a new tax due to come into effect from April that could be applied to income from the past two decades. 

“We haven’t got the money,” says 45-year-old Mrs Smith (not her real name). “Our lives are on hold. It’s a permanent cloud. It’s the first thing we think of when we wake up and the last thing we think about before we go to sleep.”

Back in 2004, her husband — an IT contractor working for what she describes as a “household name” company — had been advised by his accountant to enter into a loan-based remuneration scheme. As a self-employed contractor billing for services via his own limited company, the loan scheme was suggested as a way of ensuring compliance with new regulations called IR35 designed to crack down on “disguised employment”. 

Under the new arrangements, Mr Smith would work for an umbrella company, which would administer his contract with the firm. Instead of being paid a salary, attracting income tax and national insurance, workers in such schemes were instead loaned money — typically via an offshore trust — on terms that meant the debt was unlikely ever to be repaid. For administering these arrangements, the promoters of the schemes took a fee of about 15-20 per cent. 

“I vaguely remember [my husband] asking me whether he should sign up to this loan scheme,” Mrs Smith recalls. “I said — stupidly, I now realise — what is everyone else in the industry doing?”

By 2004, use of loan schemes was widespread within the contractor community, and the couple decided to go ahead. Tax experts say that between 50,000 and 100,000 IT contractors and other freelance workers in the UK entered into these arrangements in the late 1990s and 2000s. 

A financial bombshell was dropped in the 2016 Budget when then chancellor George Osborne promised to “shut down disguised remuneration schemes”. All outstanding disguised remuneration loans, made from April 6 1999, would be treated as income in the 2018-19 tax year; this would be known as the loan charge. It was accepted that the tax owed would be substantial, so a three-year period was granted to allow contractors to get their affairs in order. HM Revenue & Customs encouraged those affected to come forward and agree a settlement. 

HMRC claims the average amount of tax avoided was £20,000 per person, per year. “The tax avoided on their income would have provided them with the luxuries and lifestyle that other people on a similar income, who paid their taxes in full and on time, could not have afforded,” its website says. HMRC expects to raise £3.2bn from the loan charge by the 2020-21 tax year.

Campaigners argue that the retrospective nature of the crackdown is unfair. Many are now retired or approaching retirement, and have no idea how they will pay huge tax bills. Interest and penalties also apply in some cases. 

Some fear they will be bankrupted or lose their homes, despite assurances from HMRC. Campaigners report there has been at least one suicide, directly linked to the loan charge. Others, such as Mr Smith, are suffering from severe mental health problems. The couple have not told their children, friends, or wider family about the extent of their financial problems. Advisers to those affected say it is common for contractors not to feel able to tell their partners, and that in other cases, the stress has resulted in couples getting divorced. 

As the political campaign to halt the loan charge gathers pace, FT Money explores the arguments of the authorities who regard loan schemes as tax avoidance, the contractors who say they are victims of a mis-selling scandal, and rising political pressure to change the law.

Disguised remuneration

Richard Horsley, a 56-year-old IT contractor who has worked in the finance and banking sector, tells a similar story of how he found himself in what the tax authority now calls a “disguised remuneration” scheme.

In the early 2000s, after IR35 was introduced, he went to speak to a tax adviser about his options, as he had been told by his accountant that he could no longer work via his limited company. The adviser recommended a loan-based scheme.

“They asked me to bring my passport, looked over my all documents, checked my credit history so I was being properly financially vetted,” he says. “I asked if there were any issues with the structure and they said no it was all legal and above board. It wasn’t until the wheels started coming off in 2015, when I fully came out of the structure, that my adviser turned around and said to me: ‘You know we said there was no guarantee’. I thought: ‘You absolute liar, you said nothing of the sort’.”

Mr Horsley is now looking at a tax bill of more than £100,000. Faced with this life-changing amount of debt, he co-founded the Loan Charge Action Group, which has more than 1,000 members and is campaigning to change the law.

“I would need another lifetime to repay what in HMRC’s opinion they believe I owe,” he says.

The choice he and others are faced with is to pay the loan charge; repay the loans received from schemes; or come to a settlement with HMRC before the loan charge comes into effect. Around 25,000 contractors have taken the last option, but many dispute the level of tax being charged. 

“Most participants of these arrangements were also paying the provider fees of 15 or 20 per cent,” says Mr Horsley. “When you add that to the tax already paid and that is now being applied under the loan charge, it means HMRC are chasing a tax position that could be approaching 80 per cent. No one, regardless of their income level, can possibly afford to repay that. The only thing left for me is bankruptcy. A lot of people feel the same and this is leading to an alarming number of individuals reporting suicidal thoughts.”

The Loan Charge Action Group’s campaign has been gaining momentum in Parliament. An early day motion,expressing concern about the “retrospective” loan charge, has so far been signed by 118 MPs from all political parties. 

In December, the influential House of Lords economic affairs committee criticised HMRC for treating individuals affected by the loan charge “unfairly”. And this month, the government agreed to a review of the impact of the policy, which HMRC is due to publish days before the loan charge comes into force. 

While this has given hope to campaigners, the Loan Charge Action Group is asking for the law to be changed, so that the charge only applies from the point at which the legislation received Royal Assent in November 2017. 

Type of workers affected by loan charge
SectorPercentage
Business services65%
Construction10%
Engineering4%
Medical and education services 3%
Accountancy2%
Dentistry2%
Retail distribution2%
Other professional and technical services2%
Social and community services <2%
Recreational services<2%
Other financial activities<2%
Other transport and storage<2%
Source: HMRC (Note: figures have been rounded)

Avoidance not evasion

Normally, after a tax return is filed, HMRC has 12 months to write and tell you whether it is opening an inquiry into your tax affairs. The authority also retains the power to look into your affairs for four years after your return has been filed. This can be extended to up to six years if you have made a mistake on your return due to carelessness. In cases of tax evasion or fraud, the tax authority can investigate your affairs up to 20 years after a filed return.

Yet, tax avoidance is not the same thing as tax evasion. Avoidance is technically legal — although considered not within the spirit of the law — whereas tax evasion is illegal. However, the loan charge legislation effectively removes the time protections taxpayers would normally be entitled to, unless they had done something illegal. This, campaigners say, is a crucial distinction.

Sir Ed Davey, a Liberal Democrat who is among several MPs championing the loan charge campaign, says: “I am not in favour of tax avoidance and these are tax avoidance schemes, but that’s not the issue. The issue is that from the evidence I have seen, the vast majority of these people believed they were doing something legal and allowed. 

“They have taken advice from accountants and advisers and, in some cases, employers. So for HMRC and ministers now to say this is not retrospective because the loan charge was first announced in the 2016 Budget [three years before its effect] is angels dancing on a pinhead. The real-life experience of people is of retrospection.”

Steven Porter, partner and head of tax investigations at law firm Pinsent Masons, agrees: “It’s very hard to explain to the man on the street how this is not a retrospective tax.”

Campaigners also report that in some cases people told HMRC they were using loan schemes at the time, via their tax returns, but in many cases the authority did not take action. 

“HMRC failed to make its position on the schemes clear enough,” the House of Lords report concluded in December. “There were unreasonable delays in legislating and in failing to progress those inquiries which were opened into individuals’ tax affairs, depriving them of certainty even in situations where they were actively seeking to engage with HMRC to finalise matters.”

Meanwhile, supporters say the role some tax advisers and accountants played in these schemes could constitute a mis-selling scandal. For example, WTT, a tax advisory firm representing more than 2,000 people caught up in loan schemes, says it has evidence that advisers and accountants received financial kickbacks from loan scheme promoters worth thousands of pounds for each person they signed up.

Tom Wallace, head of tax at WTT, says: “Most promoters were charging individuals between 15-20 per cent to join the scheme, which means for a client with a contract of £150,000, the promoters received a payment of between £20,000 and £30,000 a year. So they were quite happy to pay big referral fees of £1,500 per person to accountants, advisers and anyone who could bring them volume. You have to ask yourself whether the professionals recommending these schemes were incentivised by the high fees they could earn rather than their clients’ best interests.”

Members of the Loan Charge Action Group have looked into pursuing claims against their advisers and accountants but say this it is not straightforward, particularly as many firms have since gone under or been absorbed into other firms.

Meanwhile, Dawn Register, tax dispute resolution partner at BDO, thinks HMRC should be doing more to tackle the employers who benefited from the arrangements. “Many companies, including big banks, had contract labour under these arrangements,” she says.

23/01/2019 Holborn, London. Tom Wallace - tax lawyer
Tom Wallace, head of tax at WTT: 'You have to ask yourself whether the professionals recommending these schemes were incentivised by the high fees they could earn rather than their clients’ best interests' © Charlie Bibby/FT

HMRC crackdown 

Despite the difficulties faced by individuals caught by the government’s tax avoidance crackdown, HMRC says it is right to pursue those who gained an unfair advantage from using loan schemes.

The tax authority estimates that 50,000 people, or 0.2 per cent of income taxpayers in the UK, will be affected by the loan charge. HMRC says that on average, users of disguised remuneration schemes earn twice as much as the average UK taxpayer. About 65 per cent of these individuals work in the business services sector and are predominantly IT and management consultants.

Mr Porter concurs: “From my experience, it was mostly sophisticated high net worth individuals [who used these schemes]. The majority of people understood what they were doing was different from the norm and carried with it a risk.”

Although loan charge campaigners have highlighted examples of nurses and social workers being affected by the loan charge, HMRC statistics suggest that less than 3 per cent of those affected work in medical services or teaching. 

“Disguised remuneration schemes are aggressive tax avoidance structures which a minority of relatively well-paid contractors have used to try and dodge the taxes that Parliament requires them to pay,” HMRC says. 

“The charge on disguised remuneration loans is not retrospective. It is a new charge, arising at a future date, on disguised remuneration loan balances outstanding at that date. It does not change the tax position of any previous year, the tax treatment of any historic transaction, or the outcome of any open compliance checks. Its announcement at Budget 2016 provided scheme users with a three-year period to repay their disguised remuneration loans, or to agree a settlement with HMRC before the charge takes effect.”

Some tax experts agree that the loan charge is not retrospective.

“On a very narrow technical interpretation the legislation is not retrospective,” explains Andrew Hubbard, tax consultant at RSM. “It looks at a situation at a future date — is there a loan in existence on April 5 2019? — and imposes a tax liability for 2018-19 based on that situation. It does not impose a tax liability for a previous year, which would be retrospective. But it is easy to see why it feels like retrospective legislation, because the loans were often taken out a long time ago.”

HMRC strongly disputes that it did not do enough to communicate its disapproval of loan schemes at the time.

Pointing to warnings against the use of tax avoidance schemes in the media and online from 2009, Sir Jonathan Thompson, HMRC chief executive, says: “HMRC has opened tens of thousands of inquiries into these schemes starting before 1999, making users and their representatives aware that their tax return was under investigation.”

He adds that the number of people who informed HMRC they were using loan schemes at the time they entered into the arrangements was very small, and the fact the authority was litigating against users in these types of schemes throughout the 1990s and 2000s should have made it clear to individuals and their advisers that it considered them unacceptable. 

Ray McCann, president at the Chartered Institute of Taxation and a former tax inspector at HMRC, acknowledges that loans schemes were initially popular with some advisers. But, he adds, he does not believe any “reputable adviser” who was knowledgeable about these schemes would have advised a client after 2004 to enter into them without warning them of the risk. 

But what of the banks and City institutions that the IT contractors worked for? If an employer set up a loan scheme then the tax liabilities would fall to them and not the employee. But the financial services companies employed the contractors via umbrella companies set up by offshore promoters. 

Sir Jonathan adds: “Employers have a legal obligation to operate pay as you earn, and wherever possible HMRC will collect the tax due from an employer. We expect around three-quarters of the money that we collect by tackling disguised remuneration will come directly from them — not employees. But the fact remains that an individual is, ultimately, responsible for making sure they’ve paid the right tax.”

HMRC is also “cracking down hard on the promoters of tax avoidance schemes”, the authority says.

Edward Davey - UK Parliament official portraits 2017
Sir Ed Davey, MP: 'The vast majority of these people believed they were doing something legal and allowed' © Handout

What happens next?

This month, campaigners won a review into the impact of the loan charge, after an amendment to the 2019 finance bill tabled by Sir Ed Davey was backed by a cross-party group of more than 30 MPs.

“People will be grabbing on to this review, wanting it to show that the loan charge is unlawful, but my expectation is it is a bit of a paper tiger,” says Mr Porter, noting that its remit was vague. 

HMRC adds: “The amendment does not change the legislation but will ensure that a review of the impact of the loan charge is published before that date.”

Political sympathy for those facing large tax bills has to be weighed against the feeling that affected contractors are “being let off paying tax they should have paid years ago”, argues Mr Hubbard at RSM. 

However, Sir Ed believes the government could and should act to prevent the loan charge coming into effect on loans going back 20 years. A fair outcome, he thinks, would be for the charge to apply on loans taken out from the date when legislation was mentioned in the 2016 Budget. 

Although he disapproves of tax avoidance, he says: “In this case, the way the government has gone about it is so over the top and unfair that they have to back down. Fine, close these schemes down. But don’t bankrupt people, don’t make people homeless, don’t make people ill or break up families.”

A group of MPs supporting the campaign are due to meet Philip Hammond, the chancellor, in coming weeks, and an All-Party Parliamentary Group — an informal group of cross-party MPs — is being set up to bring further pressure on the government.

But time is running out, and the progress of the loan charge is being overshadowed by Brexit. HMRC’s review is due on March 30 — the day after the UK is scheduled to leave the EU.

Regardless of the outcome of its review, HMRC is likely to face practical problems dealing with disguised remuneration users. The authority is struggling to cope with the number of cases it has to administer. The Financial Times revealed recently that 60 per cent of people who had requested to settle their disguised remuneration debts had yet to receive tax calculations.

A 15 per cent cut in staff at the authority in recent years is a factor, according to Mr McCann.

“HMRC cannot handle 100,000 cases [of disguised remuneration] as it takes time to train tax inspectors,” he says. “If half of the 100,000 people involved in these schemes are reluctant to engage, that makes it harder still — the phrase “herding cats” comes to mind. HMRC has got to cut its losses and offer a more generous settlement to these people so they recognise that this is the best they are going to get.”

HMRC settlement offers could be made more generous through removing tax liabilities from any years where an individual reported on their tax return that they were using a loan scheme, he suggests. This solution was also backed by the Lords economic affairs committee. 

HMRC’s promise 

HMRC says it is already enacting measures to help people in hardship as a result of their participation in loan schemes. It promises that anyone earning less than £50,000 will automatically be given at least five years to settle their debts. Even those earning more than £50,000 a year could receive extended periods to pay if they come forward now, it says. The tax authority says nobody will be forced to sell their home if the only debt they have with HMRC is the loan charge.

“We’re not here making any moral judgment on anybody, and how they ended up in [these schemes],” the HMRC official says. “What we want to do is get them out because we recognise that there will be people that are in pretty stressful circumstances and if they haven’t engaged with HMRC they are looking at a sizeable amount of tax and wondering how they’re going to pay for it.”

Bankruptcies will be the absolute last resort, HMRC adds.

However, Rebecca Smith is not reassured. “Talk is cheap,” she says. “I know somebody who was served with a bankruptcy offer [order] three days before Christmas.” 

Figures from the Loan Charge Action Group show that somebody earning £50,000 a year would pay a staggering 69 per cent of their net income to HMRC for five years to clear their debt (see below). 

WTT plans a legal challenge to contest whether individuals should be solely liable for tax in disguised remuneration schemes and believes that HMRC should do more to tackle loan scheme promoters, financial advisers and the companies that contractors worked for.

“The loan charge is not black or white but a classic shades of grey scenario,” says Mr Hubbard. “I don’t know at all where this is going to go. It’s a really messy situation.” 

Tax experts also feel the loan charge dispute raises wider questions concerning the blurring of the lines between tax evasion, avoidance and planning.

“People doing tax planning need to think about how HMRC will view what they are doing now in the future, and whether HMRC’s view is likely to change,” says Ms Register. “But given the complexity of tax, that’s very difficult for individuals to work out. The loan charge is a prime example of this.”

“HMRC is right to tackle tax evasion and aggressive tax avoidance,” says Lord Forsyth of Drumlean, chairman of the House of Lords economic affairs committee. “However, a careful balance must be struck between clamping down and treating taxpayers fairly. Our evidence has convinced us that this balance has tipped too far in favour of HMRC and against the fundamental protections every taxpayer should expect.”

In the meantime, affected contractors are waiting nervously to see if political pressure will change anything. 

“We’ve been living under this weight for three years already,” says Mr Horsley. “It’s crushing.”

Impact of debt payment over five years

The interest rate for individuals using HMRC’s debt management process — called Time to Pay (TTP) — is 4.25 per cent.

This means an individual facing a liability of £115,000 (£100,000 debt plus £15,000 penalties) would pay £12,854 in interest over a five-year period — generating a total debt of £127,854.

They would need to pay £2,131 a month over five years (£127,854 divided by 60 months) to clear the debt. 

  • Example 1 — Individual earning £50,000 gross per annum (£3,084 net per month). After TTP payment of £2,131, this would leave this person with £953 for mortgage/rent, food, heating, electricity and other living costs. They would be expected to pay 69 per cent of their net income to HMRC for five consecutive years.

    Example 2 — Individual earning £30,000 gross per annum (£1,982 net per month). This individual would have to borrow money just to pay TTP repayment [of £2,131 a month].

Source: Loan Charge Action Group

[Note: HMRC told the Financial Times penalties will only be charged in very exceptional cases]

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