Contractor Loan Charges and Settlements – When Tax Avoidance Goes Wrong

Sometimes, if something sounds too good to be true, that is often because it is too good to be true. This is definitely the case in contractor off-shore loan schemes, as some contractors are now realising.

Even more unfortunately, many contractors are also discovering that the operators and promoters of such schemes have ceased to exist – leaving them (the contractor) with no “come back” and personally open to tax liabilities going back years.

Loan schemes are usually (but not always) based off-shore, using a non-UK trust – however, some are operated by UK umbrella companies. They “work” by paying the contractor a minimum salary and the remainder is paid to the contractor by way of a “loan” (minus an admin fee levied by the scheme provider). Income tax and national insurance are not payable on loan income – hence the tax avoidance. However, in practice, these loans are not expected to be repaid – which is why HMRC views such loan payments as disguised remuneration.

HMRC introduced anti-avoidance measures which means that any such loan taken out since 1999 and that is still outstanding on 5 April 2019 becomes taxable, all in one go, on that date (5 April 2019).

The loan income is considered employment income by HMRC and in theory, the employer is liable for PAYE. However, where the employer is offshore (which includes the Channel Islands and the Isle of Man) or the employer has dissolved (ceased to exist) or HMRC thinks that the individual knew that the employer failed to make the correct PAYE deductions or the employer is unable to pay, the tax liability can pass to the individual.

If you are affected, you essentially have two options available to you:

• Reach a settlement with HMRC – which essentially means calculating and paying tax on the historic tax years, as if the loans were taxable in the year(s) the loans were received (eg, if you had a £5,000 salary and a £20,000 loan in 2016/17 you pay tax on £25,000 income for 2016/17 plus the historical interest on the tax from 2016/17 to date. This calculation is made for every tax year that you had loan income.
• Pay the loan charge as at 5 April 2019. So the total of all your loans is added to your 2018/19 income (on 5 April 2019) and you’re taxed accordingly in 2018/19. This may push some people into the higher rate or even the additional rate tax band. You may also have to repay any child benefit you received (if you end up over the threshold in 2018/19)

In either case, you may also reach an instalment arrangement, in which case HMRC will charge “forward interest” on the outstanding amounts. (Forward interest just means they calculate all the interest that would apply over the period of time it will take you to pay the tax in instalments)

The loan charge is not without controversy. It is a retroactive charge with a “look back” period of 20 years (because HMRC can go back and tax loans dating from 1999) – which is further back than a tax enquiry can usually be opened. This means that some contractors owe substantial amounts of tax and interest.

Ignorance is not a defence, so any freelancer, consultant or contractor should be very wary of any scheme promising to net 80%+ of income and HMRC are investigating thousands of contractors. It is also worth noting that contractors are not the only people caught by the loan charge – such schemes have also affected celebrities and other high-net-worth individuals.