Contractors | Loan Schemes and Tax Avoidance

Contractor loan schemes are a relatively new form of tax avoidance. While the exact details that you’re told by whoever is offering you the scheme may change, and the exact level of risk can vary between fairly safe and extremely aggressive, HMRC is doing their best to recover every penny of the tax that they can. Read on to find out a little more about what these loan schemes are, how to recognize excessively aggressive schemes, and what the likely outcome is of getting involved in this sort of tax avoidance.

What are loan schemes?

Loan schemes are a method of tax avoidance which is currently being offered by tax avoidance contractors. In a scheme like this, rather than being paid directly for your work, you’re paid in the form of a loan through either a trust (sometimes referred to as a ‘remuneration trust’) or an umbrella company. This loan will not come directly from the business you’re actually working for but will be diverted through a series of shell companies or trusts until it gets to you. On the other hand, some businesses simply offer you the ‘loan’ directly. Again, the exact details can change.

Of course, the point is that it’s not really a loan. It’s just declared to be one. You never have to pay anything back; so from your end, nothing is different compared to getting paid through the normal route. Nothing, that is, except that you pay less tax since HMRC think it’s a loan! These ideas are nothing new, and have been used for the past twenty years or so.

Various measures have been introduced to stop businesses from paying people with this method, but even so, a loophole in part 7a of the Income Tax (Earning and Pensions) Act 2003 means that it’s still possible. Essentially, loan schemes these days avoid section 7a by claiming that they are operating on a commercial basis and that since this method has been around for a good twenty years or so that it doesn’t fall under the General Anti-Abuse Rule, or GAAR of the Finance Act 2013.

What kind of schemes are there?

These loan schemes come in a number of shapes and sizes. Currency arbitrage is one of the riskier methods. The idea behind it is that through signing up with an off-shore company, and receiving exotic foreign currencies in exchange for loans, that your earnings can be turned into non-taxable foreign exchange gains.

The Icebreaker scheme is a well-known name for this type of tax avoidance. Essentially, the contractor forms a partnership with a business in the creative industry which ostensibly trades in the rights to songs, ideas for books and so on. The business then claims tax relief on their losses, and these losses are passed on to the members of the scheme to save on their personal taxes.

But as we’ve already pointed out, these schemes come in any number of shapes and sizes. So don’t be surprised if what you’re told doesn’t sound exactly like currency arbitrage, for instance: do your homework and think about what you’re being offered. If it’s too good to be true, it probably is!

What are the likely signs that you’re being sold one of these schemes?

Because these schemes can save a business a lot of money, they’re being pushed quite hard at the moment. That means that if you’re a relatively successful contractor or freelancer, and you do a lot of your work with specific companies, then you’ve probably been offered something like this before. Certain schemes of this kind will promise that if you do, you will be able to keep between 80 and 90% of your income, tax-free. In reality, no deal could possibly be that good; HMRC will be on it in a shot. But that is of little concern to the promoter, who would have long since had their fee.

You’re also likely to be told that the service you’re being offered is HMRC approved, or that you won’t have to declare what you’re doing. Of course, there are perfectly legal ways of limiting the amount of tax you pay- although whether HMRC ‘approve’ of that sort of thing or put up with it is a different question- so whenever you encounter a new way that you may be able to save on your taxes, do your research and find out whether it is legal or if it’s likely to land you in hot water. Don’t take any promoter at their word!

What’s the likely outcome of using one of these schemes?

HMRC challenge every case of this kind of avoidance that they detect, and in the event that they detect your part in a tax avoidance scheme, you will be placed under a COP8 Investigation. These investigations can target individuals, partnerships, limited liability partnerships, companies, and trusts, and can uncover unpaid taxes, duties, and levies. In essence, there’s not much room to hide.

Where the outcome is litigation, HMRC wins around 90% of the cases that are taken to court. So if you are detected, and you are challenged for having taken part in a loan scheme, then you are likely to lose your case. An accelerated payment notice may be sent to you as part of HMRC’s investigation, which would mean that you have to pay the disputed tax up front. Even worse, if your loan was paid through a trust, then you may have to pay inheritance tax on what you ‘earned’ either after the investigation or at some point in the future.

These sorts of tax avoidance schemes are exactly what HMRC tax recovery is currently targeting. Using their state of the art Connect Computer System, HMRC is better able than ever to detect schemes such as these and come down hard on those who use them, and those who offer them.  HMRC’s official guidance is to avoid engaging with a promoter offering you something of this nature, or if you are already avoiding tax, to withdraw from the scheme and immediately settle any tax you owe. If you voluntarily withdraw from the scheme, you avoid the twin costs of investigation and litigation and lower the penalty you may be charged.

If you have used anyone of these schemes and are worried about the tax liability which may arise if the scheme fails please contact The Accountancy Solutions on 01216297768 for a free and no obligation advice.