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shield and sword | accountingweb | Contractor loan scheme disclosure not clear enough

Disclosure shield failed in contractor loan case


The discovery disclosure in this contractor loan scheme was not deemed clear enough to act as an adequate shield.

8th Aug 2023
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Where a tax return discloses information that should alert a hypothetical HMRC officer to an insufficiency of tax, HMRC cannot issue a valid discovery assessment under Taxes Management Act 1970, Section 29.

This and the other conditions necessary for a valid discovery assessment were explored in the case of Dr Pradip Kumar Sheth (TC08790).

Sheth took part in two contractor loan schemes promoted by Sanzar and Darwinpay in 2009/10 and 2010/11. Under these schemes he was employed by offshore companies, receiving a modest salary subject to PAYE and national insurance, but the vast majority of his remuneration was in the form of low-interest loans from offshore trusts, which were in turn funded by the employers.

His 2010 and 2011 tax returns included on the employment pages the salaries and PAYE deducted by Sanzar and Darwinpay, together with the Disclosure of Tax Avoidance Schemes (DOTAS) reference numbers for each scheme.

Forms P11D were submitted for both years showing benefits in kind on the following loans: 

  • £72,577 outstanding at 5 April 2010 
  • £48,434 and £16,672 outstanding at 5 April 2011.

In neither case did Sheth include the benefits from the loans on his employment pages.

HMRC considered that Sheth’s self-assessments were inadequate in that the loans constituted diverted employment income and issued discovery assessments in February 2014. Sheth appealed, alleging that the assessments were invalid.

Validity of assessments

In situations where a normal enquiry can no longer be opened into the return, HMRC must either argue that the insufficiency of tax arose from careless or deliberate behaviour, or invoke the “hypothetical officer” condition which says: “The officer could not have been reasonably expected, on the basis of the information made available to him before that time, to be aware of the [insufficiency of tax]”.

The “information made available” is limited to information:

  • contained in, or accompanying, the taxpayer’s return for the year or any claim made in respect of the year
  • contained in any documents produced or furnished by the taxpayer to the officer in response to an enquiry
  • whose existence and relevance could reasonably be expected to be inferred by an officer of the board from the above or are notified in writing by the taxpayer to an officer.

Since HMRC was not arguing careless or deliberate behaviour, the assessments would stand or fall on the question of whether Sheth’s disclosure “was adequate to make the hypothetical HMRC officer aware of the actual insufficiency in those returns at the date on which the enquiry window into those returns closed”.

The hypothetical officer

Judge Popplewell pointed out that the hypothetical officer should possess “general competence, knowledge or skill, which includes a reasonable knowledge and understanding of the law”.

The actual officer who made the discovery was able to conclude that the loans were taxable employment income. “The hypothetical officer would have been able to come to the same conclusion once they knew of the facts.”

They would have been aware, in a general way, of recent case law such as Dextra, which showed that this type of scheme existed “to ‘convert’ what would otherwise have been employment income and taxed as such, into loans that were taxed only as a benefit in kind”.

In the judge’s opinion, “contractor loan scheme arrangements are… very much down the shallow end of the pool of tax avoidance schemes, and in our view this was the case at the time of the closure of the enquiry windows.”

Yet while any officer would think it “unusual, we suspect, that a taxpayer would have been lent almost eight times his taxable salary by his employer, this is not sufficient to comprise adequate disclosure. It would not have made the hypothetical officer aware of the actual insufficiency”.

The return also included the DOTAS reference, which should prompt an officer to seek to find the purpose of the scheme that had been utilised. If they had, what would the hypothetical officer learn?

The scheme disclosures

The AAG1 form (disclosure by scheme promoters) was, said the judge, “a typically disingenuous disclosure”.

  • No mention is made of loans under the heading “summary”, which describes the aim of the scheme as enabling the sale of a life interest without incurring a charge to capital taxes.
  • The heading “statutory provisions” makes no mention of the Income Tax (Earnings and Pensions) Act 9 (ITEPA), once again giving the misleading impression that the scheme is all about avoiding capital taxes.
  • The only mention of loans is found in the explanation section and is buried between a reference to the taxability of the salary and a restating of the capital taxes planning around selling a life interest. There is no suggestion that the loans were a crucial and indispensable element of the planning.
  • “What would not have been apparent from these documents was that the loans were designed to compensate [Sheth] for the salary that he had foregone by accepting the lower salary set out in his tax return... [or] that the statutory provisions which were relevant to this re-categorisation were set out in ITEPA.” 
  • While “the level of disclosure required to alert the hypothetical officer to the actual insufficiency is a modest one, [Sheth] has not met it. The DOTAS disclosure is confusing, misleading, and as far as that contractor loan scheme is concerned, deficient of relevant factual and statutory information”.

A sufficient level of disclosure, per the example given by the case of Hicks, should include:

  • brief but comprehensive details of the individual to whom it applied
  • the “tax magic”
  • the statutory provision which is relevant
  • the result 
  • the tax benefit for the individual.

The first tier tribunal (FTT) found that Sheth’s disclosure had not been sufficient to alert the officer to the actual deficiency in tax, and dismissed his appeal.

Obfuscation not an adequate shield

Ever since the Langham vs Veltema case and HMRC’s subsequent SP1/2006, it has been clear that the level of disclosure required to protect against a discovery assessment is, in effect, a level of disclosure that will encourage HMRC to open an enquiry into the return. Obfuscation is no longer an adequate shield.

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