Loan schemes ruled ‘abusive’
Andrew Robins explains why two recent GAAR rulings are important for users and promoters of loan schemes designed to be used by contractors and employees.
What is GAAR?
In July 2013, the government introduced a new ‘general anti-abuse rule’ (GAAR) to attack ‘abusive’ tax arrangements aiming to take advantage of loopholes in the tax law by, for example, inserting artificial steps into a commercial arrangement. The GAAR only applies to actions undertaken after its commencement.
Its application is overseen by an independent ‘GAAR Advisory Panel’ which can determine whether arrangements are abusive, in which case HMRC may impose penalties and issue accelerated payment notices (APN) to demand payment of the tax avoided by using the scheme.
The GAAR panel has published two rulings affecting arrangements concerning loans provided in place of salary, which were designed to get around the ‘disguised remuneration’ rules. In both cases, the taxpayer lost.
Neither decision was a surprise and the GAAR panel is expected to review other structures designed to stop disguised remuneration rules from applying in the near future. It is therefore worth understanding its approach to these arrangements.
The first case concerned Mr N, who was employed by agency ABC to provide his services to E Ltd. ABC was paid £110,000 by E Ltd and paid N a salary of £8,000, plus a loan of £83,000. ABC subsequently transferred the loan to an employer-financed retirement benefit scheme (EFRBS – a form of pension scheme) of which N was the beneficiary and thus was entitled to received payments.
HMRC argued that the loan would in reality never be repaid and was really employment income. Alternatively, the whole cash payment of £91,000 was made as a result of N’s employment and was therefore liable to income tax and NIC.
N argued that the loan was fully repayable and, because the loan arrangements did not constitute remuneration under s62 ITEPA 2003 or meet the definition of relevant steps under the disguised remuneration rules, the loan capital fell outside any taxing provisions.
In its ruling, the GAAR panel ignored HMRC’s attempt to recharacterise the loan as earnings and treated it as real. However, the panel was not impressed by the argument put by N that the steps taken via ABC were a legitimate way to avoid what the GAAR guidance calls a ‘bear trap’ – a negative tax effect not intended by parliament that requires the taxpayer to take artificial steps to escape.
The panel decided that the arrangements were artificially designed to avoid the clear intention of parliament and concluded that a loan made directly to N by the EFRBS would have been taxed as earnings, so routing it through ABC, which then transferred it to the EFRBS, was just an artificial way to try to escape parliament’s intended outcome.
The second case concerned Mr B who was a director of A Ltd. He terminated his employment contract on 17 August 2014 and was instead employed by an agency, XYZ. He remained as a non-executive director of A Ltd. As with Mr N, A Ltd then paid XYZ, and XYZ paid Mr B a much-reduced salary and made monthly loans to him. XYZ later transferred its loans to an EFRBS for B’s benefit.
The arrangement aimed to avoid B being taxed on the funds loaned to him as employment income. HMRC’s arguments were the same as with Mr N in the first case. B did not put forward any defence of the transactions, which resulted in the GAAR panel assuming that they were entirely tax-driven. The panel nevertheless did not automatically rule in favour of HMRC but considered the arrangements overall.
Industry insightsView more
The key findings of the panel were that A Ltd continued to enjoy the benefit of B’s services, and B continued to receive payments for those services. As a result of the new structure, B received more funds than he did under his previous direct employment.
This was a fairly straightforward case for the Panel to decide. In the absence of any evidence from B, and since the arrangements had very little commercial impact, the only realistic conclusion was that B undertook a series of artificial steps designed solely to reduce his tax liabilities when compared with the position had he continued to be employed by A Ltd throughout.
How the GAAR works
Both of these cases involved marketed tax avoidance schemes designed to defeat the effects of the disguised remuneration rules. In both cases, the GAAR Advisory Panel stood back from the taxpayer’s reliance on a narrow technical reading of the legislation and concentrated on the overall tax and economic effects.
Like it or not, this is exactly how the GAAR is intended to work, and these decisions demonstrate how difficult it is for avoidance schemes to succeed in keeping taxpayers out of the clutches of widely drawn anti-avoidance measures. The rulings provide a clear warning to taxpayers that it is no longer enough for tax planning to be effective based on the letter of the law: in order to work, it must also be consistent with the intention of parliament and not be intended to reduce tax charges artificially.
Andrew Robins is a partner in RSM’s London private client tax team, advising on all areas of UK personal taxation. He specialises particularly in advising high net worth individuals, non-UK domiciled individuals, non-UK trusts, and members of corporate remuneration plans such as employee benefit trusts and international pension plans.