The pros and cons of loan charge spreading
If taxpayers elect to spread the loan charge over three years, they may pay less tax, particularly now, as one of those years will be 2020/21. But could such an election lead to a red flag for a tax investigation?
In his report on the loan charge, Sir Amyas Morse recommended that: “Taxpayers should be entitled to opt to spread their outstanding loan balances over three years, to mitigate the impact of taxpayers paying tax at a higher rate than they ordinarily would. This reduces the effect of stacking their outstanding loan balances into a single year, which artificially created an increased exposure to a higher rate of income tax.”
Nightmare doesn’t end
A controversial and confusing feature of the loan charge is that it does not actually go away by paying for it. If there is an open tax enquiry or assessment, those underlying enquiries or assessments will still need to be dealt with. Basically, making a spreading election in these circumstances may not really benefit the taxpayer as much as you might think.
However, LITRG understands that from 2016/17 onwards, HMRC did not routinely challenge tax returns where loan arrangement use was suspected, in view of the loan charge coming in. This means that many of the workers LITRG is concerned with – agency workers put into loan arrangements by umbrella companies, typically in later, rather than earlier years – will not currently have any open enquiries or assessments with HMRC and so could benefit from the spreading elections.
Clearly, if the taxpayer’s income has been adversely affected by the coronavirus in 2020/21, they could now save even more tax by spreading the charge into 2020/21: for example, if their loan income, when added to any other income they have, falls within the £12,500 personal allowance.
Risk of assessments and enquiries
If taxpayers opted to spread, and thereby save tax, would HMRC follow what one might regard as the spirit of the Morse recommendations and not look to open tax enquires or assessments? On the other hand, would HMRC try and force a settlement of the underlying tax liability – thereby collecting the tax ‘saved’ by using the spreading provisions?
In this latter scenario, although people will get a credit for any tax they have paid under the loan charge, they will end up paying the settlement amount, if this is larger.
Not only would this reverse the benefit given by spreading the loan charge, but it could actually leave people financially worse off than if they had opted to declare the whole amount in 2018/19 (because historic interest and potentially penalties will come into play). It also means that such workers, and their advisers, would face the prospect of having to deal with an enquiry or assessment.
There would appear to be a precedent for this type of intervention by HMRC with the introduction of the off-payroll working. In that case, HMRC gave reassurance to contractors that IR35 enquiries from previous years would not automatically be triggered when individuals start paying employment taxes under the off-payroll rules for the first time following the reform of the rules.
What will HMRC do?
LITRG has given some thought to this and based on current known practice, we think that for the foreseeable future HMRC's resources will be largely focused elsewhere – for example, taxpayers who used disguised remuneration but are no longer in the scope of the loan charge and where HMRC has protected their position.
In this regard, it is worth noting that the 'August 2020' settlement terms for users with disguised remuneration liabilities that are not subject to the loan charge, have recently been published and you can find more information on settlement terms and how to settle.
We also expect HMRC to be looking closely at 2018/19 returns, to check compliance with the loan charge where it thinks there has been non-compliance or partial compliance, or for other purposes (eg an omitted capital gain). They may well also open enquiries into 2019/20 and 2020/21, where appropriate if a taxpayer elects to spread the loan charge and there are risks that suggest the returns are not correct.
Whilst we could not give a blanket reassurance that HMRC would never use it’s enquiry or assessment powers for 2016/17 and 2017/18, taking all of this together, we think the risk of HMRC opening an enquiry or assessment (where possible) solely for the purpose of recovering the ‘saved’ tax where people have made a spreading election, is fairly low. However, it is something that you should be aware of when advising clients.
For further hints and tips to help you move your clients through towards the 30 September deadline, and for more on how the coronavirus situation might impact on their position, for example, with regards to payment arrangements and forward interest, see comment by LITRG Loan charge: where are we now?
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Meredith McCammond is a Technical Officer for LITRG and Chartered Tax Adviser, formerly in practice. LITRG is an initiative of the Chartered Institute of Taxation which is a charity. Since1998, LITRG has been working to improve the policy and processes of the tax, tax credits and associated...