As appealing and alluring as promises of high income retentions and paying less tax may be, many tax avoidance schemes come at a price. That price is not only a financial one, but an emotional one too, because just a few years down the line it is almost certain that HMRC will investigate those involved in such schemes and the Revenue will have their pound of flesh and more.
When a scheme fails following a successful challenge by the Revenue, contractors can expect to be left holding the baby as many scheme providers simply up sticks and disappear. This leaves the freelancer vulnerable and having to pay professional fees for advice but ultimately they are likely to have to stump up the back tax, plus interest and potentially penalties as well. With this in mind HMRC have issued their periodical guidance to contractors about the perils of getting involved with such schemes.
Loan schemes involve an individual receiving income in the form of, well of course, loans. However, if it looks too good to be true then it probably is and HMRC have come up with ten good reasons to steer clear of these arrangements.
A promoter of a contractor loan scheme may tell you that loans aren’t taxable but the judge in the tax tribunal case of Boyle v HMRC (2013) found that HMRC are entitled to tax loans where contractors receive them as payment for their work. The Revenue don’t like these schemes and they will challenge them.
Some scheme promoters point to the fact that their contractor loan scheme has a Disclosure of Tax Avoidance Scheme (DOTAS) reference number and therefore HMRC has approved it. This is wrong as HMRC never approve such schemes. The DOTAS reference number identifies you as a user of a scheme and as night follows day, HMRC will investigate you.
Promoters may tell contractors that their scheme is 100% compliant because it doesn’t need to be disclosed under DOTAS. This doesn’t mean it is watertight and HMRC will challenge these schemes.
HMRC has a very high success rate in defeating these schemes in the courts and wins around 80% of avoidance cases that a taxpayer elects to take to court. Unless you are confident of triumphing via the legal system, then settling your affairs with HMRC may be prudent. It will avoid the cost, stress and sleepless nights that court action can bring.
HMRC now issues APNs to users of tax avoidance schemes. Those who receive one will have to pay the disputed tax upfront while HMRC probes the contractor loan scheme they are involved with.
Loans paid via a trust may mean that a contractor could face an IHT charge further down the line.
During their investigations HMRC may need to contact clients of the contractor to check their tax position relating to their contract with the freelancer. This could potentially damage the working relationship between the two parties.
HMRC will ask to see information provided to the contractor’s mortgage provider and other creditors about loans from these schemes. If the level of income disclosed on the tax return is lower than that shown on the mortgage application, then HMRC may consider charging penalties.
It’s unlikely that a promoter will give any user of its scheme a guarantee that it will work. Furthermore, they may scarper when HMRC starts investigating a contractor’s affairs leaving the freelancer isolated and vulnerable.
At Autumn Statement 2015, the government warned that it would consider legislating in a future Finance Bill to close down any further new schemes intended to avoid tax on earned income; where necessary, with retrospective effect from 25th November 2015.