On 29 September 2018, the campaigning group Loan Charge Action Group announced that it was leading a challenge to rules introduced by F(No. 2)A 2017 targeting amounts that had historically been paid to employees by means of loans (the so-called ‘loan charge’ rules).
There is an old joke that if you owe the bank £100, you have a problem, but if you owe the bank £100m, then the bank has a problem. In this case, according to the Treasury, the loan charge will affect 50,000 people and be worth up to £3.2bn. HMRC may be bullish in defence of the loan charge, but the scale of the issue presents a sizeable problem for HMRC.
Avoidance of tax on employment income has been a consistent target over the last 40 years.
For many years, HMRC faced schemes under which amounts were paid to employees in increasingly inventive ways to avoid tax. In the late 1990s and early 2000s, certain arrangements involved providing funds to an employee benefit trust (EBT), which then loaned them to employees. There are legitimate reasons to use an EBT but, equally, many arrangements constituted a way to avoid tax on amounts always intended for employees, as reward for services.
The initial focus was on the disallowance of deductions for payments by an employer to an EBT (which is the position that was eventually reached in Dextra Accessories Ltd & Others v MacDonald [2005] STC 1111). The focus for HMRC then shifted towards imposing PAYE at the point the funds were loaned by the EBT to the employee.
In particular, in 2010, the government announced ‘disguised remuneration’ rules – which became Part 7A of ITEPA 2003 – that targeted (amongst other things) amounts paid to employees through third parties, such as EBTs. Although this ended much of the use of EBTs for this sort of avoidance, there continued to be attempts to circumvent the rules.
At the same time, EBT arrangements that pre-dated the disguised remuneration rules were also being challenged. The case that was to test the taxation of payments to EBTs was RFC 2012 Plc (in liquidation) v Advocate General for Scotland [2017] UKSC 45, in which footballers and senior executives employed by the club benefited from loans from EBTs to which the club had contributed.
However, HMRC did not succeed on the basis that the loans were taxable. Instead, the Supreme Court (following the Court of Session) held that ‘the sums paid to the trustee of the [EBT] for a footballer constituted the footballer’s emoluments or earnings’. In short, it was not the loan but the original contribution that was taxable.
That decision also caused HMRC some problems. By treating amounts as a ‘redirection’ of an employee’s income, it ran counter to the disguised remuneration rules, the targets of which were loans from an EBT rather than the original contribution. Indeed, if it was the original contribution that was taxable, a number of taxpayers found themselves able to argue that HMRC had issued assessments for the wrong year (i.e. the year of the loan): if amounts were income of an employee going into an EBT, they could not also be employment income coming out. Given the age of these arrangements, HMRC was likely to be out of time to raise assessments for earlier periods.
The loan charge was HMRC’s response to the Rangers case, sweeping away most of the remaining arguments that EBT arrangements might escape tax. The rules treat any third party, employment-related loan made on or after 6 April 1999 (and which is outstanding immediately before the end of 5 April 2019) as taxable under the disguised remuneration rules.
A subsequent amendment in FA 2018 also made it clear that if earnings were treated as redirected to an EBT (in line with the decision in the Rangers case), they could be treated as subject to the disguised remuneration rules, irrespective of how they were (or should have been) treated when contributed to the EBT. This effectively reinstated HMRC’s right to tax amounts that were out of time because HMRC had assessed the loan and not the contribution.
Strictly speaking, the loan charge applies prospectively to a circumstance in the future, namely an outstanding loan as at 6 April 2019. For that reason, Steve Baker MP noted that HMRC had described the change as ‘retroactive rather than retrospective’ (see the debates on 20 November 2018).
This is a fine distinction. The Chartered Institute of Taxation (in a discussion paper on retrospective taxation on 18 November 2010) gives the removal of taper relief on business assets and the withdrawal of capital allowances as examples of retroactive, rather than retrospective, legislation.
Withdrawing a relief that applies to an ongoing state of affairs, however, is fundamentally different from bringing into account an amount that has previously been received without tax at the time.
Certainly, there is a large group of MPs, including Baker, who consider the loan charge to be ‘retrospective legislation that undermines the rule of law’.
A report published on 4 December 2018 by the Economic Affairs Committee of the House of Lords – The powers of HMRC: treating taxpayers fairly – was also critical of the loan charge. The report criticises HMRC for failing to communicate properly with taxpayers and describes the rules as disproportionate. The committee had no doubt that the rules were artificially triggering a future charge.
Although taxpayers have challenged tax authorities on the basis of a number of grounds under the European Convention on Human Rights (the ‘Convention’), the starting point of any such challenge is article 1 of the First Protocol to the Convention (A1P1), which requires that:
‘Every natural or legal person is entitled to the peaceful enjoyment of his possessions.’
The difficulty is that A1P1 goes on to say that:
‘The preceding provisions shall not, however in any way impair the right of a State … to secure the payment of taxes.’
That is a hurdle that taxpayers have found hard to clear.
In R (Huitson) v HMRC [2011] EWCA 893, the Court of Appeal (upholding the High Court’s decision) considered legislation to block a scheme that sought to avoid tax by diverting income through an Isle of Man partnership and an Isle of Man trust by relying on the applicable double tax agreement. The court noted that ‘retrospectivity of fiscal legislation is not prohibited as such’. Instead, the critical point is ‘the balancing of community interests and individual rights’.
In Huitson, the claimant had entered into an uncertain and artificial scheme that HMRC did not accept. The retrospective amendment ensured that double tax agreements would operate as intended and prevented a windfall for those using the scheme. The court concluded that ‘the retrospective amendments were enacted pursuant to a justified fiscal policy … The legislation achieves a fair balance between the interests of the general body of taxpayers and the right of the claimant to enjoyment of his possessions.’
The courts have been largely unmoved by human rights arguments in respect of tax claims. R (APVCO 19 Ltd & Ors) v HMRC [2015] EWCA Civ 648 considered retrospective rules that were intended to counter aggressive SDLT avoidance arrangements. The court concluded not merely that the rules were proportionate, in line with the test in Huitson, but also that the legislative changes only removed ‘an alleged, genuine, but not established, right to tax relief asserted in the appellants’ SDLT tax returns’. That alleged right to relief was not a possession to be protected under A1P1.
It is questionable whether tax can properly be described as contingent: surely tax either does or does not arise under the law? It is only potential in the sense that a court might be required to communicate what is the right answer.
The real difficulty for taxpayers in APVCO was similar to Huitson. The court clearly saw the arrangements as highly objectionable. In the case of APVCO, in the 2012 Budget the chancellor had described these types of arrangements as ‘morally repugnant’ and indicated that he would take steps – including retrospectively – to close them down.
It might be argued that the position involving EBTs is not dissimilar to Huitson and APVCO.
In December 2004, Dawn Primarolo (the paymaster general at the time) announced that measures would be taken against those determined to frustrate the proper taxation of employers and employees. Although she did not have in mind the type of arrangements targeted by the loan charge, Primarolo confirmed (with echoes of APVCO still to come) that while tax authorities would challenge arrangements in the courts, ‘we cannot … await the outcome in the courts before taking action’. Primarolo announced that she was:
‘... giving notice of our intention to deal with any arrangements that emerge in future … Where we become aware of arrangements which attempt to frustrate this intention we will introduce legislation to close them down, where necessary from today.’
Primarolo’s statement was reminiscent of the so-called ‘Rees rules’ that date back to 1978. The chancellor at the time announced provisions that would restrospectively block certain artificial tax avoidance arrangements. The eponymous Peter Rees MP suggested that such retrospective legislation needed to have been preceded by a warning and should be carefully prescribed and put in place as soon as possible.
For many, the Primarolo statement undermined legal certainty far beyond the exceptional circumstances envisaged by the Rees rules.
It is clear, however, that for the most part the courts do not agree. The courts have given the government significant latitude in protecting the interests of the ‘general body of taxpayers’, even if it is at the expense of some legal certainty.
The question, however, is whether the courts will feel the same way about the loan charge, assuming they even agree that the rules are retrospective.
It is difficult to argue that a portion of the arrangements that HMRC is challenging are highly artificial. Most reasonable advisers share HMRC’s frustrations with such schemes. They rarely work, they expose those who use them to significant liability, and when HMRC inevitably proposes legislation against them, there is the risk of collateral damage against those who have not taken such an aggressive and artificial approach.
That is a potential problem here. The government has signalled its intent for decades and taxpayers might not be surprised at HMRC’s patience finally being exhausted.
Nonetheless, the loan charge challenges almost any arrangement for the last 20 years, often disregarding years of practice and treating arrangements entered into years before the disguised remuneration rules were even enacted in largely the same way as those entered into afterwards.
In addition, further provisions relating to the loan charge do not simply protect the tax base but also mitigate HMRC’s procedural failures, by giving it a second chance to tax amounts that it missed when they were paid into EBTs.
The report from the Economic Affairs Committee considered that the individuals involved in the types of arrangements covered by the loan charge were ‘very different from those generally perceived to be involved in tax avoidance’.
There continues to be a problem with how these issues are discussed. On one side of the debate, the loan charge is described as ‘diabolical’ or ‘pernicious’ by MPs, as well as the Loan Charge Action Group. On the other, taxpayers are depicted as engaged in morally repugnant scheming. Such polarised language does not lend itself to nuanced legislation.
Nonetheless, the actions of so many arrayed against the loan charge have prompted the government to announce a review of the rules by the end of March.
Given the history of these arrangements and the difficulty in pursuing human rights arguments, whether this review will do more than tinker with the rules is questionable. If we are in the last act of a long running saga, it does not promise a happy punchline.
On 29 September 2018, the campaigning group Loan Charge Action Group announced that it was leading a challenge to rules introduced by F(No. 2)A 2017 targeting amounts that had historically been paid to employees by means of loans (the so-called ‘loan charge’ rules).
There is an old joke that if you owe the bank £100, you have a problem, but if you owe the bank £100m, then the bank has a problem. In this case, according to the Treasury, the loan charge will affect 50,000 people and be worth up to £3.2bn. HMRC may be bullish in defence of the loan charge, but the scale of the issue presents a sizeable problem for HMRC.
Avoidance of tax on employment income has been a consistent target over the last 40 years.
For many years, HMRC faced schemes under which amounts were paid to employees in increasingly inventive ways to avoid tax. In the late 1990s and early 2000s, certain arrangements involved providing funds to an employee benefit trust (EBT), which then loaned them to employees. There are legitimate reasons to use an EBT but, equally, many arrangements constituted a way to avoid tax on amounts always intended for employees, as reward for services.
The initial focus was on the disallowance of deductions for payments by an employer to an EBT (which is the position that was eventually reached in Dextra Accessories Ltd & Others v MacDonald [2005] STC 1111). The focus for HMRC then shifted towards imposing PAYE at the point the funds were loaned by the EBT to the employee.
In particular, in 2010, the government announced ‘disguised remuneration’ rules – which became Part 7A of ITEPA 2003 – that targeted (amongst other things) amounts paid to employees through third parties, such as EBTs. Although this ended much of the use of EBTs for this sort of avoidance, there continued to be attempts to circumvent the rules.
At the same time, EBT arrangements that pre-dated the disguised remuneration rules were also being challenged. The case that was to test the taxation of payments to EBTs was RFC 2012 Plc (in liquidation) v Advocate General for Scotland [2017] UKSC 45, in which footballers and senior executives employed by the club benefited from loans from EBTs to which the club had contributed.
However, HMRC did not succeed on the basis that the loans were taxable. Instead, the Supreme Court (following the Court of Session) held that ‘the sums paid to the trustee of the [EBT] for a footballer constituted the footballer’s emoluments or earnings’. In short, it was not the loan but the original contribution that was taxable.
That decision also caused HMRC some problems. By treating amounts as a ‘redirection’ of an employee’s income, it ran counter to the disguised remuneration rules, the targets of which were loans from an EBT rather than the original contribution. Indeed, if it was the original contribution that was taxable, a number of taxpayers found themselves able to argue that HMRC had issued assessments for the wrong year (i.e. the year of the loan): if amounts were income of an employee going into an EBT, they could not also be employment income coming out. Given the age of these arrangements, HMRC was likely to be out of time to raise assessments for earlier periods.
The loan charge was HMRC’s response to the Rangers case, sweeping away most of the remaining arguments that EBT arrangements might escape tax. The rules treat any third party, employment-related loan made on or after 6 April 1999 (and which is outstanding immediately before the end of 5 April 2019) as taxable under the disguised remuneration rules.
A subsequent amendment in FA 2018 also made it clear that if earnings were treated as redirected to an EBT (in line with the decision in the Rangers case), they could be treated as subject to the disguised remuneration rules, irrespective of how they were (or should have been) treated when contributed to the EBT. This effectively reinstated HMRC’s right to tax amounts that were out of time because HMRC had assessed the loan and not the contribution.
Strictly speaking, the loan charge applies prospectively to a circumstance in the future, namely an outstanding loan as at 6 April 2019. For that reason, Steve Baker MP noted that HMRC had described the change as ‘retroactive rather than retrospective’ (see the debates on 20 November 2018).
This is a fine distinction. The Chartered Institute of Taxation (in a discussion paper on retrospective taxation on 18 November 2010) gives the removal of taper relief on business assets and the withdrawal of capital allowances as examples of retroactive, rather than retrospective, legislation.
Withdrawing a relief that applies to an ongoing state of affairs, however, is fundamentally different from bringing into account an amount that has previously been received without tax at the time.
Certainly, there is a large group of MPs, including Baker, who consider the loan charge to be ‘retrospective legislation that undermines the rule of law’.
A report published on 4 December 2018 by the Economic Affairs Committee of the House of Lords – The powers of HMRC: treating taxpayers fairly – was also critical of the loan charge. The report criticises HMRC for failing to communicate properly with taxpayers and describes the rules as disproportionate. The committee had no doubt that the rules were artificially triggering a future charge.
Although taxpayers have challenged tax authorities on the basis of a number of grounds under the European Convention on Human Rights (the ‘Convention’), the starting point of any such challenge is article 1 of the First Protocol to the Convention (A1P1), which requires that:
‘Every natural or legal person is entitled to the peaceful enjoyment of his possessions.’
The difficulty is that A1P1 goes on to say that:
‘The preceding provisions shall not, however in any way impair the right of a State … to secure the payment of taxes.’
That is a hurdle that taxpayers have found hard to clear.
In R (Huitson) v HMRC [2011] EWCA 893, the Court of Appeal (upholding the High Court’s decision) considered legislation to block a scheme that sought to avoid tax by diverting income through an Isle of Man partnership and an Isle of Man trust by relying on the applicable double tax agreement. The court noted that ‘retrospectivity of fiscal legislation is not prohibited as such’. Instead, the critical point is ‘the balancing of community interests and individual rights’.
In Huitson, the claimant had entered into an uncertain and artificial scheme that HMRC did not accept. The retrospective amendment ensured that double tax agreements would operate as intended and prevented a windfall for those using the scheme. The court concluded that ‘the retrospective amendments were enacted pursuant to a justified fiscal policy … The legislation achieves a fair balance between the interests of the general body of taxpayers and the right of the claimant to enjoyment of his possessions.’
The courts have been largely unmoved by human rights arguments in respect of tax claims. R (APVCO 19 Ltd & Ors) v HMRC [2015] EWCA Civ 648 considered retrospective rules that were intended to counter aggressive SDLT avoidance arrangements. The court concluded not merely that the rules were proportionate, in line with the test in Huitson, but also that the legislative changes only removed ‘an alleged, genuine, but not established, right to tax relief asserted in the appellants’ SDLT tax returns’. That alleged right to relief was not a possession to be protected under A1P1.
It is questionable whether tax can properly be described as contingent: surely tax either does or does not arise under the law? It is only potential in the sense that a court might be required to communicate what is the right answer.
The real difficulty for taxpayers in APVCO was similar to Huitson. The court clearly saw the arrangements as highly objectionable. In the case of APVCO, in the 2012 Budget the chancellor had described these types of arrangements as ‘morally repugnant’ and indicated that he would take steps – including retrospectively – to close them down.
It might be argued that the position involving EBTs is not dissimilar to Huitson and APVCO.
In December 2004, Dawn Primarolo (the paymaster general at the time) announced that measures would be taken against those determined to frustrate the proper taxation of employers and employees. Although she did not have in mind the type of arrangements targeted by the loan charge, Primarolo confirmed (with echoes of APVCO still to come) that while tax authorities would challenge arrangements in the courts, ‘we cannot … await the outcome in the courts before taking action’. Primarolo announced that she was:
‘... giving notice of our intention to deal with any arrangements that emerge in future … Where we become aware of arrangements which attempt to frustrate this intention we will introduce legislation to close them down, where necessary from today.’
Primarolo’s statement was reminiscent of the so-called ‘Rees rules’ that date back to 1978. The chancellor at the time announced provisions that would restrospectively block certain artificial tax avoidance arrangements. The eponymous Peter Rees MP suggested that such retrospective legislation needed to have been preceded by a warning and should be carefully prescribed and put in place as soon as possible.
For many, the Primarolo statement undermined legal certainty far beyond the exceptional circumstances envisaged by the Rees rules.
It is clear, however, that for the most part the courts do not agree. The courts have given the government significant latitude in protecting the interests of the ‘general body of taxpayers’, even if it is at the expense of some legal certainty.
The question, however, is whether the courts will feel the same way about the loan charge, assuming they even agree that the rules are retrospective.
It is difficult to argue that a portion of the arrangements that HMRC is challenging are highly artificial. Most reasonable advisers share HMRC’s frustrations with such schemes. They rarely work, they expose those who use them to significant liability, and when HMRC inevitably proposes legislation against them, there is the risk of collateral damage against those who have not taken such an aggressive and artificial approach.
That is a potential problem here. The government has signalled its intent for decades and taxpayers might not be surprised at HMRC’s patience finally being exhausted.
Nonetheless, the loan charge challenges almost any arrangement for the last 20 years, often disregarding years of practice and treating arrangements entered into years before the disguised remuneration rules were even enacted in largely the same way as those entered into afterwards.
In addition, further provisions relating to the loan charge do not simply protect the tax base but also mitigate HMRC’s procedural failures, by giving it a second chance to tax amounts that it missed when they were paid into EBTs.
The report from the Economic Affairs Committee considered that the individuals involved in the types of arrangements covered by the loan charge were ‘very different from those generally perceived to be involved in tax avoidance’.
There continues to be a problem with how these issues are discussed. On one side of the debate, the loan charge is described as ‘diabolical’ or ‘pernicious’ by MPs, as well as the Loan Charge Action Group. On the other, taxpayers are depicted as engaged in morally repugnant scheming. Such polarised language does not lend itself to nuanced legislation.
Nonetheless, the actions of so many arrayed against the loan charge have prompted the government to announce a review of the rules by the end of March.
Given the history of these arrangements and the difficulty in pursuing human rights arguments, whether this review will do more than tinker with the rules is questionable. If we are in the last act of a long running saga, it does not promise a happy punchline.
