In his recent article, my chambers colleague David Pett writes ‘in defence of the outstanding loan charge’ (Tax Journal, 6 September 2019). The essence of David’s argument appears to be that Parliament is fully entitled to tax individuals on the full value of a loan as outstanding on a particular date (in addition to any charge for the ongoing ‘benefit’ of that loan and notwithstanding the fact that, at least in theory, the loan remains an outstanding debt due from the taxpayer).
As someone who has written extensively condemning the loan charge, readers might be surprised to learn that I agree with most of what David has written. However, this common ground is not the result of any sudden change of heart on my part nor even a case of a cosy collegiate agreement amongst chambers colleagues, but more a consequence of the fact that, in my view, David has not addressed what I consider to be the more egregious aspects of the loan charge.
I shall assume that the basics of the loan charge and the arrangements which it addresses are well known to readers. For a refresher, I am happy to rely on the summary as set out in David’s article. In a nutshell, however, the arrangements generally involve contractors working through agencies where some of the contractors’ pay was diverted into trusts, with the trusts then advancing the funds in the form of a loan, the repayment terms of which shall we say were shrouded in mystery. (In other cases, shareholder-directors used similar strategies for the extraction of bonuses in a supposedly tax-efficient fashion.)
It is also worth noting that some contractors were given little choice about the basis of payments being made to them. Furthermore, the arrangements were also often described as ‘HMRC-approved’ and ‘QC-backed’. As tax practitioners will know, the former of those claims would clearly have been false, but the arrangements were usually notified to HMRC under DOTAS and this undoubtedly gave participants the assurance that, if HMRC did not like them, they would have said so.
The argument for the defence…
The essence of David’s article is that Parliament is fully within its rights to decide how it wishes to tax citizens, whether in relation to present, future or even past transactions. As a question of constitutional law, that is undoubtedly correct. Furthermore, David is equally right when he notes that income tax is an annual tax and therefore Parliament is entitled to look at each tax year afresh.
… and the flaw in that argument
But, crucially, just because Parliament can do something, it does not mean it is right for Parliament to do it. Indeed, there are many occasions when Parliament has chosen to do one thing and then at a later stage changed its mind (sometimes with retrospective effect when it is realised that its original stance was mistaken).
The loan charge is a prime example of where Parliament should fully reconsider its previous decision (formally taken in 2017) and repeal (or seriously curtail) the loan charge.
Why the loan charge is unfair
My principal objection to the loan charge is that it gives HMRC a second bite of the assessing cherry. Accordingly, it has driven a coach and horses through the statutory safeguards, such as time limits, that have long existed within the tax code. Such protections are an inherent part of the checks and balances within the legislation, ensuring that HMRC’s extensive (and, largely, necessary) powers are used proportionately and to provide taxpayers with the certainty to which they are entitled. Indeed, those safeguards have been repeatedly relied upon by other taxpayers (many of whose actions are far more egregious than those of the contractors who are bearing the brunt of the loan charge) and duly upheld by the tribunals and courts.
Furthermore, it should be remembered that the main reason that these safeguards needed to be by-passed by the loan charge was because HMRC’s own department-wide mistakes meant that the arrangements that they are attacking had not been challenged in the right way at the right time.
HMRC’s enquiries
There are clearly several tens of thousands of individuals who worked as contractors over the 20-year period governed by the loan charge. Either as a result of the DOTAS notifications (since 2004) or as a result of HMRC’s ordinary detection processes, many of those taxpayers’ returns were subject to a s 9A enquiry. It appears that a few of these enquiries were closed without adjustment. However, in most cases enquiries remained open for many years and only now are coming to conclusion. Regrettably, despite opening those enquiries, HMRC failed to communicate to the taxpayers their objections to the arrangements. This silence would only have reinforced the view that the arrangements were (even if not HMRC-approved) HMRC-compliant.
In my view, these enquiries were all misguided, but I accept that that might not have been apparent to HMRC at the time they were opened. Indeed, until relatively recently, HMRC took the view that the advance of a loan by the trusts represented the taxable moment, and it is therefore unsurprising that HMRC would have sought to tax the individuals on what (it says) was effectively the immediate forgiveness of a loan.
However, after two tribunal defeats in the Rangers case, it must have become clear to HMRC that their attack had been misdirected. Accordingly, HMRC was required to change its argument and suggest instead that the prior payment of funds into the trust represented the taxable event; this was the ‘Aunt Agatha’ point as pithily put by Lord Hodge when the case finally reached the Supreme Court (RFC 2012 Plc (in liquidation) (formerly The Rangers Football Club) v General Advocate for Scotland [2017] UKSC 45)).
However, the clear consequence of the Rangers decision was that the taxable moment was also a PAYE-able moment, meaning that the correct source of any tax should have been the contractors’ employers (or those persons deemed to be the relevant employer under the PAYE rules within ITEPA). The difficulty for HMRC is that it was by now too late to take action against these employers. Furthermore, the long-running enquiries into the individual workers’ tax returns would prove embarrassingly futile as the workers would generally be entitled to a credit for the PAYE that should have been deducted further up the contractual chain.
HMRC’s response to Rangers
The loan charge was announced in Budget 2016 shortly after the Court of Session promulgated its decision in Rangers ([2015] CSIH 77) and was enacted in F(No.2)A 2017 which followed the Supreme Court’s judgment.
Ultimately, the loan charge is a device that entitles HMRC to sidestep any potential embarrassment as it effectively transfers the tax liability from the employer to the worker. Although the loan charge is in form a charge imposed on the outstanding loan (or loans) on a particular date (5 April 2019), this is mere legal sophistry of the type one might expect to see in certain aggressive tax avoidance schemes.
In substance, the loan charge is a tax on the loans made in earlier years, as clearly demonstrated by the fact that HMRC offered to mitigate the loan charge so far as any tax is paid in respect of those earlier years. Indeed, HMRC is on the record as having recognised that part of the attractiveness of the loan charge is its ability to discourage taxpayers from pursuing statutory appeals in respect of those earlier years, although such admissions were not made until long after the ink had dried on the statute book.
No such admissions were made to Parliament when the legislation was being debated. Nor was Parliament told properly of the criticisms of the (then proposed) legislation by the professional bodies, most notably the Institute of Chartered Accountants in England and Wales which criticised the rules as ‘aggressively retroactive’ (bit.ly/2C7wAK8). Indeed, the opening line of the ICAEW’s response was:
‘We are very concerned about the proposals in the consultation document as they contravene generally accepted notions of fairness and break the constitutional convention against retrospective legislation, imposing tax charges in cases where taxpayers already had legal certainty that none were due.’
The briefing notes provided to MPs in the wake of the consultation exercise are a masterclass of disguising the truth. Were any taxpayer to apply such an approach to, say, a white space or pre-transaction disclosure, HMRC would scream ‘disingenuous’ (or worse) and rightly so. Yet, seemingly, such tactics were thought necessary to get the loan charge onto the statute book.
The effect of the loan charge
As noted above, but for the loan charge, individual taxpayers have very good arguments were they to appeal against any closure notices. However, the loan charge makes such arguments next to worthless because, through the loan charge, HMRC has given itself the right to tax the loans in another way.
In my view, taxpayers (whatever they are thought to have done) should be entitled to pursue their statutory appeals in respect of earlier years without hindrance, a right that has most recently been confirmed by the Court of Appeal in R (oao Haworth) v HMRC [2019] EWCA Civ 747. In particular, it is morally wrong for legislation to be enacted which renders such appeals entirely nugatory. However, that is precisely what the loan charge has done and why I consider it to be particularly unfair.
Of course, I have to acknowledge that many of the arguments that taxpayers would want to rely on in any appeal were recently rejected by the First-tier Tribunal in Hoey [2019] UKFTT 489. (That case in fact involved discovery assessments, but the same points apply.) However, I would be surprised if that decision were not subject to a further appeal. It is thus unlikely that the decision represents the final word on the subject. Nevertheless, even if Hoey was correctly decided, then it would mean that HMRC was, after all, right to open enquiries into the individuals’ tax returns and to issue discovery assessments in respect of those years where TMA 1970 s 9A was not properly engaged. That would mean that for all those taxpayers the loan charge is entirely superfluous.
Finally, there will be the cases where HMRC has so far failed to take any action against taxpayers or has opened enquiries only to close them again with no adjustment. Ordinarily, those taxpayers should be entitled to treat those years as settled, yet the loan charge creates anew a tax liability based on events of those earlier years.
As noted by David in his article, however, the government has recently announced that (at least in cases of ‘full’ disclosure) taxpayers in such a situation would be exempted from the loan charge.
David argues that such an exemption puts these taxpayers at an unfair advantage over all other taxpayers. However, in my view, that is simply a consequence of the fact (as has been recognised for centuries and which lies at the heart of TMA 1970) the question of fairness is not determined solely by looking at the right amount of tax but also at citizens’ entitlement to finality. The government is indeed right to waive the loan charge in those cases where HMRC had simply failed to take any action in time.
A hint of common ground
Where it is fair to say that David and I are in complete agreement is that the entire loan charge controversy has demonstrated that there is much wrong with the tax system. Potential candidates for criticism may well include promoters and other professional advisers, HMRC for letting the arrangements run unchecked for so long and their lack of candour when the legislation started to be challenged, professional bodies for the way that they supervised their members, the taxpayers themselves, the organisations that paid for their services, the agencies through which they were engaged, and ministers for reducing HMRC’s resources and generally allowing the tax system to run out of control for so long. However, I doubt that we will be able to agree how any blame should be allocated amongst these and other parties.
It is for this reason that I look forward to a full and independent review so that a long hard look be given at this whole sorry episode. Although a review by Sir Amyas Morse has now been announced, at the time of writing, its precise scope remains unclear. Pending the conclusion of any such review, the loan charge should be immediately suspended so that the review can progress without undue pressure and so that the sword of Damocles (whilst not necessarily removed for good) is not in danger of falling in the meantime.
In his recent article, my chambers colleague David Pett writes ‘in defence of the outstanding loan charge’ (Tax Journal, 6 September 2019). The essence of David’s argument appears to be that Parliament is fully entitled to tax individuals on the full value of a loan as outstanding on a particular date (in addition to any charge for the ongoing ‘benefit’ of that loan and notwithstanding the fact that, at least in theory, the loan remains an outstanding debt due from the taxpayer).
As someone who has written extensively condemning the loan charge, readers might be surprised to learn that I agree with most of what David has written. However, this common ground is not the result of any sudden change of heart on my part nor even a case of a cosy collegiate agreement amongst chambers colleagues, but more a consequence of the fact that, in my view, David has not addressed what I consider to be the more egregious aspects of the loan charge.
I shall assume that the basics of the loan charge and the arrangements which it addresses are well known to readers. For a refresher, I am happy to rely on the summary as set out in David’s article. In a nutshell, however, the arrangements generally involve contractors working through agencies where some of the contractors’ pay was diverted into trusts, with the trusts then advancing the funds in the form of a loan, the repayment terms of which shall we say were shrouded in mystery. (In other cases, shareholder-directors used similar strategies for the extraction of bonuses in a supposedly tax-efficient fashion.)
It is also worth noting that some contractors were given little choice about the basis of payments being made to them. Furthermore, the arrangements were also often described as ‘HMRC-approved’ and ‘QC-backed’. As tax practitioners will know, the former of those claims would clearly have been false, but the arrangements were usually notified to HMRC under DOTAS and this undoubtedly gave participants the assurance that, if HMRC did not like them, they would have said so.
The argument for the defence…
The essence of David’s article is that Parliament is fully within its rights to decide how it wishes to tax citizens, whether in relation to present, future or even past transactions. As a question of constitutional law, that is undoubtedly correct. Furthermore, David is equally right when he notes that income tax is an annual tax and therefore Parliament is entitled to look at each tax year afresh.
… and the flaw in that argument
But, crucially, just because Parliament can do something, it does not mean it is right for Parliament to do it. Indeed, there are many occasions when Parliament has chosen to do one thing and then at a later stage changed its mind (sometimes with retrospective effect when it is realised that its original stance was mistaken).
The loan charge is a prime example of where Parliament should fully reconsider its previous decision (formally taken in 2017) and repeal (or seriously curtail) the loan charge.
Why the loan charge is unfair
My principal objection to the loan charge is that it gives HMRC a second bite of the assessing cherry. Accordingly, it has driven a coach and horses through the statutory safeguards, such as time limits, that have long existed within the tax code. Such protections are an inherent part of the checks and balances within the legislation, ensuring that HMRC’s extensive (and, largely, necessary) powers are used proportionately and to provide taxpayers with the certainty to which they are entitled. Indeed, those safeguards have been repeatedly relied upon by other taxpayers (many of whose actions are far more egregious than those of the contractors who are bearing the brunt of the loan charge) and duly upheld by the tribunals and courts.
Furthermore, it should be remembered that the main reason that these safeguards needed to be by-passed by the loan charge was because HMRC’s own department-wide mistakes meant that the arrangements that they are attacking had not been challenged in the right way at the right time.
HMRC’s enquiries
There are clearly several tens of thousands of individuals who worked as contractors over the 20-year period governed by the loan charge. Either as a result of the DOTAS notifications (since 2004) or as a result of HMRC’s ordinary detection processes, many of those taxpayers’ returns were subject to a s 9A enquiry. It appears that a few of these enquiries were closed without adjustment. However, in most cases enquiries remained open for many years and only now are coming to conclusion. Regrettably, despite opening those enquiries, HMRC failed to communicate to the taxpayers their objections to the arrangements. This silence would only have reinforced the view that the arrangements were (even if not HMRC-approved) HMRC-compliant.
In my view, these enquiries were all misguided, but I accept that that might not have been apparent to HMRC at the time they were opened. Indeed, until relatively recently, HMRC took the view that the advance of a loan by the trusts represented the taxable moment, and it is therefore unsurprising that HMRC would have sought to tax the individuals on what (it says) was effectively the immediate forgiveness of a loan.
However, after two tribunal defeats in the Rangers case, it must have become clear to HMRC that their attack had been misdirected. Accordingly, HMRC was required to change its argument and suggest instead that the prior payment of funds into the trust represented the taxable event; this was the ‘Aunt Agatha’ point as pithily put by Lord Hodge when the case finally reached the Supreme Court (RFC 2012 Plc (in liquidation) (formerly The Rangers Football Club) v General Advocate for Scotland [2017] UKSC 45)).
However, the clear consequence of the Rangers decision was that the taxable moment was also a PAYE-able moment, meaning that the correct source of any tax should have been the contractors’ employers (or those persons deemed to be the relevant employer under the PAYE rules within ITEPA). The difficulty for HMRC is that it was by now too late to take action against these employers. Furthermore, the long-running enquiries into the individual workers’ tax returns would prove embarrassingly futile as the workers would generally be entitled to a credit for the PAYE that should have been deducted further up the contractual chain.
HMRC’s response to Rangers
The loan charge was announced in Budget 2016 shortly after the Court of Session promulgated its decision in Rangers ([2015] CSIH 77) and was enacted in F(No.2)A 2017 which followed the Supreme Court’s judgment.
Ultimately, the loan charge is a device that entitles HMRC to sidestep any potential embarrassment as it effectively transfers the tax liability from the employer to the worker. Although the loan charge is in form a charge imposed on the outstanding loan (or loans) on a particular date (5 April 2019), this is mere legal sophistry of the type one might expect to see in certain aggressive tax avoidance schemes.
In substance, the loan charge is a tax on the loans made in earlier years, as clearly demonstrated by the fact that HMRC offered to mitigate the loan charge so far as any tax is paid in respect of those earlier years. Indeed, HMRC is on the record as having recognised that part of the attractiveness of the loan charge is its ability to discourage taxpayers from pursuing statutory appeals in respect of those earlier years, although such admissions were not made until long after the ink had dried on the statute book.
No such admissions were made to Parliament when the legislation was being debated. Nor was Parliament told properly of the criticisms of the (then proposed) legislation by the professional bodies, most notably the Institute of Chartered Accountants in England and Wales which criticised the rules as ‘aggressively retroactive’ (bit.ly/2C7wAK8). Indeed, the opening line of the ICAEW’s response was:
‘We are very concerned about the proposals in the consultation document as they contravene generally accepted notions of fairness and break the constitutional convention against retrospective legislation, imposing tax charges in cases where taxpayers already had legal certainty that none were due.’
The briefing notes provided to MPs in the wake of the consultation exercise are a masterclass of disguising the truth. Were any taxpayer to apply such an approach to, say, a white space or pre-transaction disclosure, HMRC would scream ‘disingenuous’ (or worse) and rightly so. Yet, seemingly, such tactics were thought necessary to get the loan charge onto the statute book.
The effect of the loan charge
As noted above, but for the loan charge, individual taxpayers have very good arguments were they to appeal against any closure notices. However, the loan charge makes such arguments next to worthless because, through the loan charge, HMRC has given itself the right to tax the loans in another way.
In my view, taxpayers (whatever they are thought to have done) should be entitled to pursue their statutory appeals in respect of earlier years without hindrance, a right that has most recently been confirmed by the Court of Appeal in R (oao Haworth) v HMRC [2019] EWCA Civ 747. In particular, it is morally wrong for legislation to be enacted which renders such appeals entirely nugatory. However, that is precisely what the loan charge has done and why I consider it to be particularly unfair.
Of course, I have to acknowledge that many of the arguments that taxpayers would want to rely on in any appeal were recently rejected by the First-tier Tribunal in Hoey [2019] UKFTT 489. (That case in fact involved discovery assessments, but the same points apply.) However, I would be surprised if that decision were not subject to a further appeal. It is thus unlikely that the decision represents the final word on the subject. Nevertheless, even if Hoey was correctly decided, then it would mean that HMRC was, after all, right to open enquiries into the individuals’ tax returns and to issue discovery assessments in respect of those years where TMA 1970 s 9A was not properly engaged. That would mean that for all those taxpayers the loan charge is entirely superfluous.
Finally, there will be the cases where HMRC has so far failed to take any action against taxpayers or has opened enquiries only to close them again with no adjustment. Ordinarily, those taxpayers should be entitled to treat those years as settled, yet the loan charge creates anew a tax liability based on events of those earlier years.
As noted by David in his article, however, the government has recently announced that (at least in cases of ‘full’ disclosure) taxpayers in such a situation would be exempted from the loan charge.
David argues that such an exemption puts these taxpayers at an unfair advantage over all other taxpayers. However, in my view, that is simply a consequence of the fact (as has been recognised for centuries and which lies at the heart of TMA 1970) the question of fairness is not determined solely by looking at the right amount of tax but also at citizens’ entitlement to finality. The government is indeed right to waive the loan charge in those cases where HMRC had simply failed to take any action in time.
A hint of common ground
Where it is fair to say that David and I are in complete agreement is that the entire loan charge controversy has demonstrated that there is much wrong with the tax system. Potential candidates for criticism may well include promoters and other professional advisers, HMRC for letting the arrangements run unchecked for so long and their lack of candour when the legislation started to be challenged, professional bodies for the way that they supervised their members, the taxpayers themselves, the organisations that paid for their services, the agencies through which they were engaged, and ministers for reducing HMRC’s resources and generally allowing the tax system to run out of control for so long. However, I doubt that we will be able to agree how any blame should be allocated amongst these and other parties.
It is for this reason that I look forward to a full and independent review so that a long hard look be given at this whole sorry episode. Although a review by Sir Amyas Morse has now been announced, at the time of writing, its precise scope remains unclear. Pending the conclusion of any such review, the loan charge should be immediately suspended so that the review can progress without undue pressure and so that the sword of Damocles (whilst not necessarily removed for good) is not in danger of falling in the meantime.
