How much does the HMRC Loan Charge cost contractors, in tax terms?

The Loan Charge is a term that has become associated with sensationalist headlines and claims from the warring sides – taxpayer and taxman -- that it is either the worst example of retrospective tax, or a necessary step to ensure fairness.

But, writes Graham Webber, tax director of WTT Group, what is the loan charge; how does it work and what are its financial consequences?

What is the loan charge?

At its very basic level, the loan charge is a charge to tax on loans from disguised remuneration schemes received between December 9th 2010 and April 5th 2019 and not repaid.

It’s a tax charge on the employer. Most of the “employers” are long gone or (according to HMRC), untouchable, with their feet up languishing in their island havens. The charge can therefore be applied to ‘deemed employees.’

If you were genuinely self-employed, the loans you received will be treated as a post-cessation receipt of business income in 2018/19.

How does the loan charge work?

The loans – and not just loans, but all payments made in cash or kind which had not been taxed previously, which have not been repaid by April 5th 2019 are aggregated by HMRC, and get treated as income in 2018/19.

The value of each loan is the original sterling value when made. You should note that this is a rule made for tax purposes only, and does not mean that legally, the amount of any loan previously reduced, can be ‘restored’ to its original value.

If you’re a contractor caught by the loan charge, this aggregate value is added to your other income for 2018/19 and tax is calculated at the appropriate rates after the usual allowances. This results in tax rates of between 20% and 45%, applying to different portions of the gross amount.

The adding of the aggregate quantum of the loans to the 2018/19 tax year income value will usually result in restrictions to personal allowances being imposed. The effect of this? Unfortunately, it exaggerates the overall tax effective rate.

The loan charge fell due for payment on January 31st 2020, as there was a requirement to declare the aggregate unpaid loans in the 2018/19 tax return and in theory, that led to a statement of tax due and the fixing of the above ‘due date.’

Morse Review proposals: in a nutshell

But the plans were somewhat interrupted by the Morse Review of the Loan Charge which proposed some changes.

First, the review was completed in late 2019 and this persuaded HMRC to allow a delay in reporting the aggregate loan value until September 2020.

Second, it allowed the gross value of unpaid loans to be taxed in three equal instalments over 2018/19, 2019/20 and 2020/21 if a suitable election was made. This was achieved by dividing the aggregate loan value by three, and adding that result to income for each of the above years. Again, the variable tax rates applicable to the income charged to tax would apply.

Third, Morse proposed that only loans paid after December 8th 2010 should be subject to the loan charge.

The government agreed.

In summary, the original sterling value of unrepaid loans made between early December 2010 and April 5th 2019 are taxable as income in 2018/19 (or spread over three years) at the normal variable rates as applied to taxable income.

Unintended consequences

The single most confusing issue with the loan charge was that individuals thought (and still think today) that if the charge is paid, they have settled all their outstanding tax issues with HMRC. This is not true.

Any loan charge payment made will be a credit against the final position for all the tax years in which loans were received, where HMRC has opened enquiries and these remain unresolved.

The legislation sets out a means to allocate the tax paid, and while there is some considerable doubt as to whether this is being applied correctly in the ‘settlement calculations’ we have seen, there is at least an attempt (from HMRC) to apply the law.

It is also the case that if the loan charge is paid, but there is no liability arising in the tax years in which the loans were paid, then the loan charge paid may not be refundable. This is an unprecedented provision that will certainly cause more legal action to be taken.

If the loan charge were to disappear from the statute book tomorrow, HMRC would continue to chase their open enquiries. Only those contractors fortunate enough to have no (or few) open historic enquiries prior to 2018/19 would benefit from the charge being repealed.

An HMRC bully-boy tactic? Perhaps, but definitely a beast that exists only in tax law

Many contractors had settled with HMRC because they felt that the loan charge was the end game, and that further resistance was pointless. In effect, many felt that the loan charge was a bully-boy tactic. Whether that is correct or not, it worked, and many did settle with HMRC.

Post the Morse intervention, because the above settlement included “voluntary restitution”, or a sum that would equal the tax due if HMRC had opened an enquiry, in respect of pre-December 2010 loans, too much had been paid.

To their credit, HMRC promised that they would repay some or all of the settlement paid -- and they did. Unfortunately, HMRC then followed that up by saying that in many instances they had repaid too much and, they then as good as said, ‘Would the contractor mind ignoring the legally binding contract and refund HMRC?’ There is no legal basis (in our opinion) for HMRC trying to renege in this way.

Many of those affected by the loan charge are no longer UK tax resident. The loan charge purports however to create a UK source of income. This is taxable in the UK even if the “recipient” is not tax resident in 2018/19. HMRC therefore claims that a sum paid by a non-UK party, to a non-UK resident employee, is nonetheless taxable – in a later year – in the UK. It’s easy to see why many such individuals struggle to accept this position which has crossed so many tax boundaries previously held sacrosanct.

It is unfortunate that some parties saw the loan charge as an excuse to seek “repayment” of loans that were to be taxed as income. The loan charge is a beast that exists only in tax law. It has no power or ability to affect the legal status of whether a loan was made and if made, whether it could be called in. Any such attempts from any party should be referred to a suitable professional adviser.

Where are we now?

We are now in a period in which HMRC must raise assessments if they think that the loan charge applies to an individual. They appear to be doing this in a couple of ways.

First, where the loans arose in an arrangement which included the wholly owned company of the individual – a ‘PSC’ – they are issuing PAYE assessments. These are called Regulation 80s (or Reg 80s). Often accompanied by a Section 8 “decision” in respect of NIC. This is, presumably, being made on the basis that the PSC was the “employer” for the purposes of Part 7A ITEPA. We have to observe that this is an unproved and highly contentious position that could -- and should -- be challenged.

Second, HMRC is threatening to issue closure notices in respect of ongoing enquiries, especially for years 2010/11 and earlier. These will no doubt include the statement that the loans are “income.” We await those notices with some interest, as there is then an opportunity to advance toward a suitable tribunal to discuss whether HMRC is correct.

Third, if HMRC has a view that the loans are taxable and has no open enquiry, they have to issue a discovery assessment. There are a number of difficult technical and practical issues with this, which will make those assessments vulnerable to challenge. Certainly we welcome these assessments as an opportunity to bring our arguments to the tribunal as quickly as we can.

Finally, the imminent acid test

The loan charge is real, and we are seeing attempts to translate the legislation into payments to the Exchequer.

If, once the dust has settled on the inevitable visits to the tribunal, it is the case that there is a tax charge, this is not settlement of all previous enquiries. They must be settled on their own merits, although the loan charge paid will be a credit toward any liabilities. The acid test – and it’s upon us -- is with Reg 80s issued and discovery assessments due.