What's wrong with the Revenue's ER exploit scheme alert

Being asked by ContractorUK to help contractors navigate a new alert about a scheme provider’s frowned-upon attempt to exploit tax relief doesn’t sound like an invitation to take issue with HMRC, writes Graham Webber, director of tax investigations and dispute resolution firm WTT Consulting.

But the Revenue’s alert this month on how it views an alleged ‘tax avoidance scheme’ is unfortunately yet another demonstration of how the UK tax office continues to misunderstand the situation for many contractors.

In short, the idea behind the scheme is that a contractor can set up a company and have that company enter into a long term contract with a client. After a suitable interval, coinciding with the qualifying period for relief from Capital Gains Tax using Entrepreneurs’ Relief (ER), the company would be sold to a third-party in Cyprus. In effect, the monetary value of the contract for the remaining period is converted to a Capital Gain and the ER reduces the charge to around 10%, after fees and costs (probably twice that rate in reality). That still however represents a low effective tax rate -- even if the contractor has to complete the client commitment.

‘Challenge anybody using the scheme’

There are a number of ways that HMRC could challenge these arrangements. Sale of income; transfer offshore; VAT issues; new clauses in Finance Act 2016 for example. I would imagine that existing rules would be more than adequate to defeat the arrangements. Why, then, has HMRC chosen to make an announcement that they will seek to challenge anybody using the scheme?

On the positive side, we might applaud the move. It shows that HMRC is willing to identify and move against schemes that they consider to be tax avoidance, early and with full warning. This announcement or warning stops short of intervention, but at present HMRC does not have that power anyway. Nevertheless, there would be little defence for any contractor found to be using the scheme after this announcement, and probably little sympathy from HMRC too. If a client approached us with this, we would be recommending unpicking the arrangement (if possible) and settling with HMRC.

On the negative side, HMRC probably has sufficient powers to stop this scheme in its tracks. But having chosen to make this announcement, are they conveying that they have little confidence in their ability to prosecute in a timely and effective manner a case against a user? If so, will this message; intentional or otherwise, simply encourage some to take a punt?

‘Vague, biased, scant’

More concerning to us as tax investigations specialists is the way in which the scheme has been described. The rather vague language HMRC uses to warn potential users of the problems from using it is most regrettable. Moreover, the scheme is invariably being described by HMRC in a wholly biased way. The clues are all there -- the details that the Revenue provides of the steps are scant; the motivations are portrayed as wholly artificial (as one ContractorUK reader effectively remarked; “I simply stopped reading when HMRC pretty much says ‘you sell that company to an organisation based in Cyprus’”) and there is no mention whatsoever on potential counter avoidance measures already in existence. The latter is perhaps understandable, as HMRC wishes to paint the details in as poor a light as possible in order to prejudice a tribunal in the future.

But do contractors -- even their advisers, expect or deserve a more balanced and fair picture from the Revenue? Well, HMRC’s job is to administer the tax laws of this country. It is not their role to maximise tax revenues.

‘A more robust HMRC’

If we accept these two facts, then there is a case for arguing that such announcements from HMRC should be rather more balanced. They should ideally point out existing hurdles, establish the boundaries imposed in previous cases and pinpoint HMRC’s opposition to the scheme. And should or could we expect that a deeper description might serve to shed some light on a scheme HMRC dislikes against a commercial situation which the ER is designed to alleviate? This in turn would portray a more robust HMRC approach, based on specifics which affords contractors certainty over their affairs; a premise recently compromised due to the onset of retrospective legislation.

Instead, and due to the detail-scarce approach HMRC favours, some who read HMRC’s announcement will be left with the completely wrong impression that EVERY attempt to use ER is going to be challenged, despite the clear intention of parliament that the relief is there to encourage enterprise. In this sense, we believe HMRC has taken it upon themselves to place limits on what our elected representatives wanted. Unfortunately, it would not be the first time that the taxman has set himself as the sole arbiter of what parliament intended. The effect of this shouldn’t be taken lightly; it lets the tax authority extend their powers into areas that are surely beyond their remit.

‘Precise and surgical strike’

And also consider; it might be that HMRC has little more information to share. If so, is it acceptable for HMRC to have arrived at 100% of the answer (‘we think this is tax avoidance’) with only, say, 50% of the facts? Imagine if the first instance to reach a tribunal rules that it is a genuine commercial position and HMRC loses. Describing the situation less than fully, as the Revenue is doing here, risks prejudicing genuine cases of ER claims. Is that acceptable?

Despite the answers we lean towards giving to the two questions in the above paragraph (for anyone unsure that’s ‘no’ and ‘no’), on balance, we do actually welcome this early announcement from HMRC. It’s helpful for contractors and their advisers to know that such schemes are seen as areas that will likely be challenged. With your next announcement-cum-warning though Hector, we would ask for a more precise and surgical strike rather than the generalist approach you’ve taken here.