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Use this guide to help your clients understand how their liabilities will be calculated if they’ve used a disguised remuneration (DR) scheme and want to settle their affairs before April 2019.
If you’re in a disguised remuneration scheme, there’s additional guidance on settling your own tax affairs.
A DR loan charge will be introduced in April 2019. Your client will need to settle their liability before this date if they want to avoid the charge.
This guide explains the standard settlement terms for DR scheme users. How your client needs to settle depends on whether they’re classed by HM Revenue and Customs (HMRC) for the purposes of these settlement terms, as a:
If your client has used more than one type of scheme you will need to look at the guidance for each type to arrive at the final possible settlement position.
HMRC recognises that DR arrangements can be wide and varied. This guide therefore explains the general principles that apply to DR schemes as it’s not possible cover how it applies in every particular situation.
We expect that most people will have simple tax affairs, so not all of the guidance will apply to everyone. If you have any questions, you should contact HMRC on 03000 534 226.
All settlements will be subject to normal governance procedures that are tailored to the size of the case. This is to ensure compliance with HMRC’s responsibilities under collection and management powers and the Litigation and Settlement Strategy (LSS).
The terms of settlement in this guidance may not be available if your client’s appeal has been referred to the Tribunal or the new loan charge on outstanding disguised remuneration loans arises in April 2019.
If your client pays the loan charge, it may not settle all of their earlier liabilities. If they’ve not agreed a settlement with HMRC for earlier liabilities by the time the loan charge arises, they’ll have to pay, subject to any double taxation relief:
- the loan charge
- any earlier liability
- any interest due
A contractor, for the purposes of these settlement terms, is someone who provides services to clients that don’t directly engage them. They may provide their services through an umbrella company, agency, partnership or their own company.
Contractors can be classed as either:
employed - they’ll have an employment contract, often providing their services via an offshore employer
self-employed - they’ll have a contract for services, meaning they provide their services in a self-employed capacity
Different tax rules apply to different types of scheme use. The main differences in the settlement terms are highlighted in this guidance. If you’re not sure the scheme your client has used means they’re employed or self-employed, contact HMRC.
2.1 Contractor settlement terms
Settlement will be on a net basis - Income Tax will be applied on all the DR loans, or other payments made for your client’s benefit, rather than the gross amount paid by the client. This means that the fees deducted from the gross amount by intermediaries (scheme expenses) will not be taxed as part of income or profits.
Income Tax is due for years in which loans were paid, or other payments were made, where HMRC has an assessment in place or is still in time to make an assessment (referred to in this guidance as ‘protected years’). The tax is calculated at the rates and bands applicable in the year of the loan or payment.
To prevent future DR charges (including the loan charge) arising on loans or other payments made from funds paid into the DR scheme in years which are not protected, contractors must make a voluntary payment. This voluntary payment (referred to as voluntary restitution) is calculated at the rates and bands applicable in the year the loan or payment was made. Once a contractor enters into an agreement with HMRC to make voluntary restitution, it will become legally enforceable.
Late payment interest is due for protected years. No late payment interest will be payable on voluntary restitution.
Where appropriate, penalties will apply.
Inheritance Tax (IHT) may also be due dependent on the nature of the scheme and the amounts put through.
2.2 National Insurance contributions (NICs): employed contractors
Employed contractors will not have to pay NICs personally but HMRC may still pursue their employer or other liable party.
2.3 NICs: self-employed contractors
Self-employed contractors will need to pay Class 2 and Class 4 NICs as appropriate on all DR loans or other payments. They may need to make voluntary restitution payments.
Class 2 and Class 4 NICs will be calculated using the rates and bands in the years the loans were made.
2.4 County Court Fees
If HMRC has protected its right to pursue the NICs liability that arose as a result of a contractor’s use of the DR scheme by issuing a County Court claim, the fee for issuing that claim will need to be included in the settlement amount.
2.5 Loans claimed under benefit in kind legislation
The amount in settlement can be reduced by any Income Tax the contractor has paid because they declared a benefit in kind on the basis of receiving a beneficial loan. This reduction is only available if that tax year is in time to be amended or for an overpayment relief claim to be made.
2.6 Previous settlements
Some employment based contractor loans schemes operated until 5 April 2011. If someone settled their use of these schemes by 16 March 2016, they don’t need to pay any further Income Tax or NICs to obtain relief from a future DR charge (including the loan charge) which would otherwise arise in relation to those schemes. This doesn’t apply to any scheme which they asked us to exclude from the settlement.
For any settlement entered into after 16 March 2016, or any settlement in relation to a scheme which operated after 5 April 2011, the amounts in respect of which relief from a DR charge can be claimed will be restricted to those specified in the settlement agreement.
An employer, for the purposes of these settlement terms, is someone who has entered into a disguised remuneration scheme to reward their employees.
3.1 Employer settlement terms
An employer will need to pay Income Tax and primary and secondary Class 1 NICs on the amount contributed to the scheme or, depending on the facts, the amount allocated within the scheme. They will need to pay for all years where HMRC has a PAYE determination or protective NICs claim in place (as appropriate) or is still in time to make such a determination or issue a protective claim (protected years).
To prevent future DR charges arising, including the loan charge, on contributions made to, or allocations made within, the scheme in years which are not protected, they must make a voluntary payment (voluntary restitution). This payment is of the Income Tax and NICs on the contribution to, or allocation within, the scheme in those years.
An employer won’t have to pay Income Tax and NICs on any contributions or allocations:
- where Income Tax and NICs has already been paid
- in some circumstances where they have been used to pay scheme expenses, for example, trustee fees
If the trust deed allows, and the secondary Class 1 NICs is paid to HMRC from the funds contributed to the scheme, HMRC will treat the contribution to the scheme as earnings plus secondary Class 1 NICs on those earnings. This will reduce the amount of earnings on which Income Tax and NICs is payable.
Income Tax and NICs will be calculated using the rates and bands in the years the employer contributed to the scheme or when the amounts were allocated within the scheme, depending on the facts.
An employer will need to pay late payment interest for any protected years. This is in accordance with the Compliance Operational Guidance manual COG908170 and COG915075. No late payment interest will be payable on voluntary restitution.
Where appropriate, penalties will apply.
In certain circumstances IHT will need to be paid. This will depend on the nature of the scheme and the amounts put through it.
The amount due in settlement can be reduced by any NICs paid by the employer, and any Income Tax paid by their employees on the basis of receiving a beneficial loan from the scheme and declaring a benefit in kind. This reduction is only available if the tax year in which the benefit in kind was declared is in time to be amended or for an overpayment to be claimed.
Employees will also need to complete mandates allowing their tax repayment to be offset against the employer’s liability. We will provide employers with a copy of a mandate.
Where the relevant Corporation Tax return is open or capable of amendment employers will be able to make a deduction for the original contribution and the fee paid to the promoter for entering into the scheme.
Employers will be able to claim a deduction for Corporation Tax purposes for the Income Tax and NICs that they pay under the settlement agreement. Under the Business Income Manual BIM47090, this deduction will be available in the year in which the contribution was made, if that year is still open or capable of amendment, or in the earliest subsequent open year.
3.2 Allowing deductions for Corporation Tax purposes for contributions by an employer into a scheme where none was claimed
Historically there are some DR arrangements where a Corporation Tax deduction was not claimed for the contribution to the scheme at the time the contribution was made. In some cases there is no open enquiry for the relevant year and the time limit for overpayment relief has expired. Therefore there is now no statutory route to claim relief for the contribution in the year the contribution was made by the employer.
In such cases, if a relevant step under Part 7A of Income Tax (Earnings and Pensions) Act 2003 is triggered in the current year and the Income Tax and NICs due on that relevant step is paid, HMRC may also allow the employer to make a deduction for Corporation Tax purposes in the current year in the amount of the corresponding original contribution.
3.3 Regulation 80 determinations
In some instances, HMRC has issued Regulation 80 determinations (Income Tax (PAYE) Regulations 2003) with a view to bringing into charge tax only at the basic rate (BR) on DR. This may be because HMRC did not hold sufficient information to enable an alternative determination to be made or, in some very rare cases, because a BR tax code had been issued for an employee.
In order to prevent future DR charges arising, including the loan charge, BR and any higher rate tax needs to be paid. No late payment interest will be payable on the amount of the higher rate of tax paid.
3.4 Section 222 and 223 of the Income Tax (Earnings and Pensions) Act 2003
Where the use of the DR scheme or settlement of the liabilities arising from the use of the scheme gives rise to an Income Tax and NICs charge as a result of section 222 or 223 of the Income Tax (Earnings and Pensions) Act 2003 this will also need to be settled. For both, the tax charge arises on the employee, not the employer.
For section 222 there needs to be an open enquiry for the relevant earlier year for the individual employee and, if the year is open, we expect section 222 tax to be accounted for in the settlement - either by inclusion by the employer or by an amendment to the individual’s personal tax return. If that year is closed or incapable of amendment then section 222 does not need to be paid.
If within 90 days of the allocation being made there’s a legally enforceable obligation in place on the part of the trustee to indemnify the employer for any tax and NICs due as a result of the allocation, HMRC will accept that this is making good for the purpose of section 222 (if the tax and NICs are accounted for by the trustee or employee) so that a section 222 charge will not arise.
Section 223 is a current year charge for the period when Income Tax is paid by the employer and not deducted from the employee. As a result, in all settlement agreements where section 223 applies, HMRC will be within time to collect any section 223 duties due.
Where the employer settles either the section 222 or 223 charge on behalf of the employee, this will give rise to a further Income Tax and NICs charge which will also need to be included in the settlement amount.
3.5 County Court Fees
Where HMRC has protected its right to pursue the NICs liability that arose as a result of an employer’s use of the DR scheme, by issuing a County Court claim, the fee for issuing that claim will need to be included in the settlement amount.
3.6 Previous Settlements
Many employers settled all, or part, of their employment Income Tax and NICs liabilities resulting from their use of a DR scheme as part of the Employee Benefit Trust Settlement Opportunity (EBTSO), which closed in 2015. Many others settled all or part of their liabilities before 1 April 2017 to benefit from the Part 7A relief on investment growth provided for in Paragraph 59 of Schedule 2 to the Finance Act 2011.
Provided that the payment terms of those agreements are met, there will be no further employment Income Tax or NICs to pay for contributions, or allocations, included in those settlements. This will mean that any Part 7A charge, including the loan charge, will not apply to loans made from those contributions or allocations.
However, for settlements of employment Income Tax and NICs liabilities entered into since the EBTSO closed there will be a potential Part 7A charge on any growth on the secondary Class 1 NICs held in the scheme. Where those settlements were entered into after 31 March 2017 there will be a potential DR charge on any growth held in the scheme.
Where there was only a partial settlement, the employer can still settle the remaining liabilities now.
Some employers, including some users of Employer Financed Retirement Benefit Schemes, settled on the basis of denial of the Corporation Tax relief, which did not involve a payment of Income Tax or NICs. These employers are also in scope of Part 7A, including the loan charge. They may be able to prevent the loan charge arising if a Part 7A charge is triggered.
For the purposes of these settlement terms, an employee is someone who has been paid through a disguised remuneration scheme entered into by their employer, and is not a contractor. If their employer has not already settled and does not wish to settle, then the employee can settle without them but will need to be a party to the agreement. A third party, for example the trustee, cannot settle on the employee’s behalf.
4.1 Employee settlement terms
The employee will have to pay the same amount of Income Tax and NICs as if their employer was settling on the amount contributed to the scheme or, depending on the facts, the amount allocated within the scheme for their benefit. If the employer no longer exists, the employee will not have to pay any NICs.
Late payment interest will have to be paid for any years where HMRC has issued a PAYE determination and/or a protective NICs claim on the employer or is in time to make such a determination or claim. This is in accordance with the Compliance Operational Guidance COG908170 and COG915075. No late payment interest will be charged where voluntary restitution is made.
Where appropriate, penalties will have to be paid.
IHT may also be due dependent on the nature of the employer’s scheme and the amounts put through the trust.
Employees can reduce the settlement amount by any Income Tax they paid because they declared a benefit in kind on the basis of receiving a beneficial loan. This reduction is only available if that tax year i is in time to be amended or for an overpayment relief claim to be made.
Employees cannot reduce the settlement amount by any Corporation Tax relief or Class 1A NICs repayment which their employer may be entitled to as a result of them settling their liability.
There is also information about previous settlements.
5. Double taxation relief
DR schemes can give rise to more than one Income Tax and NICs liability on the same underlying income. For example, a liability can arise when the amount is contributed to the scheme and again at a later date when a Part 7A charge arises.
Part 7A contains comprehensive relief provisions to make sure there is no double taxation. These work by identifying Income Tax liabilities arising on overlapping, or the same underlying, amounts of income. Whichever Income Tax liability, plus late payment interest, is paid first creates a notional payment on account (NPoA), which relieves the other overlapping liability, including interest, to the extent of the NPoA.
Finance Bill (no 2) 2017 is expected to prevent double taxation of self-employed income.
Penalties may apply where a person has made a return which contains an inaccuracy which leads to an understatement of liability to tax (or NICs) (schedule 24 of the Finance Act 2007). A penalty is not payable if the inaccuracy was made despite the person taking reasonable care.
Penalties are based on the additional amount of tax and NICs payable as a result of correcting the inaccuracy in the return. DR schemes can result in users submitting more than one inaccurate return containing an understatement of tax on, essentially, the same income or earnings.
Where there is more than one inaccurate return and liability to tax relating to the same person and earnings, and the comprehensive double taxation relief rules in Part 7A apply, we will only charge one inaccuracy penalty.
We will take the same approach if the penalty is payable under section 98A(4) or section 95 of the Taxes Management Act 1970 where a taxpayer has negligently or fraudulently made an incorrect return which was due to be filed before 1 April 2009.
7. Inheritance Tax
Many DR schemes use a trust as the third party, and therefore IHT charges can arise.
Broadly, an IHT charge can arise when there is a payment, or disposition, resulting in a loss of value to a trust. This includes outright payments, or distributions, to beneficiaries, and occasions when settled property is no longer held in a section 86 Inheritance Tax Act 1984 (IHTA84) compliant trust. It also includes where a loan is released, in certain circumstances where a loan is made, as well as other charging occasions where payments and distributions are made to participators and settlors
IHT charges may be relieved if the payment from the trust giving rise to the charge is also treated as income. So if funds leaving the trust or moving to a sub trust are also treated as income at the same time, relief against the IHT charge may be due. However, any IHT charge will need to be paid if funds leaving a trust are not income at the same point in time. For example, if a contribution to a trust is taxed as earnings at that time, and your client has, more than 3 months after that date, transferred funds to a sub trust then charges may arise under section 72 IHTA84. There is no relief under section 70(3) IHTA84 as the funds transferred are not, at that second date, income nor will they become income for the purposes of IHT relief.
Further charges may arise under section 64 IHTA84 where sums have been held in a non-section 86 IHTA84 compliant trust structure for more than 10 years. This tax is calculated on the value of assets held in the trust on the tenth anniversary of the settlement. Your client will need to agree the value of assets and the tax due with HMRC as this must be included in any settlement amount.
If your client plans to collapse their structure immediately after settlement with HMRC, then HMRC are happy to calculate IHT exit charges. These will be calculated on the value of the assets leaving the trust and HMRC will need to agree that value if your client wants to include the taxes from winding up the trust as part of the settlement amount.
There can, in certain circumstances, also be IHT ‘entry’ charges on participators of close companies when the company makes a transfer of value, typically when a payment is made into trust.
IHT liabilities which have crystallised at the date your client settles with HMRC must be paid as part of the settlement amount.
8. Accrued interest
Many DR schemes involve a loan to the employee from the third party. Some of these loans are interest bearing and require the borrower, the employee, to pay interest to the lender, the trustee. Often, this interest is unpaid and either accrues or is added to the loan balance (capitalised).
When a DR scheme is closed the trustee may release or write-off the outstanding loan balance. This will give rise to a Part 7A charge on the accrued and capitalised interest, whether this has been actually paid or not.
As part of these settlement terms, HMRC will allow relief against the Part 7A charge that would otherwise arise in connection with accrued interest. This only applies where the trust is closed, or collapsed, as part of the settlement.
IHT applies to capital in the trust, but it is generally relieved when an Income Tax charge arises on the same transaction. There are some situations where a release, or write-off of a debt by the trustees may give rise to IHT despite there being an Income Tax charge due. In the absence of an Income Tax charge IHT is engaged.
As part of these settlement terms IHT will not be paid on accrued interest. This also only applies where the trust is closed, or collapsed, as part of the settlement. This is subject to all other IHT liabilities that have already crystallised, or will arise on closing or collapsing the trust, being paid as part of the settlement.
This Part 7A and IHT treatment applies to interest on loans made to employees or contractors. It can also apply to interest on loans made to the employer company, if the interest has not been actually paid and no tax deduction has been sought for the interest. Where funds contributed into a trust have been invested in any other way, any investment growth will be subject to a Part 7A and IHT charge as part of the settlement, or when the funds are distributed from the trust.
9. Capital payments and benefits
This section relates to capital payments and benefits enjoyed by beneficiaries where investment income has arisen within the trust.
If your client receives a capital payment from the trust and there is unmatched relevant income the capital payment may be subject to Income Tax under section 731 Income Tax Act 2007 to the extent that it can be matched with the relevant income.
For most DR arrangements any capital growth will not be subject to Capital Gains Tax, however, to the extent that the capital distribution can be matched against relevant income arising within the structure there may be an Income Tax liability under section 731 on the distribution. Where there is no growth on the initial contribution to the scheme, or the growth is limited to accrued interest on loans to employees, there will be no Income Tax liability under section 731.
If a settlement is reached on the basis that a relevant step under Part 7A occurred after 5 April 2011, the value of which includes the trust income and gains then the income and gains will be taxed as part of the disguised remuneration charge.