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This publication is available at https://www.gov.uk/government/publications/disguised-remuneration-transfer-of-liability-technical-note/tackling-disguised-remuneration
The government is introducing legislation to tackle existing, and prevent future use, of disguised remuneration (DR) avoidance schemes. These schemes are used by employers, employees, and the self-employed, and claim to avoid income tax and National Insurance contributions (NICs) on remuneration.
The majority of this legislation has already been enacted. The remaining primary tax legislation was published in draft on 13 September 2017. This technical note details the changes made to the draft legislation in response to stakeholder comments as well as a further clarification of when Part 7A applies.
This technical note also includes information on the changes to ensure the tax and NICs from a DR employment income charge are collected from the appropriate person.
Initial proposals for these changes were included in the 2016 technical consultation.
HM Revenue and Customs (HMRC) will discuss potential settlement with all DR scheme users who are interested in putting their use of DR avoidance schemes behind them.
Settlement terms were published on 7 November 2017 to help scheme users have a clear indication of what they will need to pay to settle with HMRC.
If you would like to discuss settlement, and you are already speaking to someone at HMRC about your involvement in a DR scheme, you should contact them in the first instance.
If you don’t have a contact, you should email:
- firstname.lastname@example.org for contractor loan schemes
- email@example.com for all other disguised remuneration schemes
All statutory references in this document are to the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) unless otherwise stated.
In addition, references to ‘employee’ include directors, and also include any individual ‘contractors’ who have entered into a contract of employment, as part of the avoidance scheme.
Strengthening Part 7A
The majority of the changes to strengthen Part 7A, and prevent the future use of DR schemes, have been enacted. Two further changes are included in Finance Bill 2017-18:
- introducing the close companies’ gateway
- a clarification of when Part 7A applies
Close companies’ gateway
One of the changes still to be enacted is the close companies’ gateway (CCG), which is intended to put beyond doubt when Part 7A applies to the remuneration of owners of close companies.
The CCG was published in draft on 13 September 2017 with a technical note setting out the changes that had been made since Spring Budget 2017. This document only provides details of the changes made to the CCG since 13 September 2017.
Stakeholders welcomed the changes to the CCG but had some further concerns.
One of these concerns was that there was no requirement for the employment to exist at or around the same time as the relevant transaction and relevant step. This contrasted with the material interest test, which had to be met within 12 months of the relevant transaction. Therefore, a similar time limit has been added so that the employment must have existed within the preceding three years of the relevant transaction.
The time period in the material interest condition has been extended from 12 months to 3 years so that the two tests align. However, the tests remain separate. Both have to be met at some point in the 3 year period, but not necessarily at the same time.
A close company ‘B’ contributes £10,000 to a trust for an ex-Director ‘A’. The trust subsequently made a loan to ‘A’ of £10,000. ‘A’ retired 5 years ago, but has maintained a material interest in ‘B’.
‘A’ has a material interest in ‘B’ and so the material interest condition is met. ‘A’ ceased to be employed by ‘B’ more than three years before a relevant transaction was taken, therefore the employment condition is not met. The conditions of the close companies’ gateway are not met.
A close company ‘B’ is wholly owned by an individual ‘A’, ‘A’ is not an employee of ‘B’. ‘A’ sells their interest in ‘B’ in December 2015, as part of the sale agrees to join ‘B’ as chief financial officer for the 2016 calendar year. ‘B’ contributes £10,000 to a trust, after ‘A’ leaves their employment in December 2016. ‘A’ receives a loan of £10,000 from the trust in February 2017.
‘A’ had a material interest in the three years preceding the relevant transaction, so the material interest condition is met. ‘A’ was employed by ‘B’ in the same period, so the employment condition is met. The conditions in the close companies’ gateway are met.
There were similar concerns that the avoidance purpose test did not have a time limit. Stakeholders felt it was unclear when the test should be applied, and thought it was possible for the purpose of the arrangement to change over time.
The avoidance purpose test has now been amended to take account of when the relevant transaction and the relevant step occurred. This will ensure that the purpose of entering into an arrangement, for example by setting up a trust, many years before the scheme was used will not be taken into consideration.
A company ‘B’ sets up an EFRBS in 2005 with the intention of providing employees with retirement benefits. The EFRBS invested the company’s contributions in gilts. In 2015 the EFRBS was closed to new investment and all the funds were distributed. In 2017 ‘B’ makes a large contribution to the EFRBS, which subsequently loans the money to a shareholding director employed by ‘B’. The loan is made to the director as a way of avoiding income tax and NICs.
The trust was not set up with an avoidance purpose, but the purpose changed in 2017 when it was used in a disguised remuneration avoidance scheme. The avoidance purpose test would be met in these circumstances.
Had the converse happened, so that a trust which was set up for an initial avoidance purpose many years ago is now a party to a relevant transaction and relevant step which are not related to avoidance, the avoidance purpose test would not be met.
Stakeholders identified that the introduction of the purpose test meant that some of the exclusions, which contained anti-avoidance provisions, were no longer effective.
The definition of excluded transactions, at section 554AC, has been updated to reflect stakeholder feedback.
The single employer exclusion, at section 554AD, has been removed. It was only available where there was no avoidance purpose to the arrangement. However, for the CCG to apply there must be an avoidance purpose to the arrangement as per section 554AA. Therefore, any intra-group transactions which do not have an avoidance purpose will not be caught by the CCG.
Part 7A clarification
Some promoters of avoidance schemes have suggested that Part 7A cannot apply if the DR scheme previously triggered an employment income tax charge. The argument, broadly, relies on an earlier income tax charge preventing the conditions of the Part 7A gateways being met.
The government has always been clear that earnings charges and charges under Part 7A are not mutually exclusive. Section 554A contains a number of objective conditions which determine whether or not Part 7A applies. If a Part 7A charge arises, it will not be affected by an income tax charge that arises as a result of any other legislation.
There are comprehensive double taxation relief provisions in Chapter 2 of Part 7A, and paragraph 59 of Schedule 2 to Finance Act 2011, to ensure no one has to pay tax twice on the same underlying income, even if there are overlapping tax charges.
However, the government has decided to amend Part 7A to put beyond doubt when Part 7A applies. The amendment makes clear that Part 7A applies regardless of whether contributions to DR schemes should previously have been taxed as employment income. This change is effective from 22 November 2017.
Transfer of liability
The 2016 technical consultation set out three scenarios where the government was concerned it would not be possible to collect the tax and NICs arising from the measure. These are where:
- there is a non-UK employer set up for the purposes of the DR scheme and the employee provides services to a UK person
- the employer exists at the time the Part 7A charge arises but is unable to meet the liability
- the employer no longer exists at the time the Part 7A charge arises
The 2016 technical consultation also included initial proposals for each of those scenarios. The government has considered stakeholders’ views and the final proposals for each of the scenarios are set out below.
Some DR schemes use an employer located outside the UK (“offshore”). The employees then supply their labour, or services, through one or more intermediaries and agencies. The engager of their services is often a UK based end client, paying a fee to the intermediary or agency.
Since offshore employers are not required to account for Pay As You Earn (PAYE), section 689 can require a UK entity to account for the tax arising on employment income through PAYE.
An employee ‘A’ is employed by an offshore company ‘B’. ‘A’ provides services to a UK based end client, Host Ltd. The offshore company invoices Host Ltd for ‘A’s’ services either directly or via an intermediary or an agency based in the UK. £10,000 is contributed to a trust by ‘B’, the trust subsequently loans £10,000 to ‘A’. The loan to A is a relevant step and a Part 7A charge arises.
‘B’ is outside the scope of the PAYE regulations and so section 689 will apply to make Host Ltd, or the agency, responsible for operating PAYE on the Part 7A charge arising on the loan to ‘A’.
The government believes it would be inappropriate, and impracticable, for section 689 to apply with the new charge on outstanding DR loans (“the loan charge”). The main party to benefit from the DR scheme is the employee, and they should be liable to pay the income tax arising from the DR scheme.
The government has therefore introduced legislation in Finance Bill 2017-18 which prevents section 689 from placing the liability to pay the loan charge onto the UK end client or intermediary where the employer is offshore. Section 689 will not apply to require a UK entity to operate PAYE in respect of the loan charge.
Sections 7, 8 and 9 of the Taxes Management Act 1970, set out the employee’s responsibility to return the employment income to HMRC. As a result the employee is responsible for reporting the income and paying the tax to HMRC by making a self-assessment return.
An employee ‘A’ is employed by an offshore company ‘B’. ‘A’ provided services to a UK based end client, Host ltd, in 2008. The offshore company invoiced Host ltd for ‘A’s’ services either directly or via an intermediary or an agency based in the UK. ‘B’ contributed £10,000 to a trust, the trust subsequently loaned £10,000 to ‘A’ in 2009. The loan remains unpaid on 5 April 2019. The outstanding loan triggers a loan charge relevant step and Part 7A charge arises.
‘B’ is outside the scope of the PAYE regulations, and section 689 does not apply to the loan charge relevant step. As there is no UK entity required to operate PAYE, ‘A’ must report the income and pay the tax to HMRC directly.
The government will also introduce secondary legislation in relation to NICs which will mean the end client and the employee are not liable for Class 1 NICs.
Annex A contains the draft statutory instrument.
Employer unable to pay
Some employers may not be able to pay the tax arising from a Part 7A charge, in particular the loan charge. To ensure DR scheme users pay their fair share the government considered extending HMRC’s powers to transfer the liability from the employer to the employee.
Stakeholders raised various concerns, including the need for sufficient safeguards and suggesting that the existing powers HMRC has are sufficient.
The government has considered the options and agrees that the existing powers are sufficient to ensure the tax arising from Part 7A charges is collected.
HMRC intends to use regulation 81 of the PAYE regulations to transfer the outstanding liability where the employer is unable to pay. Broadly, a regulation 81 direction can be made if either Condition A or B is met. Condition B allows a transfer of liability if the unpaid tax is in relation to a notional payment, which covers all Part 7A tax charges, including the loan charge.
The regulation 81 direction only transfers the tax liability. The employer will remain liable for any Class 1 NICs due. The employee will not be liable for any Class 1 NICs due.
Employer unable to pay – in practice
HMRC will consider the facts of each case when dealing with employers who are unable to pay. However, the broad stages of the process of transfer of liability are set out below.
Using existing procedures, HMRC will assess the employer’s ability to pay. HMRC will consider time to pay (TTP) arrangements, especially where employers are in scope of the loan charge, and arrangements can be made to pay the liabilities over a number of years.
Where these options are exhausted, and it is clear that the employer is unable to pay the outstanding liability, HMRC will issue a regulation 80 determination in respect of the unpaid tax included in their Real Time Information (RTI) return. Once this determination has been unpaid for 30 days HMRC will use regulation 81 to direct the liability on to the employee. The unpaid tax will then be collected from the employee directly.
The government expects, and encourages, employers who have used DR schemes to include all Part 7A charges in their RTI/PAYE submissions regardless of their ability to pay. This will prevent any inaccuracy, or failure to notify, penalties.
Where the employer does not include Part 7A liabilities in their RTI submission, HMRC will issue a regulation 80 determination. Once the determination is final HMRC will make an assessment of whether or not the employer has the ability to pay the outstanding liability. Where appropriate a regulation 81 direction will be made.
As the third party in a DR scheme exists independently from the employer, it is possible for a Part 7A charge to arise where the employer has been dissolved or no longer exists.
Sections 7, 8 and 9 of the Taxes Management Act 1970, set out the employee’s responsibility to return the employment income to HMRC by making a self-assessment return. As a result the employee is responsible for reporting the income and paying the tax to HMRC.
The employee will not be liable for any Class 1 NICs due.
Loan charge additional information
The draft legislation published on 13 September 2017 included a duty on every employee who had an outstanding DR loan on 5 April 2019 to provide information to HMRC.
In their responses to the technical consultation on the draft legislation stakeholders raised the need for clarification between the duty to provide information to the employer, contained within paragraph 36 of schedule 11 of Finance (No. 2) Act 2017, and this separate duty to provide information to HMRC in paragraphs 35A to 35K.
Paragraphs 35A to 35K require employees to provide information to HMRC. This will allow HMRC to ensure the loan charge is complied with.
Paragraph 36 requires employees and third parties to provide information to their current, or former, employers. This will allow employers to operate and comply with their PAYE obligations relating to the loan charge.
To ensure consistency, the information that must be provided to the employer and to HMRC has been harmonised. Effectively, an employee will have to provide the same loan balance information to their employer and HMRC.
Stakeholders were concerned some third parties would be reluctant to provide information to employees. Therefore the government has extended the additional information requirement in response to these concerns. The third party, used in the DR scheme, is now required to provide the employee with the information needed to fulfil their duty to provide information to HMRC.
A drafting error in paragraph 35A has also been corrected, to reflect the policy that the information requirement does not arise where the employee is no longer alive at the relevant date.
The government has also extended the scope of the duty to provide information to HMRC to include self-employed users of DR schemes.
Additional technical detail
The Finance Act 2017 contained comprehensive double taxation relief provisions to ensure no scheme user pays tax twice on the same underlying income.
There are currently provisions to relieve liability for overlapping NICs in regulation 22B of, and paragraphs 2 and 2A of Part 10 of Schedule 3 to, the Social Security (Contributions) Regulations 2001. The government intends to introduce further provisions to clarify how double NICs relief is given in more complicated fact patterns.
Annex B contains the draft legislation.
The legislation is wholly relieving and will apply from the introduction of Part 7A in the same way as the tax rules. HMRC will apply the principles of the draft NICs provisions in practice where multiple NICs charges arise.