Policy paper

Tackling disguised remuneration - technical note

Published 13 September 2017

Introduction

1. The government is introducing legislation to tackle existing, and prevent future use of, disguised remuneration (DR) avoidance schemes. These schemes are used by a small minority of employers, employees, and the self-employed, and seek to avoid Income Tax and National Insurance contributions (NICs) on remuneration.

2. The majority of this legislation has already been enacted, or has been consulted on and is included in Finance Bill 2017. Detailed guidance on all of those changes will be published shortly in the Employment Income Manual.

3. The remaining legislation, with an explanatory note, was published in draft on 13 September 2017. This technical note provides more information, and detail, on that draft legislation, including illustrative examples.

4. The draft legislation doesn’t include the changes to ensure the tax and NICs from a DR employment income charge are collected from the appropriate person, which were included in the 2016 technical consultation. They will be set out in detail later in 2017 and this document doesn’t include any further information on those changes.

5. HM Revenue and Customs (HMRC) will discuss potential settlement with all users of DR schemes who are interested in putting their use of DR avoidance schemes behind them. Later this year high-level settlement terms will be published so that all DR users have a clear indication of what they will need to pay to settle with HMRC.

6. If you would like to discuss settlement and you’re 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 exitsteam.counteravoidance@hmrc.gsi.gov.uk.

7. All statutory references in this document are to the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) unless otherwise stated.

8. In addition, references to ‘employee’ include directors, and any individual ‘contractors’ who were working under a contract of employment, even where those individuals might normally think of themselves as self-employed.

Close companies’ gateway

1. The majority of the changes to strengthen Part 7A, and prevent the future use of DR schemes, have been enacted.

2. 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.

3. The CCG was due to be enacted earlier this year and to commence on 6 April 2017. At Spring Budget 2017, the government announced the CCG would be legislated in a later Finance Bill to commence on 6 April 2018. This would allow for further consultation with stakeholders to ensure the CCG is appropriately targeted only at DR schemes.

4. The draft legislation published on 13 September 2017 includes an updated CCG, which has been revised to address stakeholder concerns. The changes:

• introduce an avoidance purpose condition
• introduce a time period in which the material interest condition must be met
• require a stronger link between the relevant transaction and relevant step
• correct an error when defining excluded transactions
• clarify the interaction with the loans to participators rules

5.This document only provides details of the changes made to the CCG since the technical note published on 5 December 2016. Anyone wanting further details on the CCG should read this document alongside that note.

New avoidance purpose condition

6.A purpose test has been added to the CCG, at subsection 554AA(1)(c), so that it can only apply to avoidance arrangements, and not genuine commercial arrangements or those without an avoidance purpose.

7.DR schemes can be used to avoid different taxes, or regimes, although the vast majority are sold as avoiding Income Tax and NICs. For example, some DR schemes have sought to accelerate Corporation Tax deductions for corporate employers. Therefore, the purpose test also considers other taxes that scheme users sometimes seek to avoid.

Timing of the material interest condition

8.The previous draft of the CCG required the employee to have a material interest in the close company employer. This condition had no time limit, or relationship to the other conditions, which could have led to the CCG applying unfairly in some circumstances.

9.The material interest condition now has to be met at the time the relevant transaction is made, which is, broadly, when the remuneration is disguised, see subsection 554AA(1)(f). This is intended to more closely align with period the employee, and participator, has influence over the close company employer’s actions.

10.To prevent the employee, and participator, temporarily disposing of their material interest prior to the relevant transaction, the material interest condition also considers the period one year before the relevant transaction.

Example 1.1:

’A’ owns 50% of the ordinary share capital in close company ‘B’. They are also a director of B.

On 24 October 2018 B decides to enter into a DR scheme, and A, as director, is involved in reaching that decision.

On 26 October 2018 B enters into a relevant transaction with a third party. The material interest test is met at this point as A has more than 5% of the ordinary share capital of B.

Example 1.2:

’A’ owns 25% of the ordinary share capital in close company ‘B’. They are also a director of B.

On 16 June 2018 A sells all their shares to an unconnected third party.

On 14 November 2018 B enters into a DR scheme, and A receives a large loan from a third party. The material test is still met as A had a material interest within one year of the relevant transaction.

Relevant transaction and relevant step link

11.The previous draft of the CCG required both the relevant transaction and the relevant step to be indirectly linked by both being taken in pursuance of the same relevant arrangement or scheme. This could have led to a Part 7A charge arising unfairly where a relevant transaction and relevant step were only very loosely connected.

12.The current draft, at subsection 554AA(1)(i), now requires the value of the relevant step to derive from the relevant transaction. This revised approach focuses more closely on the nature of DR schemes, which is to extract funds quickly from the close company employer, and removes the likelihood of Part 7A applying unfairly.

Excluded transactions

13.An excluded transaction, section 554AC, is a transaction which is not a relevant transaction for the purposes of section 554AB. This includes a distribution by, and a distribution made during the winding-up of, the close company employer. The definition of a distribution in a winding-up was insufficient in the previous draft and this has now been corrected.

Loans to participators interaction

14.The previous draft of the CCG made clear it was possible for a charge to arise under both Part 7A and the loans to participators rules in Chapter 3 of Part 10 Corporation Tax Act 2010 (CTA 2010).

15.Generally, a loan to participators charge under section 455 CTA 2010 only arises on loans made directly from the close company to the participator. Therefore, a charge won’t arise in a DR scheme, which involves loans from, or right to repayment to, a third party.

16.However, it is possible, but not common, for loans to participators charges to arise by virtue of section 459 CTA 2010, which also considers transactions by third parties. Therefore, it is possible for a charge to arise under Part 7A and section 455 CTA 2010 in limited circumstances.

17.The draft legislation includes comprehensive priority rules, at section 554Z2A, to ensure that a charge can only arise under one regime. Broadly, a decision has to be made by the customer at the outset as to whether, or not, the loan is within the loans to participators regime. If it is, and all the rules of the loan to participators regime are followed, Part 7A, by virtue of the CCG, will not apply. If the loan is not within the loans to participators regime, or not all the rules are followed, then Part 7A, by virtue of the CCG or the existing gateway at section 554A, can apply.

18.The draft legislation sets out that the loans to participators regime has priority over Part 7A in the following circumstances:

• section 455 CTA 2010 charge is paid in full on time
• section 455 CTA 2010 charge is nil as relief has been given under section 458 CTA 2010
• section 455 CTA 2010 charge is not paid in full on time but HMRC agrees

19.In the first 2 circumstances above the loans to participators rules are followed and the loan has been appropriately treated.

Example 1.3:

‘A’ is a director of close company ‘B’. B makes a loan to a third party ‘P’ of £10,000. The purpose of this loan is to make a further loan from P to A of £10,000.

The loan to A is treated as a loan to a participator under section 459 CTA 2010. The conditions of the CCG are also met and a charge could arise under Part 7A.

B pays the tax due under section 455 CTA 2010, by virtue of section 459 CTA 2010, in full and on time. This charge takes priority over the Part 7A so that there is no double taxation.

Example 1.4:

‘A’ is a director of close company ‘B’. B makes a loan to a third party ‘P’ of £25,000. The purpose of this loan is to make a further loan from P to A of £25,000.

The loan to A is treated as a loan to a participator under section 459 CTA 2010. The conditions of the CCG are also met and a charge could arise under Part 7A.

Before the due date for the tax due under section 455 CTA 2010, by virtue of section 459 CTA 2010, the loan is repaid in full. No charge arises under Part 7A, as the loan has been repaid in full, so there is no double taxation.

20.The majority of customers pay their tax on time but there are occasions due to error, or unforeseen circumstances, where tax is paid late. It would be unfair to immediately apply an employment income charge without considering those particular circumstances. Therefore, the draft legislation allows HMRC the discretion to maintain the loans to participators priority where neither of the first 2 circumstances above are met, and the charge has been included in the close company employer’s Corporation Tax return.

Example 1.5:

‘A’ is a director of close company ‘B’. B makes a loan to a third party ‘P’ of £25,000. The purpose of this loan is to make a further loan from P to A of £25,000.

The loan to A is treated as a loan to a participator under section 459 CTA 2010. The conditions of the CCG are also met and a charge could arise under Part 7A.

B correctly includes the loans to participators charge in their Corporation Tax return but is unable to make a full payment of the tax on time. B makes a final and full payment 2 months after the due date.

B can request that the loans to participators charge takes priority over the Part 7A charge. HMRC can exercise its discretion to allow this as the payment was made shortly after the due date due to unforeseen circumstances unconnected to a DR avoidance scheme.

Example 1.6:

B is a close company employer that uses a DR scheme. It is possible that both a Part 7A charge under the CCG and a loans to participators charge could arise. B disputes that a charge arises under either regime, and doesn’t include the section 455 CTA 2010 liability in their Corporation Tax return.

Before litigation proceedings begin, B decides they should settle with HMRC. B asks HMRC to give the loans to participators charge priority over Part 7A. HMRC can’t exercise its discretion as the section 455 CTA 2010 charge was not included in B’s Corporation Tax return.

21.It is possible, and much more common, that a charge under the loans to participators rules at Chapter 3A of CTA 2010 will apply to DR schemes. This is because those provisions are also intended to apply to loans made through third parties to participators. However, section 464A CTA 2010 already gives priority to Part 7A so no further legislation is required to give priority.

22.The same principles, at paragraph 18 above, that give priority to the loans to participators regime, are replicated for the new charge on DR loans outstanding on 5 April 2019 (“the loan charge”) at paragraph 36A.

Loan charge additional information

1. The new charge on DR loans outstanding on 5 April 2019 (‘the loan charge’) is included in Schedule 11 of Finance Bill 2017.

2. As set out in the technical note published on 5 December 2016, the government has been considering whether there should be a requirement to report additional information specifically for the loan charge.

3. Only the outstanding loan balance information will be provided by the employer in the Pay As You Earn (PAYE) return or by the individual in their self-assessment return. This will vary based on the amount of the loan repaid by the employee, and if all the loan is repaid no information will be provided.

4. However, sufficient information needs to be available in order for HMRC to:

• ensure that the loan charge has been complied by all DR scheme users, and
• apply the double taxation relief provisions enacted in Finance Act 2017

5.To meet those 2 objectives the draft legislation includes a requirement for all employees to report additional information to HMRC before 1 October 2019, see paragraphs 35A to 35J.

Duty to provide information to HMRC

6.All individuals, regardless of whether they are a current employee, who have received a loan, or quasi-loan, from a DR scheme must provide the additional information where one of the following conditions are met:

• the loan charge arises on 5 April 2019
• the loan charge would arise on 5 April 2019 but it has been postponed to a later date
• the loan charge doesn’t arise on 5 April 2019 but all the conditions of the loan charge were met on 16 March 2016

7.The last condition only applies if the other conditions are not met, which means the loan charge doesn’t arise on 5 April 2019. This could be because the loans have been repaid or because another avoidance scheme has been entered into which seeks to avoid the loan charge. To ensure HMRC is aware of those cases this condition considers if the loan charge would have arisen on 16 March 2016. If the loan charge would have arisen on that date individuals will need to complete the additional information.

Example 2.1:

An individual ‘A’ has received multiple loans from a DR scheme in the years up to 2016. In 2017 they repay all the loans in money, and the repayments are not connected to a further avoidance arrangement.

In 2019 the outstanding loan balance is nil so there is no tax to pay under the loan charge. However, A still needs to complete the additional information as all the conditions of the loan charge were met on 16 March 2016.

8.The individual doesn’t need to provide the additional information if:

• a full and final settlement has been reached with HMRC before 1 October 2019 that covers all of their DR loans
• the loans to participators regime has priority over Part 7A

Example 2.2:

An individual ‘A’ receives a loan from a DR scheme. A, or their employer, settles the tax and NICs due on the contribution to the DR scheme. A has no other DR loans and no further tax will be due under the loan charge. A doesn’t need to complete the additional information.

Example 2.3:

An employer contributes to a DR scheme to reward an employee ‘A’ once a year for 5 years. A, or their employer, settles the tax and NICs due on the contribution to the DR scheme for 3 of those 5 years. The loan charge will apply to the loans received from contributions to the DR schemes in the other 2 years. A must report the additional information before 1 October 2019 as the loan charge will arise.

Required information

9.The required information fits into the following 3 broad categories:

• contact details
• case identification
• loan, or quasi-loan, outstanding balance calculation

10.Case identification includes any case references, scheme reference numbers, and other information that allows the loan charge information to be linked to existing enquiries. This also includes any details of partial settlements.

11.The outstanding balance calculation includes details of all loans, and repayments, aggregated by tax year. This includes details of any repayments which are disregarded or loans that that have previously been released or written off.

Format and process

12.HMRC is developing a digital tool for employees to provide their information. There will also be another option for those unable to use the digital tool. More information on these tools will be provided at a later date.

Non-compliance

13.To ensure compliance, and fairness for those who do complete the reporting requirement, the draft legislation includes penalties. Broadly, the approach is similar to those for information notices in Schedule 36 of Finance Act 2008.

14.A failure to complete the reporting requirement fully, or by the deadline, may result in a fixed penalty of £300. A continued failure to comply may result in daily penalties of up to £60 a day for a maximum of 90 days.

15.A penalty of up to £3,000 may be due if an individual carelessly, or deliberately, includes an inaccuracy in their reporting requirement return. A penalty may also be due if the individual identifies the error but doesn’t inform HMRC.

16.These penalties can be appealed in the same way, and for the same reasons, as penalties arising under Schedule 36 of Finance Act 2008.

17.HMRC intends to contact all individuals it is aware of to inform them of their duty to provide information, and the consequences for failing to do so. Guidance will be published setting out how HMRC intends to apply these penalties at a later date.

Duty to provide information to the employer

18.Paragraph 36 of Schedule 11 of Finance Bill 2017 includes a duty to provide information to the employer. Broadly, the third party and employee must provide the employer with enough information for the employer to calculate the outstanding loan balance within 10 days of the loan charge arising. If the third party, or employee, are unable to contact the employer they should inform HMRC.

19.To ensure consistency, the information that must be provided to the employer and HMRC is being harmonised. Effectively, an employee will have to provide the same loan balance information to their employer and HMRC.

20.The requirement to contact HMRC if the third party, or employee, are unable to contact the employer will be removed. This is because the employee will now have to contact HMRC as part of the additional information reporting.