Guidance

Tackling disguised remuneration technical update

Published 20 March 2017

1. 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 employers, employees, and the self-employed, and claim to avoid income tax and National Insurance contributions (NICs) on remuneration.

2. Following a technical consultation, the government published a technical note and summary of responses (‘the technical note’) setting out its legislative proposals in detail on 5 December 2016. The technical note, published at the same time as draft Finance Bill 2017, can be found at Tackling Disguised Remuneration: technical consultation.

3. This document provides details of the changes made to the legislative proposals since the technical note was published. For an explanation of all the legislation being introduced to tackle DR schemes this document should be read alongside the technical note.

4. Detailed draft guidance on the DR legislative changes affecting employers and employees in the 2017 to 2018 tax year can be found at Tackling disguised remuneration: draft guidance for changes to Part 7A. Guidance for all the DR legislation introduced in Finance Bill 2017 will be published later in 2017.

5. Proposals on how the tax and NICs from a DR employment income charge will be collected from the appropriate person are not included in this technical update. There will be a technical consultation on the detail of those changes later in 2017.

6. HM Revenue and Customs (HMRC) will discuss potential settlement, including setting out the terms, with all users of DR schemes who are interested.

7. 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: CAGetHelpOutOfTaxAvoidance@hmrc.gov.uk.

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

9. 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.

10. Any references to an individual trading through self-employment, also include an individual trading as a member of a partnership (including a Limited Liability Partnership (LLP)). References to trade also include professions and vocations.

2. Strengthening Part 7A

1. As set out in Chapter 3 of the technical note, Part 7A is changing to put beyond doubt that it applies to all forms of DR schemes, as was always intended. All the provisions are included in Schedule 16 of Finance Bill 2017, and the majority will apply from 6 April 2017.

2. Since the technical note was published, the new exclusions for payments to HMRC and loan transfers have been amended to ensure they are only used when intended. Some additional provisions have also been added to make clear when Part 7A charges arise.

Loan transfer exclusion

3. As set out in the technical note, section 554C is being amended to make clear that loan transfers will be treated in the same way as if the third party made the loan directly to the employee. To ensure the transfer of employment-related loans between two employers does not give rise to Part 7A charge, the exclusion at new section 554OA is being introduced.

4. A monetary limit of £10,000 has been added to prevent this exclusion being abused and target it at non-avoidance employment-related loans transferred between employers. This will prevent the exclusion applying to loans where the principal exceeds £10,000 in the year of the loan transfer. The £10,000 limit aligns with the threshold for beneficial loans at section 180.

5. When considering if the £10,000 limit has been met in the year, all employment-related loans from the same employer must be added together. This is the same as the approach for beneficial loans in section 180.

Example 1.1

An employer makes a loan of £2,400 to employee ‘A’ so that they can purchase a rail season ticket for their travel to work.

During the year ‘A’ finds a new job with another employer. The outstanding loan balance of £1,800 is transferred from the employer to the new employer.

This is a loan transfer but all the conditions of section 554OA are met and a Part 7A charge doesn’t arise.

Loan releases

6. As set out in the technical note, section 554C is being amended to include the release, or write-off, of a DR loan.5

7. It is possible for the employee who has received a loan, or loan transfer, from a third party to acquire the loan, or right to repayment. Where the borrower also becomes the lender, the loan ceases to exist for practical purposes. Section 554C has been extended to put beyond doubt that where a loan is released in this way a Part 7A charge arises.

Example 1.2

An employee, ‘A’, has a loan of £30,000 from a trust, ‘P’, as part of a DR scheme.

‘A’ enters into an arrangement to acquire the right to repayment of the £30,000 loan from ‘P’.

As ‘A’ is now the borrower and the lender of the same DR loan a Part 7A charge arises.

Close companies’ gateway

8. The technical note included a new gateway to put beyond doubt when Part 7A applies to DR schemes used by close company employers.

9. The government acknowledges the proposal set out in the technical note could catch commercial arrangements that aren’t DR schemes. Therefore, the government has decided the close companies’ gateway (CCG) will be introduced in the next Finance Bill for commencement on 6 April 2018. This will allow for further consultation to ensure the CCG is appropriately targeted at only DR schemes.

10. All the provisions related to the CCG, including the interaction with the loans to participators rules in Chapters 3, or 3A, of Part 10 Corporation Tax Act 2010, will be included in the later Finance Bill. After its introduction the CCG will apply with the loan charge in the same way as the existing gateway at section 554A.

Part 7A charge arising when paying HMRC

11. As set out in the technical note, new section 554XA is being introduced to prevent a Part 7A charge arising when tax is paid to HMRC. This exclusion only applies to liabilities arising from the same DR scheme from which the funds are used to pay HMRC.

12. To meet this objective more clearly, and prevent abuse, section 554XA has been changed to require the payment of tax:

• to have been made as part of a settlement with HMRC
• where not made as part of a settlement, that HMRC agree the payment is to meet liabilities of the same DR scheme the payment is made from

13. For HMRC to agree the liabilities arise from the same DR scheme as the payment, an application must be submitted. The application process will be set out later in 2017.

Example 1.3

A company ‘B’ agrees a settlement with HMRC for tax due from their use of a DR scheme. The trust which was used for the DR scheme makes a payment of £20,000 in full and final settlement directly to HMRC.

No Part 7A charge arises on the payment of £20,000 to HMRC.

Example 1.4

The trustee of an employee benefit trust used for a DR scheme agrees to release the employees from their obligations to repay their loans. This creates a Part 7A tax charge due to the changes to section 554C.

The trustees want to pay the tax and NICs due directly to HMRC. They apply to HMRC for this to meet the conditions of the exclusion at section 554XA. HMRC agree the payment is to meet liabilities of the same DR scheme, and no Part 7A charge arises on the payment to HMRC.

Anti-avoidance

14. Some DR schemes have clauses in trust deeds which seek to prevent a Part 7A charge arising even when all the conditions of Part 7A are met. They claim to do this by prohibiting the trustees from doing anything which gives rise to a Part 7A charge regardless of the action they take. A new provision has been added in section 554A to put beyond doubt that such clauses are ineffective, and a Part 7A charge arises where all the conditions of Part 7A are met.

NICs

15. The changes in Schedule 16 of Finance Bill 2017 will ensure Part 7A charges arise in the appropriate circumstances. Where these changes result in a charge under section 554Z2, a NICs charge will arise due to Regulation 22B of the Social Security (Contributions) Regulations 2001 (‘Regulation 22B’). This regulation treats the amount of employment income under section 554Z2 as earnings for, both primary and secondary, Class 1 NICs purposes.

3. The loan charge

1. As set out in Chapter 6 of the technical note, a new charge will be introduced on DR loans outstanding on 5 April 2019 (‘the loan charge’). This is included in Schedule 17 of Finance Bill 2017, and related provisions have now been grouped under separate parts.

2. Since the technical note was published, the loan charge exclusions have been updated and two additional exclusions added. The legislation now sets out how the outstanding loan balance is calculated where currencies other than sterling have been used, and some further anti-avoidance provisions have been added.

Exclusions

3. As set out in the technical note, the loan charge will not apply to loans that met one of the existing exclusions in Part 7A when they were made. To achieve this two exclusions were replicated in the loan charge Schedule, and two exclusions (commercial transactions and employee car ownership schemes) were amended.

4. The commercial transactions and employee car ownership schemes exclusions have now been replicated in Schedule 17 at paragraphs 23 and 31 so that all the loan charge exclusions are in the same place.

5. The exclusion for transferring employment-related loans at section 554OA has also been replicated in Schedule 17 at paragraph 25. This is to prevent loan transfers meeting the exclusion in Part 7A, so no charge arises, but still meeting the conditions of the loan charge.

6. Following stakeholder feedback, the exclusion for the acquisition of unlisted share schemes at paragraph 33 has been extended to include quasi-loans.

7. The technical note stated that money repayments of loan, or quasi-loan, principal amounts would not automatically meet the conditions of section 554B, and trigger a Part 7A earmarking charge. To put this beyond doubt, an exclusion has been added at section 554RA to Part 7A charges arising where a loan is repaid. However, this will not apply where action is taken after the money repayment transaction.

Example 3.1

An employee, ‘A’, has a loan of £40,000 from a third party, ‘P’, as part of a DR scheme that is in scope of the loan charge in 2019. ‘A’ repays the loan of £40,000 to ’P’ to prevent the loan charge applying.

No Part 7A charge will arise on the repayment of £40,000 to ‘P’.

Example 3.2

Following on from Example 3.1 above, ‘P’ allocates the £40,000 to a sub-trust where ‘A’ is the only beneficiary.

A Part 7A charge arises because the conditions of section 554B are met. The exclusion at section 554RA does not apply as ‘P’ has taken an action with the £40,000 after the repayment.

Anti-avoidance

8. For the loan charge to apply, a DR loan, or part of a DR loan, must be outstanding to a third party at 5 April 2019. Some scheme users may seek to prevent the loan charge applying by moving the right to repayment to a party other than a third party. Therefore, paragraph 4 requires the outstanding loan balance calculation to include any DR loans which have been deliberately moved to the employer or employee.

9. Paragraph 11 applies the same treatment for quasi-loans.

Other currencies

10. Stakeholders raised the concern that the outstanding loan balance calculation did not take currencies other than sterling into consideration. For example, whether a loan made in euros should be converted to sterling on the date it was made or on the loan charge date.

11. Therefore, paragraphs 5 to 9 have been added to make clear how the outstanding loan balance, for loans made in currencies other than sterling, should be calculated in each of the following scenarios:

• the loan principal and repayments are made in the same currency
• the loan principal and repayments are made in different currencies
• a depreciating currency is deliberately used to artificially reduce the outstanding loan balance

12. In the first two scenarios, the outstanding loan balance is calculated in the currency the loan was made in, and then converted to sterling on the loan charge date.

Example 3.3

An employee ‘A’ has a loan of €300,000 from a third party as part of a DR scheme that is in scope of the loan charge in 2019. ‘A’ decides to repay €200,000 in 2018.

As the loan and the repayment are both made in the same currency, the repayment is deducted from the principal. The outstanding balance of €100,000 is then converted to sterling at the appropriate spot rate when the loan charge applies on 5 April 2019.

Example 3.4

An employee ‘A’ has a loan of $400,000 from a third party as part of a DR scheme that is in scope of the loan charge in 2019. ‘A’ decides to repay €200,000 in 2018.

As the repayment is in a different currency to the loan principal currency, the repayment is converted to the same currency at the appropriate spot rate on the date of the transaction.

If the spot rate is €1 to $1.10 then the repayment is $220,000. This is deducted from the principal to calculate the outstanding balance of $180,000.

The outstanding balance of $180,000 is then converted to sterling at the appropriate spot rate when the loan charge applies on 5 April 2019.

13. In the third scenario, the loan is made in a currency knowing that it will depreciate significantly in a short space of time. Where this occurs both the loan principal and repayments are converted to sterling on the date they are made. The outstanding loan balance is then calculated by deducting the repayments from the principal amounts.

Example 3.5

An employee ‘A’ has a loan of 1,000,000 Zambian Kwacha (ZMW) from a third party as part of a DR scheme that is in scope of the loan charge in 2019. The spot rate at the time of the loan was 1ZMW to £0.10, so ‘A’ received £100,000.

‘A’ requested a loan in ZMW because it was highly inflationary. Within in a short period of time the exchange rate has changed to 1ZMW to £0.03. At the spot rate ‘A’ now has a loan of only £30,000 so decides to repay it.

As the currency was chosen deliberately and specifically because it would depreciate in a short space of time, other rules set out how the outstanding balance is calculated.

Both the loan principal and repayment are converted to sterling using the appropriate spot rate at the time they were made. The outstanding balance of £70,000 is then calculated by deducting the repayment from the principal.

14. Paragraphs 12 to 16 apply the same treatment to quasi-loans.

Reporting

15. More information on the format and process for reporting information to HMRC about the loan charge will be provided later in 2017.

Postponements

16. As set out in the technical note, the loan charge can be postponed in two circumstances. These are where:

• the loan meets the criteria of an approved fixed term loan
• an employee wishes to make a full repayment of the loan but is unable to as they have paid an Accelerated Payment (AP), under Part 4 of Finance Act 2014

17. Applications for the approved fixed term loan postponement must be made in 2018, and HMRC will inform the applicant of the outcome.

18. The process for applying for AP postponement has now been aligned with the process for approved fixed term loans postponement. This means applications must also now be made in 2018, and HMRC will inform the employee of the outcome.

19. The process for both approved fixed terms loan and AP postponements will be set out later in 2017.

NICs

20. As the loan charge will give rise to a charge under section 554Z2, Regulation 22B will also apply as set out in the previous chapter.

Interaction with settlements

21. The double taxation relief provisions will ensure that the loan charge will not apply if, before 5 April 2019, income tax has been paid on the DR loan, or on the money from which the DR loan was made. This includes where the tax was paid under the Transfer of Assets Abroad rules at Part 13, Chapter 2 of the Income Tax Act 2007.

22. This also applies where tax was paid in a settlement agreement with HMRC. However, in some cases it may not have been clear if all DR loans were included in the settlement agreement. If you, or your client, reached a settlement agreement with HMRC before Budget 2016 and you are unsure whether all DR loans are included in the settlement, you should contact HMRC.

4. Double taxation relief

1. As set out in Chapter 7 of the technical note, comprehensive double taxation relief provisions will be introduced to deal with cases where a Part 7A charge will apply to money, or assets, that have already been subject to an earlier income tax charge.

2. These provisions are unchanged, apart from a few minor amendments, from those set out in the technical note. They can be found in Schedule 16 of Finance Bill 2017.

NICs

3. There is an existing provision that currently prevents a NICs charge arising twice that will also apply for the new double taxation relief provisions. This is paragraph 2A of Part 10 of Schedule 3 of the Social Security (Contributions) Regulations 2001 (‘Paragraph 2A’). Paragraph 2A prevents a NICs charge arising on payments which represent, or arise or derive from, amounts which have already given rise to a charge under Regulation 22B.

4. Where new section 554Z5 applies so that the value of a later relevant step is reduced to nil there is no charge under section 554Z2. Therefore as no amount is treated as employment income under Part 7A, there is no amount to be treated as earnings under Regulation 22B and a NICs liability does not arise.

5. Where a Part 7A charge is paid and new sections 554Z11B to 554Z11D apply, Paragraph 2A will ensure a NICs charge only arises once.

Example 4.1

An employer, ‘B’, uses a DR scheme to reward an employee ‘A’. ‘B’ contributes £100,000 to a trust, ‘P’, in 2012 which is loaned to ‘A’. In 2018, ‘P’ releases the loan so ‘A’ no longer has to repay it. The tax and NICs liability on both charges are the same.

‘B’ initially disputes that either of these transactions create an employment income charge. HMRC’s view is that both the contribution and the loan release are Part 7A charges. HMRC raises determinations for both charges.

‘B’ then decides to settle the liability by paying the tax and NICs due on the earlier Part 7A charge.

Section 554Z11C applies to create a notional payment on account against the later Part 7A charge so no further tax is due.

As NICs have been paid on the earlier Part 7A charge, Paragraph 2A prevents a further NICs liability arising for the later Part 7A charge.

5. Additional technical details

1. As set out in Chapter 8 of the technical note, there are interactions with provisional payments of tax and other taxes.

2. New section 554Z11G has been added to set out the interaction with section 222 and inheritance tax (IHT), and there is an addition to the employer deductions changes.

Section 222

3. The technical note acknowledged an interaction with section 222. It applies where an employer is required to operate PAYE from a notional payment of employment income. As the employer can’t deduct tax from the notional payment it has effectively been made gross of tax. Unless the employee reimburses the employer for the tax, within a certain timeframe, a benefit-in-kind charge arises on the tax paid by the employer.

4. All Part 7A charges, including the loan charge, are notional payments and therefore section 222 can apply.

5. Where more than one overlapping charge is unpaid the new double taxation relief provisions at section 554Z11B to 554Z11D apply. This leaves all the overlapping charges in place but ensures that tax is only paid once through the notional payment on account (NPOA). This means a section 222 charge can arise on every overlapping liability even though tax is only paid once. This is clearly an unfair outcome resulting in either the employee having to reimburse the employer for more than they have paid, or in several benefit-in-kind charges even though they have received no benefit.

6. Therefore new section 554Z11G will ensure section 222 only applies to Part 7A notional payments which have not been reduced by the NPOA.

Example 5.1

In 2012 an employer, ‘B’, contributes £400,000 to a third party, ‘P’, which then loans this to employee ‘A’. In 2018, ‘P’ releases the loan so ‘A’ no longer has to repay it. The tax and NICs liability on both Part 7A charges are the same.

Later in 2018, ‘B’ decides to settle with HMRC by paying the tax and NICs due on the earlier Part 7A charge. Section 554Z11C applies to create a NPOA against the later Part 7A charge so no further tax is due.

A section 222 charge can arise on the employee for the payment of the tax by the employer for the earlier charge. However, no section 222 charge will arise on the later charge as it is wholly relieved by the NPOA.

Example 5.2

An employer, ‘B’, contributes £400,000 to a trust, ‘P’, which then loans this to employee ‘A’. In 2018, ‘P’ releases £100,000 of the loan so ‘A’ no longer has to repay it.

‘B’ pays the tax due on the loan release Part 7A charge. Section 554Z11C applies to create a NPOA against the overlapping part of the earlier charge.

A section 222 charge can arise on the employee for the payment of the tax by the employer for the loan release Part 7A charge if it is not made good by ‘A’.

A section 222 charge can also arise on the earlier charge on the balance, £300,000, not relieved by a NPOA.

Inheritance Tax

7. Many DR schemes use a trust as the third party, and therefore IHT charges can arise.

8. 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.

9. Where a particular transaction gives rise to both an income tax charge and an IHT charge, relief against the IHT charge is due where the same transaction is treated as income. Relief is given under either section 65(5)(b) or section 70(3) IHTA84.

10. IHT charges will apply in the same way to the changes to strengthen Part 7A, and the loan charge, as they do currently to Part 7A charges.

11. The new section 554Z5 will apply where a Part 7A charge arises on an overlapping amount that has already been subject to an earlier income tax charge that has been paid in full. Where it applies it reduces the later Part 7A charge to nil. Where the later Part 7A charge also gives rise to an IHT charge the income reliefs won’t apply as the charge hasn’t been treated as income. This is unchanged from how the IHT reliefs apply to the current section 554Z5.

Example 5.3

An employer, ‘B’, contributes £450,000 into an employee benefit trust, which satisfies the conditions of section 86 IHTA84. The trustees then allocate this to a sub-trust for the benefit of employee ‘A’, who receives a loan of £450,000 shortly afterwards.

‘B’ accepts the allocation is a payment of earnings and pays tax. Subsequently, the loans are released, and section 554Z5 applies to reduce the value of the relevant step to nil.

The allocation to the sub-trust and the release of the loan both give rise to an IHT charge. As tax has been paid on the allocation the IHT charge is relieved by section 70(3) IHTA84. The loan release has not been charged to tax as it has been relieved by section 554Z5. As it has not been treated as income there is an IHT charge under section 65 IHTA84.

12. Where more than one overlapping charge is unpaid, new section 554Z5 does not apply, and relief is given under the new double taxation relief rules at sections 554Z11B to 554Z11D. This treats the tax paid on one charge as a NPOA of the other overlapping charge.

13. In order to ensure that IHT income reliefs apply as they currently do, new section 554Z11G will ensure that the employment income charges the NPOA applies to will not be treated as income for the purposes of IHT.

Example 5.4

An employer, ‘B’, contributes £500,000 to a trust, ‘P’, which then loans this to employee ‘A’ on uncommercial terms. In 2018, ‘P’ releases the loan so ‘A’ no longer has to repay it. The tax liability on both charges are the same and unpaid.

Later in 2018, ‘B’ decides to settle with HMRC by paying the tax and NICs due on the earlier charge. Section 554Z11C applies to create a NPOA against the later Part 7A charge so no further tax is due.

The making of the loan and the release of the loan both give rise to an IHT charge. As tax has been paid on the making of the uncommercial loan the IHT charge is relieved by section 70(3) IHTA84.

The loan release overlapping Part 7A charge is relieved by the NPOA. As no tax has been paid to directly meet the Part 7A liability it is not treated as income for the purposes of the IHT reliefs. Therefore an IHT charge arises on the loan release.

Example 5.5

An employer, ‘B’, contributes £500,000 into an employee benefit trust, which satisfies the conditions of section 86 IHTA84. The trustees later allocate this to a sub-trust for the benefit of employee ‘A’. This is successfully invested and grows to £600,000, which is then loaned to ‘A’. In 2018, the loan is released so ‘A’ no longer has to repay it.

‘B’ initially disputes there is an earnings charge on the contribution or a Part 7A charge on the loan release.

Later in 2018, ‘B’ pays the tax due on the allocation of the money to the sub-trust. Section 554Z11C applies to create a NPOA against the overlapping later Part 7A charge. ‘B’ also pays the additional tax due on the balance of the Part 7A charge of £100,000.

The allocation to the sub-trust has been charged to income tax so the IHT charge is relieved by section 70(3) IHTA84.

An IHT charge still arises on the £500,000 loan release. This is because the tax due on the £500,000 has been relieved by the NPOA, which isn’t treated as income for the purposes of the IHT reliefs.

The balance of £100,000 has been treated as income and so the IHT reliefs apply.

Employer deductions

14. As set out in Chapter 4 of the technical note, contributions to DR schemes by employers will no longer be allowable deductions unless certain conditions are met.

15. The changes have been extended to also include the rules that cover employers who are not carrying on a trade or a property business (section 866 of Income Tax (Trading and Other Income) Act (ITTOIA) 2005). This will ensure that all employers who use DR schemes are treated equally.

Provisional payments of tax

16. As set out in the technical note, a provisional payment of tax, such as an AP, can be used in two different ways to ensure tax is not paid twice. It can be used as a final payment of a liability, in which case it is no longer capable of being repaid.

Alternatively, it can also be simultaneously used as a provisional payment of tax for an overlapping charge. Both of these require applications to be made to HMRC and the processes will be set out in detail later in 2017.

6. Self-employed disguised remuneration schemes

1. As set out in Chapters 9 and 10 of the technical note, legislation will be introduced to tackle existing, and prevent future, use of DR schemes used by the self-employed. These changes are included in Clause 49 and Schedule 18 of Finance Bill 2017.

2. A small number of responses were received from stakeholders following publication of the technical note. These primarily focused on possible unintended consequences that could arise with respect to the provisions to tackle the future use of such schemes.

3. The main concern was that the provisions could affect ordinary commercial arrangements between partners/members and the partnerships/LLPs. This could also extend to situations where third parties have wholly commercial arrangements with the partners/members and their partnerships/LLPs.

4. Some changes have therefore been made to the draft legislation to ensure that it does not have a wider effect than intended. The principal change is to reorganise, and supplement, the conditions that must all be met for the provisions to apply as now set out in revised clauses, and specifically revised section 23A ITTOIA 2005.

5. The key addition is Condition E which refers to a tax advantage arising. ‘Tax advantage’ is further defined in amended section 23D ITTOIA 2005. The addition of Condition E will ensure that the sort of ordinary commercial arrangements highlighted in response to the draft legislation will not be brought within the scope of the legislation, provided they are taxed in accordance with normal tax rules (for example, where a capital disposal is properly charged to capital gains tax).

6. As a consequence of these changes it has been possible to simplify the legislation to omit the provision that was originally put in place to exclude loans on ordinary commercial terms.

7. A further concern raised in consultation responses was related to the potential for income to be taxed more than once. New double taxation provisions have been added to the legislation to mitigate that possibility (section 23H of ITTOIA).

8. Additional provisions are included in the Schedule, relating to the loan charge, to tackle any avoidance involving cases where loans are made in currencies other than sterling. These are similar to those for the employment measure, set out in Chapter 3.