Many contractor clients, generally IT contractors, who have used arrangements to receive income in the form of a loan instead of part of their salary will have received letters from HMRC this month offering a Contractor Loans Settlement Opportunity. They, as well as many previously unrepresented taxpayers, will have approached their accountants to ask for advice on the best course of action to take in response to the offer.
The matter has been discussed on various accountancy blogs with the consensus being that this is a try-on on the part of HMRC and that clients should be advised to sit tight. The thinking behind this conclusion is that HMRC have now lost the argument twice in the case of HMRC v Murray Group Holdings Ltd (the Rangers case) and the outcome of their application for permission to appeal the decision of the UTT to the Inner House of the Court of Session, and the decision of that court should permission be given, should be awaited before any action is taken.
In the Rangers case, the employer set up an Employee Benefit Trust (EBT). After the EBT had been set up, a number of sub-trusts were set up in the names of certain employees. It was explained to the employees that under the trust arrangements they would be able to take advantage of a loan facility which would give them a tax-free sum greater than they would otherwise receive after deductions were made under PAYE. The loan would be repayable out of their estate, thus reducing its value for Inheritance Tax purposes.
The terms of engagement for certain employees consisted of two documents:
- a contract of employment; and
- a side letter which provided for the constitution of a sub-trust in the name of the footballer.
The employer made contributions to the EBT, at the same time proposing that a sub-trust be constituted in the employee’s name. When the contribution was made, the employee was asked to complete a Letter of Wishes and a Loan Application on his own behalf for submission to the trustee. On receipt of these documents and the contribution, the trustees of the EBT then, at their discretion, set up the sub-trust in the name of the employee.
HMRC argued that the arrangements were a composite transaction to which the Ramsay principle should apply because the parties understood that the payments would be made to the EBT and then on to the sub-trust, and that the employee would be able to obtain the money by way of a loan or direct how it should be invested. It was further understood that the loans would be renewed on request and repayment would not be demanded during the employee’s lifetime. The composite transaction therefore resulted in earnings being made when the money was transferred to the sub-trust. HMRC argued in the alternative that there was a payment of earnings when the loans were made.
It was accepted by HMRC that the trust and loan arrangements were not shams. The Tribunal held that there was no complicated series of transactions to which the Ramsay principle should be applied. The extent of the employer’s obligation was to make the payment into the EBT and the loans were made at the discretion of the trustees. The payments were a loan and were not paid over absolutely. As the employee did not have an absolute right to any part of the capital value of the loan, they were not earnings or emoluments.
There appears to be an assumption that an HMRC attack on arrangements entered into by a contractor involving an EBT will fail unless and until they get a final decision in their favour in the Rangers case. Before this assumption is accepted, consideration needs to be given to the decision in the case of Philip Boyle v HMRC.
At first blush it would appear that the Boyle case has no relevance to most of the arrangements that contractors have entered into. The Boyle case did not involve a discretionary EBT. Mr Boyle received a “foreign currency loan” directly from his employer at the behest of his employer’s Remuneration Committee. He then “converted” the foreign currency into sterling via an offshore associate of his employer. Subsequently he purchased foreign currency from the same person at a highly artificial currency exchange rate to repay the original loan from his employer. The Tribunal found that the whole arrangement was artificial and decided that the difference between the loan and the amount repaid was remuneration.
In contrast, the majority of contractors received a discretionary loan from the trustees of an EBT in sterling and remain under a legal obligation to repay the full amount of that loan in sterling. Unlike Mr Boyle, therefore, they did not receive a financial benefit from the transaction (other than, of course, the interest free element on which they will have already paid income tax). Mr Boyle discharged his loan in full and it was the gain made at the time of the discharge (attributable to the variation in exchange rates) that was, at that point in time, part of his taxable income. Most contractors, on the other hand, remain liable to repay the whole of the loan in full.
The Tribunal accepted at paragraph 112 that Mr Boyle did not have the unreserved right to the money at the time the loan was originally advanced and so he was not taxable on it at that time. Only when he had made a profit (due to the exchange rate variation), having repaid the loan in full, did he have any taxable income, that is the amount of the profit he was left. Because most contractors remain liable to repay the loan in full, they have yet to make any profit, and therefore receive any income. Should the loan be waived the position would need to be addressed.
While this may, depending on the outcome of the Rangers case, successfully demonstrate that the loans should not be treated as emoluments unless and until the employee becomes absolutely entitled to the amount loaned, there remains a sting in the tail of the case if, as was usually the case, the arrangements provide for the contractor to be employed by a non-UK based employer. Employment by a non-UK based employer means that the transfer of assets abroad rules in ITA 2007, Part 13, Chapter 2 may apply.
In Boyle, HMRC’s alternative case if the loans were not emoluments was that Mr Boyle was liable to income tax in respect of the arrangements by virtue of the transfer of assets provisions. The Tribunal held that, if they were wrong in finding that the loans were emoluments, the loans were, nevertheless chargeable to income tax because Mr Boyle’s employment by a non-UK based employer meant that the transfer of assets abroad rules applied.
The Tribunal relied on the case of CIR v Brackett in which it was held that the rights under a contract of employment are an asset for the purposes of the transfer of assets abroad provisions. This is the case even when the rights are newly created at the time of entering into the contract of employment because “transfer” in relation to rights includes the creation of those rights.
The Tribunal also held that the employer had no UK tax presence and was not liable to deduct PAYE from any payments made to Mr Boyle (although they made arrangements for PAYE to be operated on his salary) so the liability for tax and NICs rested on Mr Boyle.
So, game, set and mach to HMRC? That depends on whether the Tribunal applied the decision in Brackett correctly to Boyle’s case. Most contractors might seek to distinguish their circumstances from those in the Brackett case on the grounds that:
- Mr Brackett was employed by a company formed by the trustees of a Jersey settlement which he had previously set up. The contractors, on the other hand, were employed by a company in which they held no interest and which they could not control.
- The company in Brackett had no source of income other than receipts from Mr Brackett’s services. The company that a contractor worked for had income from many sources, not just from the contractor.
- Mr Brackett acted as an agent for the company, finding contracts and other opportunities. Once found, Mr Brackett transferred to the company his capacity to earn income from providing his services. The contractors did not go about finding work themselves. The company found work and then offered it to them. Indeed, the contractors could not have found the work for themselves as the engager would not have wished to contract direct with them. Unlike Mr Brackett, they were not in a position to transfer their earning capacity and simply accepted work on the terms offered.
- Mr Brackett’s activities “constituted . . . the essential operations of the company’s trade”. The contractors, on the other hand, did nothing more than provide their services to the company as its employees.
It might also be pointed out that the transfer of assets legislation has to be compliant with EU law, including the freedom of establishment rights, and that HMRC's interpretation may not be compliant.
From this it would appear that if the contractor was not employed by a non-UK based employer, it would be appropriate to await the final decision in the Rangers case. Those who were employed by a non-UK based employer may wait for the Rangers decision to see whether the loans should be treated as emoluments but, if the decision is that they should not, they also need to consider whether they fall within the transfer of assets abroad provisions.
Nick Parkes taught at the HMRC training centre and was District Inspector of several tax districts before leaving HMRC to start his own tax consultancy. As well as providing consultancy services, he has written and lectured on tax matters. Most recently he has jointly authored Bloomsbury Professional’s Tax Planner Interactive.
Tax Planner Interactive is a practical online tool which guides you step by step to the most effective tax planning solutions for your client, providing everything you need to implement the advice. For a free trial, visit www.bloomsburytax.com/taxplannerinteractive, email firstname.lastname@example.org or call 01444 416119.