The Contractor Loan Scheme, the performance enters the summer season

19 Jul 2019

This article was written by our Tax Director Mike Rule and originally published in Hampshire Chamber Business News Magazine.

One commentator recently described this as a pantomime, I must agree. On 4th April, one day before the deadline an all-party parliamentary group held a debate in the Commons to air the concerns of affected constituents and raise the matter with Mel Stride, the Financial Secretary to the Treasury. The MP's were in fine voice, with tales of hardship and anguish from across the country; then a water pipe in the roof burst, so the performance was abandoned.

 For many years contractors had operated through personal service companies (PSC's), they were remunerated with a low salary and high dividend thus reducing the national insurance cost. HMRC sought to increase the national insurance cost by restricting allowable expenditure to 5% of turnover with the balance being treated as salary, thereby increasing the national insurance cost. The change was achieved by the introduction of IR35 in April 2000 and thus the stage was set.

Contractors worried about the effects to IR35 often became involved in loan schemes so that their net earnings were maintained. A contractor seeking work would traditionally approach an agent who acted for the “employing” company, they were then offered three methods of remuneration:

  1. Their own PSC, with the inherent IR35 issues.
  2. PAYE with the added national insurance cost.
  3. The contractor loan scheme, supported by counsel's opinion, with the ability to retain 92% of earnings.

With a contractor loan scheme, the agent would introduce the contractor to an intermediate company, usually based off shore, who would make the payments to them. Typically, the employer company paid the agency, they retained a fee and passed the balance on to the intermediate company, they also retained a fee before making the payments to the contractor. At this stage the funds are split some are passed through payroll with tax and NIC deducted, however the balance is paid as a loan, of course with no tax deducted.

The loan carries no interest and is not repayable. In fact, it is usually written off when the contractor dies. Not surprisingly HMRC take the view that these are not loans, but remuneration paid in such a way as to avoid tax.

Legislation was passed allowing HMRC to go back 20 years and raise assessments on loan receipts as if they were income. Those who came forward before 30th September 2018 were assessed the amounts received after the scheme operators' charges in each of the relevant tax years. Going back 20 years produces some eyewatering tax liabilities, frequently into six figures. Homes have been sold, houses have been remortgaged, some have gone bankrupt. There is even a report of one poor soul taking his own life.

What about those who stood in the wings; perhaps hoped it would all go away or joined action groups. Not so, HMRC will assess the entire amount of their loan receipts, without deduction for the scheme charges as one huge slug of income on 5th April 2019. Tax payable on 31st January 2020. These are the folk who feel outraged and have written to their MP's.

Whilst we would all like to pay tax at 8%; most of us know that if it looks too good to be true, if generally is. However, the contracting industry was led to believe that this was a legitimate scheme and HMRC failed to raise enquires on their tax returns for many years, so there is a degree of sympathy.

Those contractors who joined the action groups expect to achieve a more favourable outcome. I wish them luck but fail to see how HMRC will treat them more favourably than those who have complied and paid up.

There are, in my opinion only two possible endings; either repay the loan or settle with HMRC. Some companies are promoting schemes to escape the loan charge. HMRC and any reputable firm will advise you that they don't work. My view is that they simply put off the inevitable whilst incurring unnecessary costs.

This performance has only one ending and probably not a happy one. Please take professional advice and minimise the anguish.

There is a sequel; the effects of IR35 being enforced in the public sector in 2017 and the private sector in 2020. It involves many of the same players but with a different storyline.

If you have any further questions about this scheme do contact your client manager or call us on 0808 1644 222.

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