Loan charge

Seeking justice

Nathan Talbott asks whether taxpayers should seek a Judicial Review to address the injustices inherent in the loan charge.

Nathan Talbott

Partner, Wright Hassall

Introduced in the Finance Act 2016, the loan charge is a tax charge on any outstanding loans stemming from the use of disguised remuneration (DR) tax avoidance schemes.

Involving the remuneration of individuals (normally directors, shareholders or their family members), DR schemes relied on loans or payments from a third party, usually through a trust structure, which were never repaid.

These schemes were designed to avoid the payment of income tax and National Insurance for the employer and employee. Any loans that were taken after 5 April 1999 and had not been repaid by 5 April 2019 were treated by the loan charge as taxable income.

The loan charge received widespread criticism by taxpayers and specialists, with many questioning its retroactive nature, arguing that it undermined the finality of tax affairs where HMRC had previously taken no further action. Despite the backlash, HMRC stood its ground and outlined the following options for affected taxpayers, with regards to the loan charge: ● repay outstanding loans in full; or ● agree settlement terms with HMRC.

If neither of those options were taken, HMRC indicated that taxpayers should report and pay the loan charge.

Consequences of the loan charge

Following mounting pressure, the chancellor commissioned a review into the loan charge to consider whether it was an appropriate way of dealing with DR schemes used by individuals for tax avoidance purposes. Led by Sir Amyas Morse, the review was completed in December 2019 and recommended the following: ● The loan charge should not apply to loans entered into before 9 December 2010. ● “Unprotected years” were defined as arising from loans entered on or after 9 December 2010, where the taxpayer had made reasonable disclosure of their scheme usage to HMRC and HMRC did not open an investigation. It deemed that these should be out of scope of the loan charge. ● HMRC should refund the voluntary restitution elements of settlements made since 2016 that were paid to settle unprotected years when the relevant loans fell into one of the recommendations above.

The government accepted the review’s recommendations and draft legislation implementing the recommendations was published on 20 January 2020. The Finance Bill 2020 received Royal Assent on 22 July 2020 and

Author bio Nathan Talbott is a member of Wright Hassall’s tax and financial services litigation team, dealing with disputes relating to investments, tax schemes, pensions and HMRC enquiries and negotiations.

The Finance Act 2020 does not address situations where settlements have been agreed with HMCR for loans no longer ‘caught’ by the loan charge.”

HMRC published guidance on refunds for DR settlements on the same day.

Whilst the Finance Act 2020 deals with circumstances where settlements have been agreed with HMRC for loans no longer “caught” by the loan charge, it does not address situations where individuals have taken steps to repay outstanding loans in reliance on HMRC’s guidance and in fear of the loan charge.

Below are three examples of how the loan charge impacts different taxpayers.

Case study: Mr Bloggs

Mr Bloggs is director and shareholder of ABC Ltd. In 2003/04, Mr Bloggs, on the advice of his accountants and tax advisers, pays £5 million to a trust and takes loans in the sum of £4 million. HMRC did not open any enquiries into the scheme use.

In 2018, following the implementation of the loan charge, Mr Bloggs and ABC Ltd settle with HMRC using the November 2017 Settlement Opportunity. Pursuant to the settlement with HMRC, Mr Bloggs wrote to the trustees to write off the loans and wind up the trust. Following the loan charge review, Mr Bloggs and ABC Ltd applied and received a full refund of their settlement, with HMRC using the Disguised Remuneration Repayment Scheme 2020. Mr Bloggs now has no outstanding DR loans and the trust is no longer in existence.

Case study: Mrs White

Mrs White is director and shareholder of DEF Ltd and used the same scheme in 2003/04. HMRC did not open any enquiries into the scheme use. Mrs White decides to take no action and ignores the impending loan charge. Following the loan charge review, Mrs White’s loan now falls outside the scope of the loan charge and she need not take any further action. Her loan is still in existence and potentially Mrs White will, in the future, have to pay trust fees and be exposed to other potential tax liabilities depending on the nature of the trust.

Case study: Mr Bailey

Mr Bailey is director and shareholder of XYZ Ltd and also used the same scheme in 2003/04. HMRC did not open any enquiries into the scheme use. Following HMRC’s guidance around the loan charge, Mr Bailey chose to repay the loan in 2018. He liquidates several investments and repays the loan to the trust. Following the review, Mr Bailey’s loan would have been outside of the scope of the loan charge. He writes to HMRC requesting confirmation that he can cancel his repayment of the loan without being subject to a new tax charge. HMRC denies his request and confirms that if Mr Bailey were to cancel his repayment, this would be treated as a “relevant step” for the purposes of Part 7A of the Finance Act 2012. It would be treated as income and taxed accordingly.

Overview

Mr Bailey is therefore left in a position whereby he has repaid the money to the trust, but he has no tax efficient way of accessing that money. The only way to do so would be to extract it, at which point it would be treated as remuneration and taxed accordingly. This is to be contrasted with Mrs White who did nothing, but in doing so has now avoided the obligation to pay tax under the loan charge. She has retained the benefit of the loan for her personal benefit without paying any tax on it. Consequently, by following HMRC’s guidance that he must comply with the loan charge, which Mr Bailey dutifully did, he is in a materially less advantageous position than Mrs White – who ignored HMRC’s guidance. This appears to be an unjust outcome. However, if Mr Bailey is unhappy with the position, he has limited options available to challenge HMRC. One option that is available is to pursue a Judicial Review.

Judicial Review

A Judicial Review allows the courts to examine decisions taken by public bodies (in this instance, HMRC) to ensure that they act lawfully and fairly. On the application of a party with sufficient interest in the case (Mr Bailey), the court will conduct a review of the process which HMRC (or the public body) followed to reach its decision, and assess whether or not that decision was validly made.

There are four grounds on which a Judicial Review can be pursued, known as illegality, irrationality, procedural unfairness and legitimate expectation. After complying with the pre-action protocol for Judicial Review, the taxpayer may be faced with his only option being to issue proceedings. The claim form must be issued no later than three months after the relevant decision and accompanied by various documents.

The court will then consider and assess the Judicial Review and decide whether to permit or refuse the claim.

Conclusion

Some taxpayers have benefited from the Review and amendments made to the legislation by the Finance Act 2020. However, those who have repaid their DR loans following HMRC’s guidance will feel they have not been protected. Those taxpayers who followed the process outlined by HMRC may now find themselves in a worse position, with vital funds stuck in their trust, with fees accruing.

With any method of extraction resulting in further tax liabilities, Wright Hassall’s Judicial Review is in place to challenge HMRC’s current position and address ongoing issues. ●

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