Tax on disguised remuneration
Written by Ray Coman
A payment for services, which is also known as remuneration, can be disguised as a different sort of payment, such as a loan. The purpose of the disguise is tax avoidance. The practice is facilitated by an intermediary, usually mascaraing as an umbrella company.
Disguised remuneration schemes were prevalent since about the 1990s. However, successive anti-avoidance legislation and HMRC enforcement has ‘put out the fire’ at least to the extent that the practice is overt. It is estimated that about 50,000 people were handed correspondence from HMRC to settle tax on loans as old as 20 years. The loans were treated as being received on 5 April 2019. It is possible to spread the loan if the appropriate election is received by HMRC on or before 30 September 2020.
An employer can effectively outsource their human resource and payroll operation using an umbrella company. It is a third party to both employee and employer often closely linked to the recruiter.
Self-employed individuals pay less than an employee on the same income. The widespread practice of accountants facilitating companies for the self-employed, has provided cover for sham organisations to promise tax savings that seem above board. Furthermore, the prevalence of umbrella companies enables the sham to pay its clients via PAYE and thereby avoid explanation about the calculation of tax liability. The recent clampdown is welcomed by both HM Treasury and the tax profession.
The abundance of both contractor and umbrella companies in the open market has complicated the apportionment of culpability by the regulator between facilitator and end-user.
Tax justifications for a contractor company over unincorporated business was removed with the abolition of tax credit on dividends since 6 April 2016. A spate of sham umbrella companies followed to satisfy an entrenched expectation that companies could be used to save tax. Disguised remuneration campaign has subsequently deterred promoters of tax avoidance using loan payments as a substitute for employment earnings.
Recruiters often prefer to deal with contractors via a company. Where a contractor has been asked to provide services via a company, an intermediary offers to take on the administrate burden and tax dealings. That intermediary is commonly known as an umbrella company. It saves contractors hassle as compared to having their own company. The contractor is handed take home pay and a payslip, in much the same way as an employee. However, the tax paid by an employee using an umbrella company is higher than the for a self-employed contractor running their operation through a company.
Contractors working through an umbrella are usually taxed more than contractors using their own company. IR35 legislation, introduced in 1999, sought to tax as an employee any person who would be an employee but for a company. IR35 was an attempt to prevent the illegitimate avoidance of PAYE.
The 2007 intermediaries legislation introduced the term Managed Service Company. A managed service company is the legal definition of what are often marketed as Umbrella Companies. The regulation taxed workers of an umbrella company in much the same way as an employee. In 2016, the Supervision, Direction and Control (SDC) removed other tax incentives of using an umbrella company over being a direct employee, such as any tax deduction for commuting expenses.
Introduced by the Finance Bill of 2016, an anti-avoidance provision was announced to redefine as income amounts previously defined as loan. It is referred to as the 2019 loan charge.
Many individuals who were identified as receiving loans were presented with a loan charge notice from HMRC by 5 April 2019. The disguised remuneration is treated as income of the payee. It can be treated as income of the employee on 5 April 2019. It is possible for the taxpayer to elect for the income to be spread over three years, 2018/19, 2019/20 and 2020/21. Usually a spreading election will be beneficial. A spike in income will likely cause a higher marginal rate of tax in the year of receipt. However, a scenario test of liability with and then without the election will determine the optimal outcome.
Employee’s and employer’s national insurance is usually deducted at source from employment earnings via PAYE. As previously discussed, the widespread use of companies and outsourced arrangements complicates the determination of complicity of end user with the disguised remuneration facilitator.
HMRC will attempt to recover NI from the employer or umbrella company. Effectively, the employer is required to account for the loan as PAYE earnings. An amount of loan that has effectively been treated as reclassified as employment earnings, and subject to PAYE, is not also assessed as loan charge via self-assessment. The aim of the government is to detect and prevent promoters of disguised remuneration.
Payment for services rendered will continue to be regarded as income for tax purposes. The spreading provision explained above applies to loans from a ‘November 2017’ settlement. The prevalence of contractor loan promoters and employers prepared to engage in schemes has declined significantly over the past decades resulting from HMRC enforcement.
Any cash flow incentive of the tax avoidance scheme is deterred via an accelerated payment notice. An accelerated payment notice is a mechanism whereby HMRC can request advanced payment where the tax liability of an organisation can be established by case law. It prevents tax avoiders from delaying tax through the appeals and tribunal process.
Individuals who are liable to tax on loan charges can also receive accelerated payment notices. Once the actual tax liability has been established it is possible to offset advances to HMRC from actual liability.
The following remain valuable components of the UK economy:
- The use of companies to limit liability in business transaction.
- Accountancy service as a facility for business owners, freelancers and contactors operating via a company.
- Payroll and human resource outsourcing via the umbrella company.
- The use of legitimate business loans.
- A tax incentive for people to chose self-employment over employment, to promote innovation and enterprise.
Enforcement directed towards promoters of disguised remuneration schemes will serve to protect credit within the tax profession. In turn, this preserves a market through which the consumer can plan their finances via tax efficient and legal manners.
The target of the government is to tackle disguised remuneration promoters.
In response to the call for evidence, legislators should recognise that there is an incentive within the tax profession to discourage the use of disguised remuneration. Eliminating rogue traders helps to preserve the credibility of tax advisers. That credibility has market value. Furthermore, removal of the tax avoidance market directs behaviour of people who are seeking to reduce their tax burden towards genuine self-employment for which the business of an accountant is often sought.
Enforcement can also be channelled through the professional bodies. However, this would be effective through reservation of the term accountant and tax adviser to those individuals usitable qualified. There has long been a call for the accountant title to be afforded similar protection for accounting work as to the title solicitor is for legal work. The term umbrella and accountant can be protected names by Companies House in much the same way as names such as: architect or charity. Umbrella company activities could require regulation.
It is beyond the scope of Coman & Co Ltd to advise on enforcement issues. Notwithstanding, protecting the word accountant and tax adviser would help to reduce non-compliance. Qualified accountants and tax advisers can be monitored by their respective professional bodies and peer reviewed by competitors. The terms accountant and tax adviser are used in ordinary parlance throughout the supply chain in which a disguised remuneration promoter could operate. It refers to that person who is experienced to advise on the credibility of a tax plan.