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Loan charge under review: The 20-year retroactive tax policy pushing IT contractors to the brink

Thousands of IT contractors are at risk of financial ruin as HMRC pursues them for tax it claims they owe on work they did up to two decades ago and were reimbursed for via loan remuneration schemes. Computer Weekly investigates

This article can also be found in the Premium Editorial Download: Computer Weekly: Why thousands of IT contractors face ‘life-changing’ tax bills

Thousands of IT contractors across the UK are living in a state of limbo as they await the outcome of an independent review into a government tax policy that has saddled them with life-changing tax bills relating to work they did up to 20 years ago.

The loan charge policy, as it is known, is the central tenet of a disguised remuneration clampdown being overseen by HM Revenue & Customs (HMRC). It was announced by HM Treasury during the 2017 Budget and is predicted to generate £3.2bn in previously unpaid taxes. 

These funds will be raised by targeting 50,000 individuals, many of them contractors, who HMRC claims enrolled in loan-based remuneration schemes between 6 April 1999 and 5 April 2019.

Scheme participants are paid in the form of a non-taxable loan, rather than a conventional salary, by a third-party, offshore employee benefit trust (EBT) for either all or part of the work they do.

These loans were never intended to be repaid, says HMRC, which means they should be reclassified as income and taxed accordingly, and it has given participants until 31 January 2020 to either pay what it claims they owe, or arrange a repayment plan.

“HMRC has always stated that these schemes, which seek to avoid tax and national insurance contributions, don’t work and urged people to come forward and settle their tax affairs before the loan charge arose on 5 April 2019,” the organisation has stated previously.

How many IT contractors are affected by the loan charge policy?

It is difficult to get any solid figures on exactly how many IT contractors are affected by the loan charge. HMRC claims there are 50,000 individuals in its crosshairs who represent a huge cross-section of the contractor community, but the Loan Charge Action Group (LCAG) claims the number affected is probably closer to 100,000.

Meanwhile, another piece of research carried out by a cross-party group of MPs known as the Loan Charge All Party Parliamentary Group (APPG) in February 2019, featuring the input of 1,768 contractors, saw the majority of respondents (40%) identify as working in IT. That research has its limitations though, the group has admitted.

“Collecting employment data is difficult, particularly when spanning 20 years,” the APPG’s research document said. “Participants may have taken very radical career changes, they may provide the same service over a multitude of sectors, such as IT, but mark that they work in financial services.

“So while this data may not accurately reflect what participants actually do in which employment categories, the data does provide some indication that those involved in contracting/freelance work/personal service companies are a flexible and adaptable employment pool that provides a valuable service to a multitude of employment sectors.”

Given the length of time over which these unpaid taxes have accumulated, the settlements being sought by HMRC are often substantial, with some of the IT contractors Computer Weekly has spoken to facing six-figure tax bills.

HMRC, meanwhile, maintains that the average settlement size it is seeking from contractors caught by the loan charge policy is about £13,000.

“HMRC claims there are 50,000 contractors affected and the average figure owed is £13,000,” said Phil Manley, a director at tax consultancy PMTC, and active member of the anti-loan charge campaign community. “If you multiply one by the other, how did HMRC get the £3.2bn they expect to make from the loan charge?

“I’ve been speaking to numerous tax firms – effectively rival firms, as we’ve all had to come together on this – and the average [tax bill] we’re seeing is £135,000. So unless they missed a zero, I’m not sure where HMRC has got that figure from.”

Computer Weekly raised this point with HMRC, which declined to address the question in the response it provided.

Manley claimed that about 60% of his client base are IT contractors contesting their own loan charge bills. Many of them will struggle to pay, and – if made to – will face financial ruin, a prospect that is taking a serious toll on the health and well-being of those individuals.

So much so that a cross-party group of MPs, known as the Loan Charge All Party Parliamentary Group (APPG) has described the fallout from the policy as a “public health emergency”. 

“My job is now 50% tax advice and 50% counselling,” said Manley. “I’ve had to contact counsellors for my clients, who have kindly agreed to help free of charge purely because the situation caused by the loan charge is that bad.

“The payments are so outrageous and clearly life-changing. They are way beyond what the average person can afford. HMRC is chasing money that simply does not exist. 

“HMRC can shout, scream and demand all they like, but the average contractor does not have a six-figure sum sitting around in case a retrospective tax comes in one day.”

How are loan charge settlements calculated?

According to LCAG co-founder Andrew Earnshaw, the amount of money HMRC is seeking from contractors is calculated first by adding up the total amount of loans they received over however long they were a member of their chosen scheme.

“Say they took out £25,000 of loans for five years, and they now earn £50,000,” he said. “Over five years, that’s £125,000 of loans plus their earnings for the year, and they will be taxed on that total amount of £175,000. 

“And it’s not just the tax from that time [HMRC is after], it’s tax plus interest, and there might be additional financial penalties as well.”

On top of that, individuals may also find themselves liable for inheritance tax, because of the way these loans were structured, which will add to the final total.

“On these loans, there is a charge to inheritance tax of 1% per year while you hold these loans. So not only will you get charged tax, national insurance and interest, you will also get inheritance tax on top,” said Earnshaw. “So that’s another way the loan charge is hitting people and that’s why people end up with these huge bills, because there are all these other mechanisms coming at them and factored in.”

And why would they, you might argue, given that many of the loan remuneration schemes that IT contractors signed up to were previously marketed as compliant with UK tax law by the scheme providers and promoters. Many of whom, incidentally, have since disappeared into the ether by closing down their operations or rebranding, while the offshore nature of their businesses makes it difficult for HMRC to clamp down on them too.

“That’s where the real problem here lies, in that there were people out there, who were trusted by contractors, who said this is a perfectly legal thing to do,” said Andy Chamberlain, deputy director of policy and external affairs at the Association of Independent Professionals and the Self-Employed (IPSE). “There will be no comeuppance for them from it.”

Retrospective illegalisation?

Some of the schemes contractors signed up to were made known to HMRC through its enforcement of the Disclosure of Tax Avoidance Schemes (DOTAS) legislation.

Under its terms, “certain people” (usually the scheme promoters) are advised to register their setups with HMRC so it can ensure the mechanisms they employ to reduce their users’ tax burden do not infringe on the department’s tax policies.

A contractor, currently in contestation with HMRC, who spoke to Computer Weekly on condition of anonymity, said scheme promoters claimed the fact their scheme was registered and known to HMRC as proof of its acceptability.

“The promoters made a big deal about ‘successfully registering’ with DOTAS or being ‘fully DOTAS registered’ and used any number of variations to imply that HMRC had signed them off,” the contractor said.

This is despite HMRC’s official DOTAS guidance stating it “doesn’t approve avoidance schemes”.

“There were other [scheme promoters] who said they knew HMRC would use DOTAS as a target list, and so were being careful not to trip any of the DOTAS ‘hallmarks’,” the contractor added.

“DOTAS was quite narrowly defined, so that if the person arranging the scheme was careful, they could make out that it was not required to be disclosed to HMRC.”

In this camp would be schemes that were being marketed as heavily vetted by tax QCs and other experts, who claimed their setups met none of the criteria needed to be registered with DOTAS, so users need not worry about HMRC querying their activities.

“In short, DOTAS was neither good nor bad,” said the contractor. “It was used as a marketing phrase by all promoters, whether they had registered or not [with HMRC].”

Connecting the loan charge with IR35

Scheme promoters often preyed on the contractors’ concerns about how changes to the tax legislative landscape, which were due to take hold around turn of the century, would affect how they operate, the anonymous contractor continued.

“The main motivation for using one of these [loan schemes] was that people were worried about getting into long, drawn-out battles with HMRC over IR35,” the contractor said.

The IR35 regulations were announced in March 1999 to clamp down on “disguised employment”, whereby individuals supply services to an end client through a limited company or personal services organisation, while essentially working as a permanent employee to reduce their tax liabilities.

“Because of the way these disguised [loan] remuneration schemes were structured, in many cases, IR35 became irrelevant,” said Seb Maley, CEO of tax advisory firm Qdos Contractor.  

“Often, contractors stopped working through a personal service company and were paid through employment benefit trusts instead – which meant IR35 was no longer a consideration because these individuals became employees of the scheme. Many of these companies were based offshore too, which also meant that IR35 – a UK legislation – was avoided.”

Loan scheme promotors preying on contractor concerns

The IR35 regulations have been widely criticised since their introduction for being too complex for contractors to understand, leaving many fearful about getting their determinations wrong and then finding themselves in a long, drawn-out dispute with HMRC.

A case in point is the story of IT contractor Richard Alcock, who was pursued by HMRC for £240,000 in unpaid tax pertaining to work he did over a five-year period for the Department for Work and Pensions (DWP) and Accenture.

HMRC claimed the nature of Alcock’s engagements meant the contractor should have been classified as inside IR35, whereas Alcock claimed the roles he took on were outside IR35 – and a tribunal backed his view. 

“The Richard Alcock case shows exactly what contractors were worried about – HMRC lost, as it should have done, but it took five years and a big toll on him,” a contractor, currently contesting its loan charge case, told Computer Weekly on condition of anonymity.

“Every promoter of a loan arrangement used the spectre of HMRC opening an IR35 investigation to promote their own setup as being a way to avoid any worry. More money in your pocket was generally a minor benefit for contractors.”

Under the terms of the original IR35 regulations, limited company contractors, or those operating via personal services companies, were responsible for deciding whether their client engagements meant they should be taxed in the same way as permanent employees (known as inside IR35) or off-payroll workers (outside IR35).

If an engagement is determined to be inside IR35, contractors will be liable for pay-as-you-earn (PAYE) tax and national insurance contributions (NICs), in the same way a permanent employee would be. However, they would still not be eligible for paid sick leave or holiday, for example.

An outside IR35 designation, meanwhile, would exempt them from being taxed via NICs or PAYE, and their levels of take-home pay would therefore be higher than a contractor determined to be working inside IR35.

Working out which side their engagements come down on is tricky for contractors, said PMTC’s Manley, because of how complex the IR35 rules are. “Nobody wants to take a 30% pay cut purely due to a piece of legislation that has been poorly written,” he said.

IR35 and loan-based schemes: How one fuelled the other

Although the existence of these schemes pre-dates the arrival of the IR35 regulations in 2000, the number of them increased significantly once the tax avoidance regulations came into play – and so did the number of contractors (across all sectors) who signed up to them.

Many of the loan-remuneration schemes were marketed to contractors as a means of protecting the levels of take-home pay they had become accustomed to receiving before the onset of IR35. 

“A lot of contractors saw IR35 as a direct threat to their freedom to work independently,” said IPSE’s Chamberlain, “and that they were being pushed into more traditional models of employment [permanent contracts] against their will. In a way it was, but that was probably a bit of an over-reaction.

“So what they were advised to do in some quarters, by an umbrella company [operator] or maybe an accountant, would be to set up one of these loan arrangement schemes.

“Contractors were told this was completely compliant and fully legal, and they did it to avoid a scenario where they would be end up being [the subject of a] crackdown by HMRC through the IR35 legislation.”

How we got here: An IT contractor’s take

Gareth Parris has worked as an IT contractor for 20 years. He enrolled in a loan remuneration scheme on the advice of his accountant, whom he had worked with for eight years at that point.

“I went through a divorce and needed to pay my wife amicable divorce equity on the house we had, so I needed to materialise some money. I didn’t have any personally, but my limited company had just enough to cover it,” Parris told Computer Weekly.

“My accountant told me to shut my limited company down, claim entrepreneurs’ tax relief and get my money out that way. Except, as a contractor, I still need to work as a limited company because the clients I work for will not accept me as a sole trader.

“I was told I couldn’t reopen a limited company in that format because that’s called ‘phoenixing’ and considered tax avoidance, which is something HMRC can come down on you for.”

Instead, Parris was advised to apply to join a loan remuneration scheme via an umbrella company, which was marketed as “HMRC approved”.

“I went on these webinars, and through an approval process, and had my CV assessed to make sure I was applicable for the scheme,” he said. “It seemed genuine because it was genuine. There was nothing illegal about it. And everyone was telling me it was above board, and my own research told me the same.

“It had all these things supporting it, and I needed to carry on working. So, from 2010, that was the route I went down until 2016. From 2014 onwards, I started getting inquiry notices from HMRC saying they didn’t think the scheme I was using works, so I might have to pay more tax.

“HMRC did nothing about these schemes for so long that they were now out of time to do so and this basically culminated in them bringing in the loan charge law.”

Parris added: “And that’s where I am now. I’ve been in settlement discussions with HMRC, and can settle for a six-figure sum or I can take the loan charge for double that sum. That’s my situation.”

Chamberlain said there is an element of history repeating itself in how some private sector organisations are now responding to the news that, from April 2020, they will be responsible for determining whether the contractors they engage should be taxed in the same way as permanent employees or off-payroll workers.

“It’s a bit like we’re seeing now among some large-end clients, like Lloyds Bank, taking the stance that IR35 means they can’t use contractors any more. In 2000, the contractors felt the same way,” he said.

That is not to say that every participant in an EBT or other loan remuneration scheme did so in response to the IR35 regulations, said Chamberlain.

“Possibly some were attracted by the headline take-home rates of pay that were being touted,” he added.

“We [IPSE] have always advised extreme caution before going into any one of these schemes, on the basis that if something looks too good to be true, it probably is. So, if someone is telling contractors they can keep 90% of their take-home pay, then that’s probably too good to be true.

“We’ve always advised against making use of EBTs, loan arrangement schemes, or whatever you want to call them, but that doesn’t mean we are 100% supportive of what the government is doing with the loan charge, either.”

And neither are the scores of MPs who, before the dissolution of Parliament ahead of the General Election, have banded together as the Loan Charge APPG to oversee an inquiry into the policy, its impacts and HMRC’s enforcement of it.

Cross-party support for loan charge suspension

Before the onset of the pre-General Election period on 6 November 2019, the 200-strong group published details of a poll involving 2,000 individuals affected by the loan charge. One-third of participants had sought counselling and medication to cope with loan charge-induced stress, and 40% indicated that they had also “seriously considered” suicide.

Anecdotally, there have been seven suicides linked to the loan charge policy to date, as well as numerous reports of families breaking down as a direct result of the financial strain these requests for retrospective tax payments are putting on people.

This is what prompted the Loan Charge APPG to describe the aftermath of the policy’s introduction as a “public health emergency”. It has also made a case for the promoters of these schemes to be held accountable for “mass mis-selling” to the contractor community.  

LCAG’s Earnshaw agrees that the way promoters marketed their schemes should be at the forefront of any HMRC investigation. “People argue that this is a moral issue, and everyone should pay the right amount of tax, but that’s not an argument we’re having here,” he said.

“These schemes were sold as legal and they were legal. Some people got into them and knew what they were doing, but quite a few did not. Others did not look deep enough into what was going on, and just signed a piece of paper and got on with it.”

Earnshaw has first-hand experience of the tactics employed to lure people into these schemes, having taken part in one between 2010 and 2012.

“It was two tax years for me,” he told Computer Weekly. “I thought it was legal and above board. And when I saw the amount that I was liable for, I had a breakdown.”

This resulted in him having to take time off work and, in time, completely overhauling his working environment to accommodate the ongoing mental health issues this led to.

Earnshaw has since set about raising awareness of the loan charge and the impact it is having on individuals through LCAG, which he founded with financial services contractor Steve Packham.

Read more about the IR35 regulations

The group now has more than 4,000 members and is run by 50 or so volunteers who are actively involved with offering help and support to people affected by the policy.

“We’ve had people commit suicide, and we have a team who are looking out for people who are on the edge because of the loan charge policy,” he said.

“It’s a small proportion of the people we deal with, but a much bigger proportion [we deal with] have mental health issues. They are on antidepressants and in psychotherapy. Some of them are unable to work.”

LCAG’s volunteers also scour social media for at-risk individuals who are feeling the effects of the prolonged stress caused by loan charge investigations, and ensure they have access to counselling and support. The organisation has also set up a text support line for contractors.

“Loan charge is causing divorces and family breakups, but HMRC doesn’t acknowledge that, because they’ve got a large cash box they need to get hold of,” said Earnshaw.

In a statement to Computer Weekly, an HMRC spokesperson rejected this claim, saying that the organisation knows the “worry and anxiety” large tax assessments can cause for people, which is why it has pulled together a package of resources to support affected contractors.

“We have put in place dedicated resources, including specially trained HMRC officers, to support customers,” the spokesperson said.

“We have also set up a disguised remuneration helpline, which can provide details for vulnerable customers of organisations such as the Samaritans and Mind, as appropriate, and we are committed to time-to-pay arrangements in respect of the loan charge, which can run for as long as the taxpayer needs.” 

The spokesperson added: “We are committed to treating everyone we serve with respect and sensitivity to their needs and circumstances. If people are worried about being able to pay the loan charge, they should get in touch with HMRC as soon as possible.” 

Loan charge under review

For the IT contractors caught up in the loan charge, the General Election – and the resultant pause it has placed on parliamentary proceedings – could not have come at a worse time.

An independent review, overseen by former National Audit Office (NAO) boss Amyas Morse, looking at whether the policy is the most appropriate way to address the use of loan-based remuneration schemes, has been under way since September 2019 and was due to conclude in mid-November.

However, at the request of finance secretary Jesse Norman, its findings and recommendations cannot be made public until a new government is in place to address them, due to the “purdah” rules banning the making of “politically contentious policy changes” during the pre-election period.

At the time of writing, there is no clue as to what Morse’s review will conclude, but there is a degree of hope that it might lead to either a temporary suspension of the loan charge policy, or an out-and-out scrapping of it.

In the meantime, the 31 January 2020 loan charge settlement deadline gets ever nearer, and the uncertainty continues over what the future holds for the contractors involved.

With that in mind, the Loan Charge APPG made its case in a letter addressed to the chancellor, Sajid Javid, on 5 November 2019 for the loan charge policy to be suspended for at least six months, with immediate effect. This is on the basis that any new government will not have enough time to act on the review’s findings by the end of January 2020.

“A suspension would lift the guillotine of the loan charge faced by so many people,” said the letter. “Without this announcement, this latest delay [in the review] will exacerbate the mental health concerns and the suicide risk.  

“With the 31 January date so close and with people otherwise forced to make life-changing decisions because of it, it would be grossly irresponsible and palpably unjust not to announce a suspension of the loan charge reporting and payment date, with this issue being, in some cases, literally a matter of life and death.”

At the time of writing, the loan charge policy remains in place and active.

Optimism during uncertainty

There is a degree of optimism among contractors that the review may help to ease some of the pressure they are under, as details have emerged in recent weeks about some of the recommendations Morse is known to have received during his review.

IPSE, for example, has suggested that the government should consider drastically reducing the number of years the policy covers to bring it more closely into line with how other tax investigations are conducted, said Chamberlain.

“Normal tax investigations go back four years or six years if there has been carelessness,” he said. “Only for really serious crimes, like fraud, can HMRC go back even further beyond that period.

“I don’t believe the contractors who are caught up in the loan charge have committed fraud or done something criminal. They were given poor advice, and were perhaps naïve, but I don’t think there is justification to go back 20 years, which is how the loan charge works right now.”

LCAG, meanwhile, is pursuing a crowd-funded judicial review of the loan charge policy, with the aim of seeing it scrapped on human rights grounds. This, in turn, would make it unlawful for HMRC to continue to enforce it.

Earnshaw said the group hopes the judicial review will take place in the new year, unless the Morse review does result in the loan charge policy being scrapped. In that case, there would be no need for any further action by LCAG. “It’s progressing,” he said, “but it’s progressing glacially.”

Until the outcome of either review is known, and while the pre-election period plays out, LCAG will continue to campaign for a revocation of the loan charge policy, said Steve Packham, its spokesperson and co-founder.

“While it is frustrating that the General Election has delayed the review and outrageous that the loan charge is still to come on 31 January 2020, it does give us a big opportunity for people to push election candidates as to whether or not they will seek to stop the draconian loan charge, if they are elected,” he said.

“The Loan Charge Action Group will be asking candidates to make clear their position and will call on our members to only support candidates who pledge to tackle the loan charge scandal.”

Attempt to clear up the confusion

The loan charge policy, coupled with the reforms to the IR35 regulations that HMRC has spent the past couple of years overseeing, are, to Manley’s mind, a retrospective attempt by HMRC to clear up the confusion caused by its 20-year-old tax avoidance legislation.

“If they had, on day one, fixed IR35 in a sensible and fair manner, then they wouldn’t have got into this mess in the first place [with the loan charge],” he said. “Trying to fix something retrospectively is what is causing all the problems here.”

And when it comes to apportioning blame for the perilous financial situation that many contractors now find themselves in, some might point the finger directly back at the contractors themselves. But, said Manley, it is only fair and right that HMRC is held accountable too.

“There is not a single contractor I know who, if HMRC had done its job at the time and said, ‘The scheme you are using is not going to work’, would have carried on with it,” he said. “But they [HMRC] carried on for 20 years with implied acceptance through silence.

“If you send in a tax return, there’s only a one-year inquiry window. And if HMRC doesn’t come back and say something is wrong, you of course assume it’s OK then. You don’t expect them to come back to you about it 20 years later.”

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