FOI release

Section 2 - Who is liable to the loan charge

Published 23 April 2020

Who is liable for the loan charge

HMRC’s position is that the income from which Income Tax and National Insurance contributions (NICs) is claimed to be avoided through the disguised remuneration (DR) schemes should be taxed as employment income. The loan charge seeks to ensure that people who have used these schemes pay tax by taxing the outstanding loan balance as employment income in 2018 to 2019.

The loan charge design charges all the outstanding loan balance to Income Tax in the 2018 to 2019 tax year, sometimes referred to as ‘income stacking’.

The biggest driver for this design choice was simplicity. It is straightforward to understand and administer, for employers, individuals and HMRC. It did not require any IT system changes or new forms. The announcement in 2016 was designed to allow users a number of years to pay the underlying liability to prevent all outstanding loans being taxed in one year.

The loan charge was not designed to target a specific amount of tax from individual cases. It seeks to ensure that income which has not previously been taxed as employment income is taxed as such.

Below, we set out how employment income is taxed and collected, and who is liable for the loan charge and our operational approach to collecting tax for the following situations:

• DR schemes used by employers
• DR schemes used by individuals – offshore employer
• DR schemes used by individuals – onshore employer
• DR schemes used by individuals – employer no longer exists

The last 3 situations refer to individuals, who consider themselves self-employed, freelancers or contractors, directly entering into schemes.

We have not set out the position for self-employed DR schemes as individuals who enter into those schemes are directly, and solely, liable.

How employment income is taxed and collected

The liability to pay Income Tax always rests with individuals. However, the obligation to operate Pay As You Earn (PAYE) to collect Income Tax and primary Class 1 NICs, arises on the employer in the first instance. Employers must also pay secondary Class 1 NICs to HMRC.

PAYE deducts tax from employment income on a provisional basis. The deductions are a payment on account to set against the actual tax liability for the year, which is established by Self Assessment, Simple assessment or informal calculation. Where an individual’s income is wholly, or mainly, PAYE income, and PAYE is operated properly, the right amount of tax should be deducted during the tax year so that they do not need to complete a Self Assessment return .

Where an employer applies the regulations and co-operates with HMRC, the PAYE system works well and individuals do not need to complete a Self Assessment return. There are instances where employers do not apply the rules correctly or fail to co-operate with HMRC. In those cases, HMRC has existing powers to transfer the liability to the employee in specified circumstances, subject to appropriate safeguards.

DR schemes used by employers

The vast majority of employers who used DR schemes are close companies and the schemes were used to reward the owner-directors. Close company owner-directors have a high degree of control over their company’s financial affairs and remuneration policy.

We have analysed the known employer population using Companies House data to identify companies that are not close, which we subtracted from the total number of employers to identify those who are close. We estimate that at least 78% are close companies.

We expect the majority of employers to have settled their underlying liability with HMRC, to be in the process of settling or to account for the tax due under the loan charge via PAYE. In all these cases, HMRC has well established processes to provide instalment arrangements where needed.

In the minority of cases where the employer cannot pay, HMRC will seek to recover Income Tax from the owner-director employee using existing powers. This is to prevent a situation where an individual, who decided their company should use an avoidance scheme to benefit them, can claim not to be liable for the unpaid Income Tax because the employer cannot pay.

Under regulation 81 of the PAYE regulations, HMRC can transfer an Income Tax liability arising under the DR rules, which includes the underlying liability and the loan charge, to an employee where:

• HMRC has issued a determination to an employer in respect of the liability; • the determination has become final; and • the employer has not paid the liability within 30 days.

HMRC’s operational approach for the loan charge is the same as it has been for the underlying liability since the DR rules were introduced in 2011. Where the employer accepts, or a court agrees, there is an Income Tax liability but they are unable to pay it, we consider using regulation 81.

There are some instances where an employer entered into a DR scheme to reward employees other than owner-directors. Where that occurs HMRC pursues the same approach; seeking tax from the employer in the first instance and considers transferring to the employee where the employer is unable to pay.

There is a well-established common law principle that where an employer pays the Income Tax liability of the employee, it can recover the money from the employee. Some DR arrangements also included specific indemnities for the employer so that they could recover Income Tax from the employee under contract law. This can mean that the employee ultimately bears the cost even if the employer pays in the first instance. This is a contractual matter between the employer and the employee.

A further tax charge can arise where the employer pays the Income Tax liability on behalf of the employee, including the owner-director, and the employee does not reimburse the employer. This tax charge arises on the benefit of the employer paying the employee’s Income Tax liability.

DR schemes used by individuals – offshore employers

The majority of DR schemes used directly by individuals involve an artificial employer, set up solely for the purposes of the scheme, in an offshore jurisdiction.

We have analysed the relevant schemes and estimate around two-thirds involve an offshore employer. These schemes account for around 80% of the number of times a DR scheme has been used and around 80% of the individuals who have used DR schemes.

Where there is an offshore employer that does not operate PAYE, the normal rules setting out who is responsible for operating PAYE transfer the responsibility to the first party onshore involved in the supply of the individual’s services (‘onshore entity’). This could be a recruitment agency or the end client using the services supplied by the individual.

The onshore entity is very likely to have been unaware that the individual was entering into avoidance and is unlikely to have benefitted from the avoidance. This is because they are likely to have engaged the services of the individual through a reputable recruitment agency and so will not be aware of what occurs further down the supply chain. If they are aware of the offshore employer, there is unlikely to be any indication that they are using an avoidance scheme. The onshore entity will also be unaware of the outstanding loan balance and have no power to obtain it in order to operate the loan charge. Therefore, the government ensured where the loan charge arose the existing rules did not transfer the liability to the onshore entity and it remains with the individual undertaking the avoidance.

Where the loan charge is due and the employer has ceased trading or there is no employer available to operate PAYE, the individual should self-assess the loan charge in their 2018 to 2019 Self Assessment return and pay the Income Tax due. No NICs is due from the individual.

HMRC’s current operational approach when collecting the underlying liability also seeks the same outcome; to collect the tax due from the individual because it cannot be collected from the employer.

DR schemes used by individuals – onshore employers

Some more recent DR schemes used directly by individuals involve an artificial employer onshore in the UK. Our operational approach is similar for the underlying liability and the loan charge and mirrors that for schemes used by employers set out above. We would seek to collect the money from the UK employer in the first instance. However, they are unlikely to have any assets or funds so we will seek to use regulation 81 to transfer the tax liability to the individual.

DR schemes used by individuals – employer no longer exists

Where the employer does not exist at the time of an employment income charge, such as the loan charge, the Income Tax liability automatically arises on the individual employee. This can already happen in limited circumstances outside DR schemes, and applies equally whether the employer was onshore or offshore when it existed. The individual should include this liability in their Self Assessment return.

The government did not change this established position for DR schemes to ensure the individual who received their income without any tax deducted pays the tax due.

Loans in scope of the loan charge

Individuals

In 2016, the government estimated 40,000 individuals would be affected. This was arrived at from the number of individuals under enquiry for using a DR scheme plus an estimate of those who HMRC were unaware had used a DR scheme but would be within scope of the loan charge.

The additional 10,000 individuals, to reach the 50,000 commonly quoted, are those estimated to be affected by the self-employed measure. This was also arrived at by considering those HMRC is aware of and an estimate of those it is not aware of.

We are aware of the higher estimate of 100,000 individuals affected quoted by campaigners but we do not know how this was calculated. We have seen from other estimates and research by campaigners that they take a small, self-selecting, sample of those affected and use this to extrapolate to a total population. This approach will inevitably lead to an overestimate. HMRC’s approach is based on the number of individuals it has under enquiry, and knows is in scope, so is likely to be more accurate.

In summer 2019, we undertook a comprehensive exercise to review the estimate of the number of individuals affected with operational teams. This involved identifying a list of schemes in scope of the loan charge and looking at the number of individuals using these schemes. This exercise showed that the figure of 50,000 remains valid and our best estimate of the number of individuals impacted by the loan charge.

The most common way for an individual who has used a DR scheme to move out of scope of the loan charge would be to settle with HMRC. The estimate of 50,000 includes those who have and those who have not settled.

Enquiry cover

Using the iCA database, we have data on the total number of open enquiries by tax year from 1998 to 2018 across the wider DR population, not just those individuals expected to be caught by the loan charge. See Table 6 below for information as at August 2018:

Time period	Number of enquiries
1995 to 1999	10
2000 to 2004	1,100
2005 to 2009	25,800
2010 to 2014	65,700
2015 to 2018	33,800
Total	126,410

This will not give a complete picture as iCA does not hold the total number of open enquiries. There are also various legacy systems, which we would need to interrogate, which cannot be done in the timeframe.

Employers

In 2016, the government estimated 10,000 employers would be affected. This was arrived at using the same methodology for individuals. This has also been through the recent comprehensive exercise and our estimate remains around 10,000.

As set out above, the 50,000 estimate includes 40,000 for the employment loan charge and 10,000 for the self-employed loan charge.

The employment loan charge was announced at Budget 2016. At that time, we had 23,000 individuals under enquiry. In order to arrive at the 50,000 estimate, this number was increased to take into account the years within scope of the loan charge we did not have enquiry data for yet; 2015 to 2016, 2016 to 2017, 2017 to 2018 and 2018 to 2019. It was also increased to take into account that there will be individuals we are unaware of that are in scope of the loan charge but recognising that many will not comply.

Between June and July this year, we undertook an exercise to review the estimate of the number of individuals impacted by the loan charge.

Counter Avoidance reviewed their records and provided a list of DR schemes in scope of the loan charge. This showed around 250 schemes within scope of the loan charge, and some schemes that we had not fully investigated to be certain.

The iCA database was interrogated to identify the number of individual users that have used these schemes. As part of the quality assurance, Counter-Avoidance to confirmed the count and provided details of those cases that are not held on iCA database and any duplicates were removed.

This exercise showed that there are around 40,000 individuals impacted by the employment and self-employment loan charge. It also showed an additional central estimate of 10,000 users that are using DR schemes that could fall within scope of the loan charge once full assessment of the schemes have been made

Reported incomes

Table 7 below shows the reported 2017 to 2018 income distribution for those who have exclusively used DR schemes since 6 April 2011. We have also excluded those who we know have used a DR scheme in 2017 to 2018, as their reported incomes are supressed, to give a better reflection of actual incomes.

Declared Income 2017 to 2018	Percentage where income is known
£0	2%
£1 - £19,999	26%
£20,000 - £29,999	12%
£30,000 - £39,999	13%
£40,000 - £49,999	16%
£50,000 - £59,999	8%
£60,000 - £79,999	9%
£80,000 - £99,999	6%
Over £100,000	9%
Total	100%

Table 8 below shows the same analysis for those who have exclusively used DR schemes since 6 April 2011 and have settled.

Declared Income 2017 to 2018	Percentage where income is known
£0	1%
£1 - £30,000	21%
£30,000 - £50,000	29%
£50,000 - £100,000	32%
£100,000 - £250,000	15%
Over £250,000	3%
Total	100%

Table 9 below shows the same analysis as Table 8 above, but also includes the settlement amount distributions.

2017 to 2018 Income bandings	Settlement band £1 - £10,0000	Settlement band £10,000 - £20,000	Settlement band £20,000 - £30,000	Settlement band £30,000 - £40,000	Settlement band £40,000 - £50,000	Settlement band £50,000 - £75,000	Settlement band £75,000 - £100,000	Settlement band £100,000 - £250,000	Settlement band Over £250,000
£0	50%	*	*	*	*	*	*	*	*
£1 - £30,000	55%	16%	10%	6%	4%	4%	*	4%	*
£30,000 - £50,000	49%	14%	8%	5%	4%	8%	3%	6%	1%
£50,000 - £100,000	30%	16%	13%	7%	5%	10%	6%	10%	2%
£100,000 - £250,000	21%	11%	12%	9%	7%	11%	5%	18%	6%
Over £250,000	26%	15%	*	*	*	*	*	15%	13%
All	40%	14%	11%	7%	5%	8%	4%	9%	2%

Table 10 below shows the reported 2017 to 2018 income distribution for those who have exclusively used DR schemes before 6 April 2011.

Declared Income 2017 to 2018	Percentage where income is known
£0	2%
£1 - £19,999	21%
£20,000 - £29,999	8%
£30,000 - £39,999	9%
£40,000 - £49,999	16%
£50,000 - £59,999	8%
£60,000 - £79,999	12%
£80,000 - £99,999	9%
Over £100,000	14%
Total	100%

Source: Analysis provided by KAI using data from iCA and reported income from PAYE/SA returns

Tables 7 to 10 exclude those who have used schemes in years both before and after 6 April 2011.

Table 11 below shows the mean and median settlement amounts for individuals who have settled.

	All years	Exclusively before 6 April 2011	Exclusively after 6 April 2011	Both before and after 6 April 2011
Mean settlement	£59,000	£64,000	£43,000	£69,000
Median settlement	£18,000	£17,000	£16,000	£25,000

Anti-forestalling rules

At Autumn Statement 2010, on 9 December 2010, the government announced it would introduce the rules which became Part 7A ITEPA 2003 from 6 April 2011.

The government wanted to avoid the forestalling risk of employers and individuals entering into DR schemes in the period before the legislation commenced. It was not possible to fully introduce Part 7A from 9 December 2010 so the government introduced anti-forestalling rules.

These applied to anyone who:

• received a payment between the 9 December 2010 and 5 April 2011;
• the payment was in a form and manner which Part 7A would apply if it was enacted; and
• had not repaid the amount by 5 April 2012.

The effect of this was that the individual or employer would be liable to the tax on the amount received in the anti-forestalling period as part of their taxable income for 2012 to 2013.

Individuals and employers who used a DR scheme during the forestalling period are ignoring the legislation in the same way as those who used a scheme after 6 April 2011.

We believe the Autumn Statement 2010 announcement caused a temporary pause in promotion by some promoters while they considered how to respond. Therefore, there should be not a large number of individuals and employers who have used DR schemes in the forestalling period.

If the loan charge applied to loans made since 9 December 2010, employers who used a scheme in the anti-forestalling period will be able to identify the loan amounts as they usually only used the scheme once a year to make a single large loan. However, some individuals may not be able to identify loans made solely in the anti-forestalling period, which may lead to disputes about when loans were made and apportioning.

Incomes of individuals affected

Individuals’ reported income at the time they used a DR scheme will be very low because they have used a DR scheme to reduce their taxable income. We need to work out what their income would have been if they had not used a DR schemes.

We have analysed the 2017 to 2018 incomes of individuals who have used DR schemes. We have taken their reported incomes on either their Self Assessment or PAYE returns, which may be lower than their actual income. For example, if they are using a DR scheme in 2017 to 2018. If we cannot find a record for an individual, perhaps because they have moved abroad, we have excluded them from the analysis.

Table 12 below shows the reported 2017 to 2018 incomes for individuals who have used DR schemes:

2017 to 2018 Income bandings	Percentage of individuals within each income band where income is known
£0	2%
£1 - £30,000	25%
£30,000 - £50,000	27%
£50,000 - £100,000	30%
£100,000 - £250,000	14%
Over £250,000	3%
All	100%

Source: Analysis provided by KAI using data from iCA

Table 13 below shows the same information with bandings for settlement amounts.

2017 to 2018 Income bandings	Settlement band £1 - £10,0000	Settlement band £10,000 - £20,000	Settlement band £20,000 - £30,000	Settlement band £30,000 - £40,000	Settlement band £40,000 - £50,000	Settlement band £50,000 - £75,000	Settlement band £75,000 - £100,000	Settlement band £100,000 - £250,000	Settlement band Over £250,000
£0	45%	13%	8%	*	*	8%	*	*	*
£1 - £30,000	48%	16%	9%	6%	4%	6%	4%	6%	2%
£30,000 - £50,000	41%	13%	9%	6%	5%	8%	5%	10%	3%
£50,000 - £100,000	29%	13%	11%	8%	5%	9%	7%	15%	3%
£100,000 - £250,000	19%	12%	10%	7%	6%	13%	7%	18%	8%
Over £250,000	13%	10%	7%	*	*	11%	7%	23%	22%
All	35%	14%	10%	7%	5%	8%	6%	12%	4%

Source: Analysis provided by KAI using data from Counter-Avoidance Operational database

• Figures have been suppressed due to case number in the underlying data falls below 5 to prevent potential disclosure of sensitive information

Table 14 below sets out the mean and median settlement amounts over time, including up to 30 June 2019.

	Median	Mean
End of December 2018	£13,000	£45,000
End of March 2019	£18,000	£58,000
End of June 2019	£18,000	£59,000

Source: Analysis provided by KAI using data from iCA

The averages have changed as more individuals have settled, and we expect they will continue to change as more individuals settle.

Examples

Example - Donald

Donald used a DR scheme with an offshore employer and received DR loans of £90,000 in 2007 to 2008, £95,000 in 2008 to 2009 and £100,000 in 2009 to 2010. Donald also had £150,000 employment income in 2018 to 2019 addition to the loans he received, which he declared in his Self Assessment return.

Donald had also declared income from the DR scheme of £20,000 each year.

If Donald settled under the November 2017 terms he would have to pay just Income Tax at the rates applicable in the year he used the scheme, including receiving the personal allowance. Statutory late payment interest is also due from the date the tax should have been paid until the date of the settlement.

Donald would have to pay the following:

Table 15

2007 to 2008	£41,660	(Income Tax: £2,432, late payment interest: £9,228)
2008 to 2009	£42,512	(Income Tax: £33,833, late payment interest: £8,679)
2009 to 2010	£43,206	(Income Tax: £35,225, late payment interest: £7,982)
Total	£127,378

Donald also has an Income Tax liability of £53,100 in 2018 to 2019 in respect of his £150,000 employment income, so would pay £180,478 in total.

If Donald decided not to settle his tax affairs with HMRC or repay his loans by 5 April 2019, he would pay the loan charge. He should include his DR loans of £285,000 and his employment income of £150,000 in his 2018 to 2019 Self Assessment return. Donald would pay a total of £181,350 in Income Tax.

If Donald pays the loan charge, he will benefit from double taxation relief against his underlying liabilities. However, he may still be liable for late payment interest of £13,370 which would mean Donald pays £194,720.

Therefore, settlement under the 2017 terms would cost Donald less than paying the loan charge by around £13,370.

Calculating double taxation relief

Double taxation relief (DTR) is available where more than one tax liability exists on the same money or asset because of the DR rules, including the loan charge. We recognise these comprehensive rules are complex as they need to cater for many different scenarios and not incentivise individuals and employers to pay one liability over the other.

To determine the DTR available, and if there is anything left to pay, there are the following steps:

• identify where the same income has been taxed more than once
• establish and compare each of the tax liabilities on the same income
• net off the tax paid against the tax due from the other charge, and then if there is any tax remaining net off against the interest

As set out above, Donald used a DR scheme with an offshore employer and received DR loans of £90,000 in 2007 to 2008, £95,000 in 2008 to 2009 and £100,000 in 2009 to 2010. Donald also had £150,000 employment income in 2018 to 2019 in addition to the loans he received, which he declared in his Self Assessment return. Donald had also declared income from the DR scheme of £20,000 each year.

Firstly, we identify the overlapping amounts of income by comparing the amounts of Income taxable for the underlying liability and the loan charge.

Table 16

Underlying liability		Loan Charge
Year	Income	Year	Income
2007 to 2008	£90,000	2018 to 2019	£90,000
2008 to 2009	£95,000	2018 to 2019	£95,000
2009 to 2010	£100,000	2018 to 2019	£100,000
Total	£285,000	Total	£285,000

Then we identify the relevant tax and interest liabilities for the underlying liability:

Table 17

Year	Income	Income tax	Interest	Tax and interest
2007 to 2008	£90,000	£28,975	£8,245	£37,220
2008 to 2009	£95,000	£30,256	£7,761	£38,017
2009 to 2010	£100,000	£31,608	£7,162	£38,770
Total	£285,000	£90,839	£23,168	£114,007

We also need to identify the relevant amount of tax due under the loan charge:

Table 18

Year	Income	Income Tax
2018 to 2019	£90,000	£37,521
2018 to 2019	£95,000	£39,605
2018 to 2019	£100,000	£41,689
Total	£285,00	£118,815

Then we net off the tax against the tax due from the loan charge, and then if there is any tax remaining net off against the interest:

Table 19

Year	Income Tax	Less 2018 to 2019 Income Tax	Remaining Income Tax	Interest	Less 2018 to 2019 Income Tax	Balance due
2007 to 2008	£28,975	-£28,975	£8,546	£8,245	-£8,245	-
2008 to 2009	£30,256	-£30,256	£9,349	£7,761	-£7,761	-
2009 to 2010	£31,608	-£31,608	£10,081	£7,162	-£7,162	-
Total	£90,839	-£90,839	£27,976	£23,168	£23,168	-

The end result is that no Income Tax or interest is due on the overlapping amounts of income.

However, there is additional Income Tax and interest due from the £20,000 declared each year. This is because it will now be taxed at higher rates as per below:

Table 20

Year	Income	Income Tax	Interest	Total
2007 to 2008	£20,000	£3,456	£983	£4,440
2008 to 2009	£20,000	£3,577	£917	£4,494
2009 to 2010	£20,000	£3,617	£820	£4,436
Total	£60,000	£10,649	£2,720	£13,370

Example - Anita

Anita used a scheme with an offshore employer and received loans of £20,000 in 2007 to 2008, £25,000 in 2008 to 2009 and £30,000 in 2009 to 2010. Anita also had £20,000 employment income in 2018 to 2019 in addition to the DR loans she received, which she declared in her Self Assessment return.

Anita had also declared income from the DR scheme of £7,000 each year.

If Anita settled under the November 2017 terms she would have to pay just Income Tax at the rates applicable in the year she used the scheme, including receiving the personal allowance. Statutory late payment interest is also due from the date the tax should have been paid until the date of the settlement.

Anita would have to pay the following:

Table 21

2007 to 2008	£5,582	(Income Tax: £4,345, late payment interest: £1,236)
2008 to 2009	£6,283	(Income Tax: £5,000, late payment interest: £1,283)
2009 to 2010	£7,360	(Income Tax: £6,000, late payment interest: £1,360)
Total tax and late payment interest	£19,224

Anita also has an Income Tax liability of £1,630 in 2018 to 2019 in respect of her £20,000 employment income, so would pay £20,854 in total.

If Anita decided not to settle her tax affairs with HMRC or repay her loans by 5 April 2019, she would pay the loan charge. She should include her DR loans of £75,000 and her employment income of £20,000 in her 2018 to 2019 Self Assessment return. Anita would pay a total of £26,360 in Income Tax.

If Anita pays the loan charge, she will benefit from double taxation relief against her underlying liabilities. However, she may still be liable for late payment interest of £3,751, which would mean Anita pays £30,111.

Therefore, settlement under the 2017 terms would cost Anita less than paying the loan charge by around £3,751.

Go to section 3: Off-payroll and Disguised Remuneration.