Tackling disguised remuneration

Disguised remuneration – or what the government would more generally describe as the provision of income and benefits through third parties to employees in a form which is not taxable as employment income - was first targeted in 2011.  The legislative regime is contained in Part 7A ITEPA 2003.

In August, following a preliminary announcement in the Budget, HMRC published a consultation document setting out details of proposals for further reforms and legislation in this area, principally to counteract the benefits of schemes which were implemented before the original rules were introduced but have not yet been unwound and to tighten the existing rules to prevent the implementation of new disguised remuneration schemes.

The changes would be introduced in the Finance Bill 2017 and, if introduced in their current form, could be of very wide application.  They are particularly relevant to arrangements involving close companies and to historic arrangements involving loans to employees and directors which would have been caught under the existing rules (or would be caught by the new rules) but were not previously affected because they were implemented before 2011.

Why are changes needed?

While the original legislation undoubtedly put a significant brake on schemes in this area, it is clear that the primary purpose of the original legislation was to counter the use of employee benefit trusts (EBTs), employer funded retirement benefit scheme (EFRBS) and other intermediaries to provide benefits to employees (or persons nominated by the employees) in a tax free manner – typically by way of loan.

While these provisions have had a significant effect on schemes in this area, it is clear that the government expected existing arrangements to be wound up (with tax paid) after the disguised remuneration legislation was first introduced.  Many of those arrangements were not unwound, however, and remain in existence.  The government has also become aware that new schemes are being entered into which, it is claimed, fall outside the disguised remuneration charge.

Countering the creation of new schemes

The consultation document sets out a comprehensive collection of measures to close perceived loopholes in the existing legislation and to provide additional disincentives to entering into new schemes which might avoid tax on remuneration or rewards from employment. Chief among these are:

1. A new and additional gateway for close companies

This will have the effect of bringing arrangements within the scope of the charge where, broadly:

(i) there is a relevant step (e.g. a payment of money or earmarking of assets) involving an individual who has at any time been an employee or director of a close company and at any time held, alone or with associates, a material interest in that company (i.e. more than five per cent);

(ii) arrangements are entered into involving the provision of payments, benefits or loans to the individual; and 

(iii) the company is a party to or facilitates the arrangements. 

This is far wider than the gateway in the existing legislation which (unsurprisingly, given that it is designed to target disguised remuneration) requires the provision of the payment, benefit or loan to be made in connection with the relevant person's employment.  Here, there is no such link, the individual simply needs to have been an employee or director of the company at some point.  This raises the absurd prospect that even a simple sale of shares by a director or employee holding more than five per cent of the shares in a close company (which is common in the context of many family owned and private equity backed companies) could be caught on the basis that the consideration would constitute payment by a third party even though the consideration is clearly paid to them as shareholder rather than by way of designated remuneration.

Some of those absurdities have been highlighted to the Revenue as part of the consultation exercise.  It is therefore hoped that the wording will be tightened to more accurately target avoidance, although experience indicates that the government may prefer to keep the wording of the legislation broad and rely on guidance (or an extensive list of carve-outs, as in 2011) to narrow the application of the rules.

2. Denial of corporation tax deductions

As a more general deterrent to disguised remuneration schemes, the government is proposing to deny all tax relief for employers' contributions to such schemes unless PAYE and NICs are paid at the time the contribution is made, even where the contribution is subsequently agreed to be remuneration.

The potential for disagreements with HMRC at the boundaries of the legislation may mean that denial, rather than deferral, of a deduction will operate as a harsh penalty in some circumstances.

Retrospective attack on existing schemes

To deal with outstanding loans, put in place prior to the introduction of the disguised remuneration legislation in 2011, a "loan charge" is to be levied on certain loans which remain outstanding at 5 April 2019.

This charge applies to any loans to directors and employees (including contractors under a contract of employment) which would have met either the existing or the new close company gateway had these been in existence when the loan was made. 

There will be exceptions only for loans entered into prior to 6 April 1999 or approved fixed term loans, i.e. broadly those with a repayment term of less than ten years and where either regular repayments of principal have been made or where the loan is from a lender in the business of making loans and on terms available to the general public.

It will be clear from all of this that the government means business here and the approach is indicative of the wider legislative and political campaign to tackle perceived avoidance in all its forms, particularly the scope of the retrospective provisions.  Regardless of the "fairness" or proportionality of these provisions, which may well be challenged insofar as they go back to 1999, practical difficulties may also arise from the imposition of PAYE charges on such historic arrangements although the consultation does propose widening the circumstances in which HMRC can transfer the liability to meet disguised remuneration PAYE and NICs charges from the employer to the employee, particularly where the employer has insufficient funds, is located abroad or no longer exists.

Next steps

Those with potentially affected EBTs or EFRBS face an unenviable choice. The definition of "relevant step" is being widened to include the transfer, release and writing off of loans, each of which will now trigger an immediate PAYE and NICs charge on the outstanding amount of the loans. If left in place, the loans will attract the new loan charge on 5 April 2019. If repaid before that date, the money will be trapped in the EBT with a tax charge as and when finally paid out. 

Targeted anti-avoidance rules ignore artificial repayments or those connected with a further avoidance arrangement, and any settlement with HMRC is unlikely to provide an incentive other than avoiding litigation or lengthy enquiries.

Whether arrangements are left in place and in what form will therefore largely depend on commercial considerations, as well as the timing of what would now appear to be an inevitable charge.

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