BN66 - An example of how you could be affected
This is the story of IT contractor, Graham, and how he lost his home, his wife and an awful lot of money by thinking he could beat the UK tax system.
Graham is a career contractor. For many years he worked as a sole trader preparing his self employed accounts to 5th April each year and completing a tax return.
In January 2006 he became aware of an offshore scheme, based in the Isle of Man, which promised large tax savings. Graham had a good accountant who advised him against the idea but Graham thought he knew best and signed up to the scheme.
Graham had been making profits of around £225,000 per annum and his annual tax liability was around £82,500 per annum. Under the self-assessment system he was making payments on account on 31st January in the year of assessment and 31st July after the end of each year of assessment. A balancing payment was then made on 31st January after the end of each year of assessment.
The year to 5th April 2006 was little different. Graham found that he needed to make a payment of just £41,250 on 31st July 2006 to completely clear his liability for 2005/06. Normally of course, Graham would make payments of £41,250 on 31st January 2007 and again on 31st July 2007 in respect of his liability for the year to 5th April 2007. However, the scheme providers assured him that his liability would be substantially lower and he notified HMRC that he would be reducing his payments on account to £1,500 each.
Under the offshore scheme, Graham continued to be self employed but the scheme providers collected all of the fees for his work and paid him at the rate of £30,000 per annum for his services. He deducted various business expenses such as traveling and administration expenses and his profit was £18,000 per annum. As far as Graham was concerned life was so much easier - he even decided that he had no more need for his accountant!
The promoters of the scheme were retaining £210,000 of Graham's fees. From this they deducted £1,500 per month charge leaving £192,000 per annum. This amount was paid to a trust based in the Isle of Man and was then transferred to Graham monthly, in effect tax-free.
Graham made a quick calculation and worked out that the half-yearly installment of £1,500 ,he would be making, would more than cover his tax liabilities. He was looking at his net income rising from £112,500 in 2005/06 to £207,000 per annum from 2006/07.
Graham was very pleased with this result and decided to spread some of his new found happiness (and wealth) around. He agreed to pay for his daughter's dream wedding. with an extravagant wedding reception at a top London restaurant; his wedding gift was a round the world trip as a honeymoon for the happy couple.
In May 2007 he submitted his 2007 self-assessment returns including details of his much reduced self employed income, but excluding the trust income which was of course tax-free. Graham was very pleased to receive a statement from HMRC in December 2007 showing that his payments were up to date and he needed to make a further payment of £1,500 on 31st January 2008. Clearly HMRC was aware of the scheme and accepted that it worked. Graham paid £30,000 off his mortgage, bought outright a new car and put down a deposit on a tropical holiday.
Graham submitted his 2008 tax return in the middle of April. He didn't bother claiming any expenses against his self employed income as it didn't seem worth the extra hassle!
It was at the end of April 2008 that the brown envelope arrived on his doorstep. It was a letter from HMRC saying that they were opening an enquiry into his 2007 self-assessment return. Graham didn't understand; that they were referring to foreign trust income and business treaties included in double taxation agreements. The scheme providers had stopped returning his calls and he was worried, confused and too embarrassed to go back to his old accountant so he made an appointment to meet with Henry Baker, a tax specialist.
Henry invited Graham to his office but said he would need a payment on account of his fees of £7,500 up front. Graham was shocked by this request but felt he had no option and so agreed. After all, if Henry could put HMRC straight on this matter, it was a small price to pay from his new found wealth for peace of mind.
Graham duly attended the meeting in early May and handed over his cheque for £7,500 in return for a nice cup of tea and some biscuits. Henry talked to Graham about the scheme and listened patiently. Graham felt very comfortable and was sure he was in safe hands. Then Henry dropped the bombshell, the scheme was illegal. He handed Graham an extract from the 2008 Budget - Budget Note 66 or BN66 for short. Graham read BN66, which was only a page long, but could see that it described the scheme he was using. Henry explained that in BN66, the government was clarifying legislation that had been introduced over 20 years earlier and was aimed at tackling the abuse of double taxation agreements to avoid UK taxes. Henry went on to explain that tax and class 4 National Insurance would be due on all of the trust income that Graham had received from the scheme.
Over the following weeks Henry wrote to HMRC on Graham's behalf accepting that BN66 applied. Henry worked out that Graham's additional liabilities for the 2006/07 and 2007/08 years totaled £150,000 including interest and that Graham would have to make payments on account for the 2008/09 year. It was no real comfort for Graham to learn that he would not be taxed on the fees withheld by the scheme providers.
Graham needed to raise £150,000 and tried to re-mortgage his house but found that no lender was interested. They blamed reduction in house prices generally, a difficult market, and concerns about Graham's level of income. Graham sold his prized new car at a big discount and had to cancel his daughter's dream wedding arrangements, breaking her heart.
Henry negotiated payment terms with HM Revenue & Customs over 12 months. However, Graham found that by January 2009 he had no funds to pay his next installment of his half yearly tax payments and he still had 6 monthly payments of arrears outstanding. In desperation he sold his house at £60,000 less than he paid to get out of the mess.
He and his wife separated and he now lives in rented accommodation.
Graham was only in this scheme for two years, in the real world, many people like Graham have been using these schemes for over 5 years. Their liabilities may be considerably higher.
HMRC are also targeting ‘dubious expense claims’ by some Umbrella Companies who are misleading UK contractors.
If you have any further questions about BN66 or contracting in general, please either call our new client services helpdesk on 01206 713680 or e-mail info@contractorumbrella.com
