What is a loan scheme, and why you shouldn’t use one

(6 minutes to read)

First thing’s first – what is a contractor loan scheme?

Contractor loan schemes (or, as the Government calls them, disguised remuneration arrangements) take many forms – but the underlying structure is that a freelance or contract worker signs a contract of employment with an employer or EBT (employment benefit trust), usually located outside mainland UK jurisdiction. The employer then pays the contractor in the form of tax-free ‘loans’ – which, although appearing as loans on paper, are never expected to be repaid. In return, the scheme provider takes a percentage of the contractor’s income as an ‘administration fee’.

As can be expected, HMRC take a dim view of such schemes.

How did these schemes come about?

It’s generally agreed that contractor loan schemes came into being in response to IR35 legislation introduced in 1999, which clamped down on public sector workers being paid as contractors – with all the tax advantages that go with it – while acting as ‘disguised’ employees. In brief, the legislation required that contract workers in working arrangements indistinguishable from those of permanent employees should pay tax at the same rate as those employees – even if they were operating through a limited company, umbrella company or third-party agency.

IR35 legislation resulted in a significant squeeze on the income of public sector contractors, particularly in the IT sector. As a result, many turned to alternative arrangements – notably loan schemes – which would allow them to preserve their net income.

So, what are the risks of using an offshore loan scheme?

Since the rise of contractor loan schemes HMRC has taken decisive action against users of such arrangements – retrospective legislation was introduced covering transactions as far back as 1999, levying charges of up to 100% of tax avoided (as calculated by HMRC) on the individuals caught in the net.

If you’re one of the tens of thousands of people already under investigation by HMRC, you’ll likely be seeking legal advice already – the crux of the matter is that the tax should be repaid by 6th April 2019. There are concessions if you speak to HMRC and reach an agreement before this date – if you earn less than £50,000 annually, repayments can be spread over five years, and if you earn under £30,000 the repayments can be spread over seven years. This isn’t as generous as it might appear – the fact that interest will be charged on outstanding amounts over the repayment period shows that HMRC aren’t offering much leeway to users of these schemes.

If you’re currently using a loan scheme (which is unlikely, as operators of such schemes have largely been scared off by the strong action taken against them), be warned that HMRC do not appear to accept defences relates to naivety, ignorance or deception – if you’re deemed to have personally avoided tax due on income, your motivations aren’t taken into account.

Are the repayment arrangements fair?

It was previously mentioned that charges can reach 100% of tax avoided, plus interest. It’s important to note that HMRC determine this figure, not the contractor… and many individuals are finding the charges to far exceed their own calculations – or those of their accountants or legal advisers.

It is also argued that retrospective legislation – that is, legislation that declares past events illegal when permitted by law at the time – is unfairly punitive on people who acted in good faith and within the letter of the law at the time. Indeed, many contractors were required to operate within such schemes by the clients who engaged them.

Finally, organisations such as the Loan Charge Action Group (LCAG) highlight the distress and disruption caused to the lives of individuals who were paid through such arrangements, some as much as two decades ago. In contrast to HMRC’s claims that the vast majority of individuals required to repay tax are high earners, LCAG claim that the majority of affected people are ordinary workers with average incomes who are now being pursued by demands for amounts they’re unable to repay – and have even found it necessary to offer advice on counselling and support for those potentially facing insolvency as a result.

What does this mean for me?

Whatever your opinion on HMRC’s retrospective action on users of loan schemes, it should be clear that the risks of using arrangements designed to avoid tax far outweigh the benefits in the long term. Anybody working as a freelancer or contractor should be extremely wary of any scheme advertising an unrealistic proportion of income as take-home pay – even if such schemes fall within current legislation, the action taken over loan schemes proves that HMRC can consider them tax avoidance and impose punitive fines at an indeterminate point in the future.

As such, our opinion won’t change – freelancers and contract workers should always be paid through compliant, proven and time-tested means such as an umbrella company or their own limited company, through organisations which take the financial security of their clients seriously and offer services such as IR35 reviews to ensure contractors are always being paid in a fair and compliant manner.

If you have any questions about loan schemes, please call Sophie Lewis on 01206 591 000 or email sophie.lewis@contractorumbrella.com.

Still thinking about if you should join Dolan Accountancy?

Give us a call on 01206 591 000 or email jessica@jvbconsultancy.co.uk

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