There is an amazing new tax scheme that is said to turn income into capital gains. Better yet, the capital gains are only taxed at 10 per cent because they benefit from entrepreneurs’ relief.
The scheme operates like this. You have a company that is currently paying you from its profits and you sell the beneficial ownership of this company to an entity based in Cyprus. You then become employed by this entity. However, you remain a director of the company you have sold and it will continue to invoice for your services, even though your employment is now with the entity in Cyprus.
The monthly payments you receive will now be taxable as a capital gain at 10 per cent because you will have made a claim for entrepreneurs’ relief on the sale proceeds. They will no longer be treated as employment income on which you would otherwise have been required to pay income tax and National Insurance contributions. Simples.
There is just one snag. HM Revenue & Customs has just publicised this scheme in Spotlight, its regular newsletter that highlights tax avoidance and evasion schemes, alongside the actions being taking to stop them in their tracks. What is more, HMRC is positive that the scheme does not work.
The promoters have argued the scheme is legal because it is a simple business transaction. However, in HMRC’s view, it involves a number of artificial steps it says are common in tax avoidance schemes. It considers it to be “highly contrived” and, as such, it will be attacked.
So what is tax avoidance? And, in particular, how is it to be distinguished from tax planning or ordinary tax mitigation? A classic definition comes from the late Lord Nolan in CIR v Willoughby 1997, in which the former tax barrister held:
“The hallmark of tax avoidance is that the taxpayer reduces his liability to pay tax without incurring the economic consequences that parliament intended to be suffered by any taxpayer qualifying for such reduction in his tax liability. The hallmark of tax mitigation, on the other hand, is that the taxpayer takes advantage of a fiscally attractive option afforded to him by the tax legislation, and genuinely suffers the economic consequences that parliament intended to be suffered by those taking advantage of the option.”
HMRC has provided its own views on the hallmarks or warning signs of tax avoidance or tax scheming. These are:
- The scheme sounds too good to be true. Some schemes promise to lower your tax bill for little or no real cost. But as with a lot of financial transactions – and most of life generally – if it sounds too good to be true, it probably is.
- You will get your pay or profit in the form of loans. Some schemes – especially those that have been designed for contractors – involve giving you some or all of your payment in the form of a loan that you will not be expected to pay back. The payments are diverted through a chain of companies, trusts or partnerships and you will be told this is to save you tax.
- You will derive huge benefits from the scheme in return for a relatively low investment or outlay. With some tax schemes, the benefits may seem to be out of proportion to the money being generated or the cost of the scheme to you. The scheme promoter will claim there is very little risk to your investment.
- Money goes round in circles. The scheme involves money going around in a circle back to where it started, or there is some similar artificial arrangement.
- HMRC has given the scheme a scheme reference number. This is where HMRC has identified the arrangement as having the hallmarks of tax avoidance and is investigating it. In such a case the promoter may have given you the SRN. You might think that having an SRN means HMRC has in some way approved the scheme. It does not. HMRC does not approve any tax avoidance schemes.
If you are involved in a tax avoidance scheme HMRC will fully investigate your tax affairs. That in itself is likely to be a tiresome, expensive and tedious affair, even if they find nothing else is amiss. But they may also take various other actions. For example:
- HMRC could require you pay the tax you are trying to avoid upfront. You could receive an accelerated payment notice. This is a tax bill requiring you to pay the full amount of tax or NICs that HMRC calculates as being due upfront and within 90 days.
- Legal action could be taken against you. You may end up in court if you do not pay the tax and NICs you owe. If you lose, you could face very large bills, with legal costs on top of the tax you owe, penalties and growing interest.
- You could be treated as a high-risk taxpayer. This undesirable outcome means HMRC will closely scrutinise all of your tax affairs in future, not just your use of the avoidance scheme.
In a recent consultation paper HMRC has proposed that from April 2017 the promoters and developers of defeated tax schemes should be subject to penalties based on the tax purportedly avoided.
Danby Bloch is chairman at Helm Godfrey