Contractor Tax: Loan scheme

Her Majesty's Revenue and Customs (HMRC) has the right to impose tax on loans funded to freelancers or contractors through umbrella companies or trusts – these loans are treated as normal income. If a freelancer/contractor has availed loan under the contractor loan scheme, then the amount received by a contractor is usually paid from a company or trust, at times denoted as a compensation or remuneration trust. Contractor loan can be availed by any qualified individual who generally works as a temporary workers or gets work from an agency for a specific number of hours

How can a contractor loan scheme cost more?

Many a times, there are misleading advertisements with regards to contractor loans. The Advertising Standards Authority (ASA) has passed a judgement against misleading advertisements of contractor loan schemes. HMRC filed a complaint with ASA regarding misrepresentative advertising and the ASA decided in favour of HMRC and stated that it is incorrect to promote contractor loans as a means of tax avoidance – the scheme was promoted by Williams Gordon. The scheme promoted by Williams Gordon is well-known as ‘contractor loan scheme’ and as per the scheme guidelines, a contractor receives a small part of the salary as pay-as-you-earn (PAYE) income, while the remaining amount is given as a loan which is claimed be to tax-free and no National Insurance (NI) is due on this amount. The Williams Gordon website stated that a contractor could take home 92% of their pay, and they would still be fully compliant with the essential HMRC regulations and with all existing IR35 policies

Such schemes can be risky for a contractor or freelancer because scheme promoters usually tell the contractor that the loan is non-taxable. However, in actuality, the loan amount is not paid back to the umbrella company, hence it’s treated similar to an income and is taxable. If a contractor is working with an umbrella company, under such a scheme, then he/she is highly probable to be evading tax. As a result, a contractor or freelancer could is required to pay extra tax, interest, and penalties along with some fee to the promoter. Under this scheme, a contractor does not get the amount directly from an umbrella company for which he/she is working – the amount is routed through a chain of partnerships, trusts, or companies. Such companies promote the scheme by telling that this method will save tax

HMRC’s take on ‘contractor loan scheme’

The HMRC has the following take on contractor loan scheme:

• Under this scheme, a freelancer/contractors is employed by an umbrella firm which offers the contractor’s services to clients (these are an umbrella company’s end-clients)
• For the services provided, an umbrella company charges the end-client and keeps 10% as a fee
• Out of the amount received from the end-clients, an umbrella company pays salary to a contractor – the salary amount is usually above the National Living Wage but less than the limit for National Insurance and tax
• The remaining invoice amount is given to a contractor as a loan – the terms and conditions of such a loan ensure that a contractor is not required to pay back the amount. Such loans are treated similar to a regular income and a contractor must be taxed in the similar manner

It must be noted that not all umbrella companies opt for such a tax avoidance arrangement. Usually, umbrella companies subtract the applicable National Insurance contribution and tax from the salary payable to a contractor

Key insights about the ASA ruling

The ASA took the objection filed by HMRC seriously and passed a ruling which states that – claims by Williams Gordon are ambiguous and must be revoked. The ruling also stated that the Williams Gordon website has failed to comment on the numerous government tools and guidelines intended at the evasion they were encouraging. This comprises the General Anti-Abuse Rule and the loan charge on masquerading compensation loans unpaid on 5-Apr-19. Additionally, the Williams Gordon website failed to highpoint the contractor loan scheme which was being offered as a practise of avoid tax. As per the ruling passed by ASA, users will be subject to an investigation by HMRC and will be held guilty if they don’t resolve their matters prior to 5-Apr-19. Additionally, contractors/freelancers might have to pay extra penalties, tax etc.

This ruling has set an example for promoters to not encourage such practises. This will ensure that other tax evading promoters cannot make similar claims under such a scheme. Williams Gordon and additional promoters will be required to withdraw the scheme or face the risk of ASA sanctions by not complying with the ruling

Protecting a contractor from such schemes

If a contractor/freelancer is operating under such a loan scheme, HMRC intensely recommends such contractors to pull themselves out of such a scheme and resolve the tax matters. If a contractor follows the suggestion of HMRC, he/she can escape the cost of enquiry and lawsuit, and reduce interest and fine charges on the actual payable tax

How to settle the tax affairs

By getting in touch with HMRC, a contractor/freelancer can resolve the tax affairs, and agree on the payable tax amount and if mandatory, decide on a payment plan. Settling the tax affairs will give a contractor confidence about his/her masquerading compensation scheme and may imply the following:

• A contractor/freelancer may not be required to pay the tax avoidance charge that will be applicable on 5-Apr-19
• A contractor/freelancer may be required to pay a decreased rate of tax on the loan – the loan charge will combine all the loan amounts and tax them in one year
• If a scheme moves to a lawsuit, these standings may not be valid

To settle the tax affair, a contractor or freelancer can still register, if, he/she has not resolved the matter by 31-May-2018, and did not inform HMRC about all the obligatory facts by 30-Sep-2018. A contractor/freelancer must get in touch with HMRC to initiate discussions to resolve the tax affair and share all the necessary information. The earlier a contractor sends the request to HMRC, the chances to reach a settlement increase. If a contractor is already in touch with HMRC about settling a disguised remuneration scheme, the following details can be used for further correspondence:

• For information about a contractor loan scheme, e-mail address is – cl.resolution@hmrc.gsi.gov.uk
• For information about disguised remuneration schemes, e-mail address is – ca.admin@hmrc.gsi.gov.uk

In order to settle the loan before the charges are imposed on 5-Apr-19, a contractor must send all the necessary information to HMRC:

For a contractor:

• Name of the employer
• Contractor’s unique taxpayer reference (UTR)
• Contractor’s National Insurance number
• Details about earnings in each tax year
• Information on the benefits a contractor wants to claim in kind offset

For an employer:

• Company’s PAYE reference number
• Name of the company and company reference number
• The amount paid into the scheme
• Information about any Corporation Tax assistance claimed on the scheme’s contributions
• Whether the umbrella company wants to claim an advantage in kind offset

A contractor can settle his/her due by paying:

• Income tax on the remaining amount of all disguised remuneration loans – this will be computed using the rates and bands in the years the payment or loans were made
• Late payment of interest due to HMRC for any years
• Remaining portion of National Insurance contributions
• Any inheritance tax and penalties, depending on a contractors circumstances

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.