HMRC has published details of tax avoidance schemes that are being used by employers, agencies and other intermediaries to avoid payment of income tax and national insurance contributions. These and other types of tax avoidance scheme are published in HMRC’s Spotlights, notifications aiming to publicise avoidance schemes that are considered by HMRC not to work. HMRC believes these tax avoidance schemes could be successfully challenged in the Courts. HMRC summarises the schemes and sets out what users of the schemes should do to bring their tax affairs into order. The Spotlights are available online on the UK government website.
One of the main types of tax avoidance scheme for remuneration is the loan scheme. These schemes involve the employees being paid a small amount of remuneration but the main part of the remuneration is paid in the form of loans from third parties.
On 10 August 2017 the latest Spotlight on contractor avoidance, Spotlight 39, was published with the title Disguised remuneration: re-describing loans. This type of scheme involves the scheme users receiving sums from their disguised remuneration schemes under loan agreements; but they can claim that the money is only held by them in a fiduciary capacity. In the view of HMRC this is just a different name for the transaction that does not change the facts of what has happened, and they consider that re-describing the loans does not change the reality.
The IMF issued a report on Japan’s economic position on 31 July 2017 following the conclusion of discussions under Article IV of the IMF’s articles of association.
The report notes that Japan’s economy is growing above potential with positive private consumption growth and stronger private investment. There are however labor shortages, weak wage growth and persistently low inflation. The IMF expects the growth to continue through 2017 but to fall back in 2018 if the fiscal stimulus support decreases as currently planned.
The IMF directors consider that the current favorable environment provides an opportunity to go ahead with a comprehensive reform package to sustain growth, raise inflation and deal with the medium term challenges including fiscal consolidation and increasing potential growth.
A selected issues paper published at the same time as the report looks at tax policy challenges of an aging and declining population. This notes that the consumption tax should remain the main part of revenue reform but that the timing of rate increases is important. Other potential tax measures should also be examined.
The consumption tax is an important policy owing to the size of the public debt and the need for more health and social security spending for the ageing population. Although expenditure reform is also required Japan will need additional revenue. The consumption tax rate is currently low relative to other industrialized countries and there is therefore room for raising the tax rate. Also the efficiency of collection of the consumption tax is high so more revenue can be raised with low collection costs. Raising the consumption tax rate is likely to be less detrimental to economic growth than other tax options. A gradual increase each year would reduce any volatility of the impact on growth. The IMF is therefore proposing gradual increases to the consumption tax as part of a broader fiscal adjustment package.
Other potential tax measures
Other taxes such as a tighter personal income tax, property tax, inheritance tax or asset and wealth tax could also be examined to supplement the revenue gains that can be earned from the consumption tax increase.
Personal income tax
Tightening the personal income tax would contribute to revenue growth. The top rate of personal income tax is currently one of the highest in the OECD but reforms could focus on addressing inequality and eliminating disincentives to work. The low collection level of the tax indicates that there are a large number of deductions and these enable the higher earners to obtain benefits. The deductions could be replaced with more progressive measures such as targeted tax credits.
This could be linked to other reforms such as eliminating disincentives to full-time or regular work resulting from the operation of the spousal tax deduction. Exemptions for pension income could be reduced and targeted tax credits for elderly workers could increase incentives for them to remain in the labor market.
In Japan only 30% of local tax revenue is raised from recurrent property tax, compared with 100% in the UK and Australia, 90% in Canada and 75% in the US. Raising property taxes would provide a more stable revenue base for local governments and reduce the level of transfers from the center. This could encourage growth and raise revenue as property tax is the most efficient tax.
Asset or wealth tax
Only a few countries currently use wealth taxes and one important motivation for them has been as a temporary measure in a broader fiscal consolidation. Countries that scrapped their wealth taxes cited high administrative costs compared to revenue collected and problems of capital flight as reasons for its discontinuance. Generally a wealth tax is best structured with very few exemptions, a high threshold of liability and a flat marginal rate set at a low level.
The UK’s National Audit Office has noted that the tax authority HMRC is currently pursuing around a third of the UK’s wealthiest people for a total of around GBP 1.9 billion in underpaid tax. The National Audit Office (NAO) is a watchdog that reviews government spending. Their report notes that most of the HMRC enquiries are related to the legal interpretation of complex tax issues rather than to tax evasion.
HMRC has a specialist unit the looks at the tax affairs of high net worth individuals. The unit scrutinizes the tax position of around 6,500 of the wealthiest individuals in the UK, defined as those with assets totaling more than GBP 20 million.
The NAO report notes that HMRC assigns a customer relationship manager (CRM) to each high net worth individual. In practice this means working with the tax agent of the individual. Each of the forty CRMs has a team of staff and each team is responsible for around 160 of the wealthy taxpayers. The report notes that the use of CRMs for high net worth individuals is not common in other countries.
HMRC considers that high net worth individuals frequently have complex tax affairs and this gives them more opportunity to carry out tax planning than is the case for the average taxpayer in the UK. In 2015/16 the specialist unit managed to collect an extra GBP 416 million in tax from this group of people, in addition to the amount the individuals had originally paid in income tax, national insurance and capital gains tax on their income and gains for the year.
HMRC sees a need to demonstrate that the tax system is fair and that the widespread impression that wealthy people pay very little tax is incorrect. The NAO is in agreement that HMRC should have a specialist unit dedicated to scrutinizing the tax affairs of these wealthy people. The report called on HMRC to identify the most effective ways to collect the tax due from this group of individuals.
The report estimated that one in three of the wealthiest individuals were currently the subject of a formal enquiry and an average of four issues was being examined for each taxpayer. The enquiries often require a long period of time to complete and the estimated GBP 1.9 billion in tax that could be collected therefore relates to more than one tax year. The report notes that of the issues subject to enquiry six thousand have been open for more than eighteen months and of these four thousand have been open for more than three years. Of the total tax in dispute around GBP 1.1 billion or more than half the total relates to tax avoidance schemes.
The report by the NAO notes that HMRC gives priority to recovering tax where it identifies fraud and uses civil investigations to recover the tax in the majority of cases. Issues of tax evasion are unusual but where such a case arises there is normally a significant amount of tax involved. In the past five years 72 cases involving tax fraud by high net worth individuals have been investigated and completed and these have resulted in the collection of GBP 80 million in additional tax and penalties. Of these cases involving tax fraud two were subject to criminal investigation and there was one criminal conviction. Another ten high net worth individuals are currently subject to a criminal investigation.
HMRC has taken note of the leaked documents known as the Panama Papers containing information on the use of shell companies. Around forty potential cases involving high net worth individuals have been identified by HMRC from those documents and those cases are currently under investigation by the fraud investigation service and by staff in the high net worth unit.
The NAO report notes that the approach used by HMRC in the case of high net worth individuals has developed over time. The tax authority initially focused on building up a better understanding of the tax situation of high net worth individuals but it has now refined its approach and has focused increasingly on the highest risk taxpayers. The report suggests that HMRC should evaluate its approach and use the resulting analysis to increase the effectiveness of its work.
On 22 August 2016 the OECD released a discussion draft on branch mismatch structures under Action 2 of the OECD report on base erosion and profit shifting (BEPS). Comments are invited from interested parties by 19 September 2016.
The discussion draft applies the principles outlined in the report on Action 2 to the basic types of branch mismatch arrangement and outlines preliminary recommendations for domestic tax rules to neutralize the mismatch in tax outcomes.
Branch mismatches arise when the ordinary tax accounting rules for allocating income and expenditure between branch and head office result in a situation where the net income of the taxpayer falls out of the charge to taxation in both the branch and the head office jurisdiction.
Branch Payee Structures
The discussion draft looks at two branch payee structures. In these structures the branch is the recipient of the payment but the income received is not subject to tax.
In the case of disregarded branch structures the payee has an insufficient presence in the branch jurisdiction to be taxable on the payment. In the case of diverted branch payments the branch jurisdiction exempts or excludes the payment from taxation on the grounds that the payment was made to the head office.
The paper notes that the simplest way to prevent a deduction non-inclusion (D/NI) outcome for the branch payee structure is for the residence jurisdiction to restrict the scope of the branch exemption so it does not cover payments that have not been brought into account for tax purposes by the branch. The residence jurisdiction could consider making improvements in the operation of the branch exemption so that payments disregarded, excluded or exempt in the branch jurisdiction are treated as received directly by the head office (and are therefore outside the exemption).
Given the similarity between reverse hybrid and branch payee structures the draft recommends that the jurisdiction of the payer should adopt a branch payee mismatch rule, in line with Chapter 4 of the BEPS Action 4 report. This would deny a deduction for a diverted branch payment of a disregarded branch if the branch structure gives rise to a mismatch in tax outcomes.
The branch payee mismatch rule should only apply to payments made under a structured arrangement or between members of the same group. The rule would only apply where there is a mismatch under the ordinary rules for allocating branch income.
Deemed branch payments
It is possible to generate an internal mismatch between the branch and the head office by exploiting rules that permit the taxpayer to recognize a deemed payment between the branch and head office and where there is no corresponding adjustment to the net income in the payee jurisdiction to recognize the effect of this deemed payment.
Given the similarity between disregarded hybrid and deemed branch payments the draft recommends that countries introduce rules neutralizing the effect of the arrangements consistent with Chapter 3 of the BEPS report on hybrid mismatches. The deemed branch payment rule would apply to a notional or deemed payment between the branch and the head office that was deductible under the laws of one jurisdiction (the payer jurisdiction) but not included in ordinary income under the laws of the other jurisdiction; and where the resulting deduction was eligible to be offset against non-dual inclusion income.
Double deduction (DD) branch payments
A double deduction outcome arises where the same item of expenditure is treated as deductible under the laws of more than one jurisdiction. These mismatches give rise to tax policy concerns where the laws of both jurisdictions permit the deduction to be offset against income that is not taxable under the laws of the other jurisdiction (i.e. against non-dual inclusive income).
The BEPS report on hybrid mismatches considered that the recommendations of chapter 6 could apply to DD outcomes using branch structures. The current consultation paper considers the application of that recommendation to branch structures.
Imported branch mismatches
This situation arises when a person with a deduction under a branch mismatch arrangement offsets that deduction against a taxpayer payment received from a third party. An imported mismatch rule is needed to deny the deduction for any payment that is directly or indirectly set off against any type of branch mismatch payment.
On 10 August 2016 HMRC issued a consultation document on tackling disguised remuneration. This consultation follows the issue earlier in the year of an overview of the proposed changes and a technical note setting out the background and intended outcome of the changes. Some of the proposed amendments have already been introduced but some are to be included in the Finance Bill 2017 following further consultation.
The changes to the legislation involve amendments to Part 7A of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) to clarify that the rules apply to all forms of disguised remuneration scheme. The changes also clarify that references in the legislation to an employee include directors and any individual contractors working under a contract of employment even if they regard themselves as self-employed.
Most disguised remuneration schemes involve a loan made by a third party to an employee. Some schemes however involve an initial loan by another party such as the employer, followed by further steps to ensure that finally the employee owes the balance of the loan to the third party.
An arrangement falls within Part 7A if it first meets the conditions of the “gateway” in section 554A ITEPA. Some schemes attempt to avoid being caught by claiming the disguised remuneration is not in connection with the employment. To clarify that these schemes are caught by the legislation another “closed companies” gateway will be added to Part 7A. This will broadly cover situations where an individual has a connection with a close company and the individual and the close company are both parties to an arrangement whose outcome is that payments or benefits are provided to the individual. A tax charge would then arise where there is a “relevant step” by a third party for the purposes of the legislation.
The disguised remuneration rules are also to be amended to clarify that the write-off or release of a disguised remuneration loan is a relevant step for the purposes of the legislation and will therefore give rise to a charge to tax under Part 7A.
In the technical note issued earlier in the year the government announced the intention of broadening the power for HMRC to transfer income tax and national insurance contributions from employers to employees if a disguised remuneration scheme is used. However safeguards need to be put in place to ensure the liability is not transferred in situations where this is not appropriate. The consultation paper therefore sets out proposals to deal with three situations which are:
- Where there is a non-UK employer that has been set up only for the purpose of the disguised remuneration scheme and the employee provides services to a person in the UK;
- Where the employer still exists when the Part 7A charge arises but cannot meet the liability; or
- Where the employer no longer exists when the Part 7A charge arises.
The consultation paper invites comments on whether sufficient safeguards are included to ensure the liability is not inappropriately transferred and whether there are other circumstances where the liability could be transferred.
There is to be a new charge on outstanding disguised remuneration loans (the loan charge). This is to apply where the loan was made to an employee or director, the gateway conditions are met on 5 April 2019; the loan was made on or after 6 April 1999; and the loan or part thereof is outstanding immediately before the end of 5 April 2019. If all the conditions are met an amount equal to the balance of the loan would be liable to tax under Part 7A. The provision for gateway conditions to be met on 5 April 2019 gives recipients of such loans a chance to repay the loan before that date to avoid the charge arising.
HMRC is inviting comments from interested parties by 5 October 2016.
On 12 July 2016 HMRC published the results of research undertaken to understand the implications for employers and engagers if they are given responsibility for operating the intermediaries legislation. The intermediaries legislation combats tax avoidance by individuals who would normally be taxed as employees but supply their services through an intermediary such as a Personal Service Company (PSC). This ensures that there is no loss to the Exchequer of tax or national insurance contributions that would otherwise be due from the individual.
Currently the responsibility for deciding whether the rules apply in a particular case lies with the intermediary. However as the current legislation is not working as well as it should HMRC published a consultation document in July 2015 on possible changes to the legislation. One option was to make employers and engagers responsible for deciding if the intermediaries legislation applies in a particular case.
The research explored the awareness and understanding of the intermediaries legislation by businesses and sought insights into the behaviors, processes and burdens of employers when hiring workers through companies rather than directly. The research was also undertaken to assess the likely impact on employers if the responsibility for operating the intermediaries rules was placed on them rather than the intermediary. Finally the research looked at likely incentives for non-compliance and barriers to compliance.
The research report concludes that the potential changes to the intermediaries legislation are not supported by all businesses. Many businesses use temporary staff and they consider these staff to be important for the success of their business because of the flexibility of the arrangments and the skills they bring with them. The option to shift responsibility for applying the intermediaries legislation to the employer was seen as undermining their businesses and their relationship with the self-employed workers. The changes were also seen as potentially costly to the businesses and imposing a burden on them. Even businesses that rarely used Personal Service Companies considered this to be the case.
The businesses also saw that there could be negative effects for the individuals working through PSCs. The businesses would have to err on the side of caution in deciding whether to apply the intermediaries legislation, to avoid negative repercussions for the business. This would mean that they were less likely to use PSCs or would want to place the individuals into the payroll of the business. This would remove the flexibility of the arrangements.
Businesses however are concerned to comply with any relevant legislation and therefore expressed their need or information from HMRC and clarity on the legislation to allow them to adapt to changes. Further information on changes could help to resolve the uncertainty of businesses about losing the flexibility of the arrangements.
The intermediaries legislation was introduced in the UK to ensure that people doing the same work for the same pay were liable to the same tax and national insurance contributions whether employed directly or working through an intermediary such as their own personal services company. The UK government considers however that there is widespread non-compliance with the intermediaries legislation and is therefore proposing some amendments.
From April 2017 public sector bodies and agencies will become responsible for operating the tax rules that apply to off-payroll working in the public sector. The rules as they apply to the private sector will continue as before.
This consultation is about reforming the intermediaries legislation to improve its effectiveness in the public sector. The proposals therefore apply to people working in the public sector through their own personal service companies. From April 2017 the public sector body will be required to apply the intermediaries tax rules and pay the relevant income tax and national insurance contributions.
The consultation seeks views on the impact of this change and the details of the policy, including the new process to help determine whether an intermediary is within the scope of the rules.
The consultation is inviting opinions from interested parties on:
• the scope of the reform of the intermediaries legislation;
• how the reformed rules will work; and
• ways to minimize burdens on engagers who are affected.
The public sector organization engaging the services will first need to decide if the rules apply and then calculate, report and pay the relevant taxes. The government is introducing a new gateway process to allow anyone taking on a worker through a personal services company to determine if the intermediary tax rules need to be considered. The aim is to give the engager certainty about the application of the rules.
There will be a right of appeal against the tax or national insurance liability. If the engager and the personal service company disagree on the application of the rules a formal review of the decision may be requested and the decision can be appealed to a Tribunal.