Warr on...

Budget Note 66 set out to outlaw a particularly aggressive tax avoidance scheme that has been in use since 2000. Unusually the budget note itself stated that the scheme was in any case ineffective as a result of legislation introduced in 1987. Draft legislation can be found in Clause 55 to the Finance Bill 2008. Sub-clause 4 makes particularly interesting reading because it states that the remainder of Clause 55 shall be treated as always having had effect. The retrospective nature of this sub-clause attracted fierce debate in the committee stages but on a division the committee voted to leave Clause 55 intact in its entirety. Royal Assent is expected in mid July.

The scheme itself purported to work by an individual setting up a trust for his benefit in a tax haven such as the Isle of Man or Guernsey. The non-UK resident trustee would then form a partnership with similar trustees. The individual would divert income generated in the UK to the partnership, which would in turn distribute its profits to its partners (non-UK resident trustees), and they in turn would make payments to beneficiaries (in this case the individual who earned the income in the first place). It was claimed that the trust income received by the individual escaped taxation by virtue of the relevant double taxation treaty.

The original users of the scheme were property developers, but more recently it has attracted interest from persons providing engineering, IT and management consultancy services. In terms of tax at stake, property developers are the largest users of these schemes, but in terms of numbers, consultants are probably the largest group.

It is difficult to see what a person in such a scheme might do once the Finance Bill becomes an Act. Promoters of schemes may seek a judicial review, but the courts will be very reluctant to overturn the will of parliament and even if a challenge were successful, HMRC will almost certainly use the courts to argue that the existing law is sufficient to successfully challenge these schemes. As a test case would almost certainly end up at the House of Lords the final outcome may not be known for five years or more.

For many consultants there may be a completely different outcome. Some scheme organisers have perhaps been a little complacent with their information gathering when taking on new clients. A good example of a scheme set up to attract consultants is Island Contract Management. The information on the site states that the consultant must be self employed and it provides guidance to employment status in a “tick box” format. It is then left up to the consultant to decide whether or not he is self employed. The promoters arrange for his client to contract with a UK company supplied by the promoters, which they describe as a “UK Employment Agency”. In many cases the consultant is already providing his services to an end client through an agency, in this case the promoter’s UK company contracts with that agency. The promoter’s UK company remits the monies it receives to an Isle of Man partnership. The members of the partnership are trusts rather than individuals and one of the partners is a trust established by the consultant referred to above. The partnership pays up to £20,000 per annum to the consultant as self employed income, and the balance is paid to the consultant as tax-free trust income.

Even if the legislation is overturned and the scheme is shown to be effective after the court process has been exhausted, for many consultants the scheme is fundamentally flawed. The mistake made by the promoters was to place too much reliance on the distinction between employment and self employment.

Longstanding legislation can be found at Sections 44-47 ITEPA 2003. Where a worker provides services to a client in circumstances that the client has a right to exercise supervision, direction or control over the manner in which those services are provided, and the worker is paid by a third party, the third party must treat payments to the worker as income from employment. The third party is known as an “agent”. In some arrangements there is more than one agent. In the Island Contract Management (ICM) scheme the following are all agents:

(a) the conventional agency already contracting with the client (if there is one);
(b) the UK employment agency provided by ICM; and
(c) the trustee.

The partnership itself is not an agent because S46 provides that a share of profits from a partnership shall be treated as remuneration paid directly to the worker.

The taxation of employment income is governed by Employment Regulations. These place the burden of responsibility for collecting and paying over PAYE firmly on the shoulders of the employer (or employers), although in some circumstances an employee can be responsible.

Useful information about how HMRC deals with these situations can be found in their internal Employment Status Manual. In most cases HMRC will seek to collect PAYE from the “agency” who paid the worker, or if that agency is outside the UK, from the “agency” in the UK who remitted monies outside the UK. If that agency becomes insolvent, HMRC will go to the next agency in the chain (if there is one).

In the ICM scheme, the promoter’s UK employment agency is likely to be the target of an attack by HMRC, followed by the traditional agency (if there is one). This is likely to come as a surprise to any traditional agency, but they are only likely to escape liability if they can show that they acted in good faith and after enquiry believed that the company they were paying was either the personal service company of the worker or an umbrella company by whom he was employed.

It is unlikely that HMRC will initially want to go down this route. They would need to look carefully at the working arrangements of each scheme member as they don’t know who is and who is not under the control of their client. A good example of the dilemma they can be faced with can be found in the Employment Status Manual at ESM2005 where a distinction is made between a relief Head Chef and an under-chef. It is far easier for HMRC to amend the self assessments of all individual scheme members to re-classify exempt trust income as taxable income from self employment. This is almost certainly what HMRC intend to do once the Finance Bill receives Royal Assent.

There exists a window of opportunity for former scheme members to use the above argument against HMRC. Before adopting such an approach professional advice should be sought, as this is a highly complex area and the strategy could backfire. However, in the right circumstances and with the right professional advice HMRC could be persuaded to collect outstanding tax from the scheme promoter’s UK company or, failing that from the UK agency through which the work was obtained (if there is one) rather than from the consultant himself.

Advice in this complex area is unlikely to be forthcoming from the scheme promoters (for obvious reasons) or from accountants who act for or receive referrals from UK agencies (because of a potential conflict of interest). Warr & Co have experience in this area and are in discussion with a number of former scheme members. Please contact us if you would like to learn more.

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Date of Article: 30th May 2008