Contractor Loan Schemes – Too Good To Be True?

With a basic rate of tax of 20%, a higher rate of 40% and National Insurance contributions on top, it is easy to see why advertised schemes that offer contractors the opportunity to retain as much as 90% of their income appear attractive. However, HMRC are clamping down on such schemes, and have warned contractors that if a scheme seems too good to be true, it probably is.

Although there are different variants of the scheme on the market, the common factor is the use of loans to reduce the tax that the contractor pays on his or her income. Instead of the contractor receiving the income directly and paying tax on it, the income is instead diverted through a chain of companies, partnerships or trusts, which makes a loan to the contractor. The contractor will usually be paid a small salary to mop up his or her personal allowance. The salary is topped up with the loan. The tax savings arise because the loan is not part of the contractor’s income and (other than any benefit-in-kind charge on the loan) provides the contractor with the use of the money tax-free – in theory, at least. 

HMRC regard schemes of this nature as tax avoidance schemes, and advise anyone who has used such a scheme to withdraw from it and settle any tax that they owe. The rub is that the ’loans’ are not really loans in the true sense of the word, as they are never repayable and the money received by the contractor is used as if it were his or her money. HMRC take the view that these schemes don’t work, and will seek tax, interest and penalties on the money received by contractors in the form of loans. The purpose of the arrangement is to avoid tax.

In the case of Boyle v HM Revenue and Customs [2013] UKFTT 723 (TC), the First-tier Tribunal supported HMRC’s view that such loans are taxable, finding that the loans were not genuine and that the appellant never believed that the ’loans’ were anything other than a means of receiving income without tax. HMRC is pursuing people who have used schemes similar to the one used by Mr Boyle (thought to be about 15,000 people).

In September 2015, HMRC published Spotlight 26, warning taxpayers about the use of contractor loan schemes. In the Spotlight, they highlight the following three warning signs that might alert potential users to the fact that the scheme is in fact a tax avoidance scheme:

HMRC will challenge the scheme and ensure users pay the correct amount of tax. You should take impartial advice on your contract work and not rely on the promoter who is selling you the scheme.

The promoters’ websites and promotional literature claim that they are fully compliant and are HMRC approved. HMRC doesn’t view these arrangements as compliant and never approves any schemes.

Contractor loan schemes, of the sort described above, must be declared under the Disclosure of Tax Avoidance Schemes legislation. The promoter is required to pass the scheme reference number (SRN) to all the users, who must put this on their tax return. A failure to show the correct SRN on your tax return will lead to additional penalty charges. 

We will investigate both disclosed and undisclosed schemes and users who have not advised of their participation may face additional penalty charges.’

HMRC have also published a list of ten reasons why contractors should steer clear of these schemes. The list (‘ten things about contractor loan schemes’) is available on the Gov.UK website (see www.gov.uk/government/publications/ten-things-about-contractor-loan-schemes).

If you have inadvertently fallen foul of one of these schemes, it is advisable to contact HMRC. Although the specific disclosure opportunity for contractor loans has now passed, it is always better to approach HMRC to settle your affairs than to wait for them to find you.