Loan charge settlement – separating fact from fiction

We recently published a news piece 'Are you affected by the 2019 ‘loan charge’? Help is available' explaining the background to the loan charge, what it is and where to get help. We explained that your best source of help might actually come from HMRC, but we also highlighted alternative sources of help for people who are worried about speaking to HMRC directly.

The loan charge is causing a great deal of debate online and in Parliament. Strong feelings about the loan charge are being voiced by some of those who are affected and it has been suggested that there may be some legal challenges against the loan charge in the near future. Although a challenge to the loan charge will not stop HMRC from seeking to settle any avoidance disputes, all of this this may be causing you some confusion as to what steps to take next.

However, putting all of that aside, the loan charge is the current law and will apply from 5 April 2019. The bottom line is that realistically, in most cases, you have two options:

1. try to voluntarily agree to settle with HMRC any income tax and interest on the loans, before the loan charge comes into play on 5 April 2019; or
2. pay the loan charge. In many cases this option is likely to be more expensive than settling.

It is therefore important that anyone potentially affected by the loan charge fully understands the alternative ‘settlement’ option and what some of the practicalities are around it. This article aims to help answer those questions.  

I’m scared I’ll have to pay HMRC thousands of pounds – please help me understand what I might be facing

If you were only in a loan scheme for a short period of time and were not highly paid, then while you will have some tax to pay, things may not be as bad as you think. Some people will owe HMRC significant amounts that could run into thousands of pounds, maybe more. But HMRC will always take account of your individual circumstances and ability to pay when seeking to agree a settlement with you.

Most, but not all, loan schemes involved a non-UK trust. But there are also loan schemes operated by Umbrella companies and it may be that lower paid workers may be more likely to have been in one of these. Under HMRC’s ‘contactor’ settlement terms (these will be the terms most relevant to you if you were a lower paid agency worker who inadvertently got caught up in an umbrella company loan scheme), you only have to pay HMRC the tax that should have been paid on any untaxed loan income you received – not the whole amount of the loan itself.

If you would have been a basic rate taxpayer in the tax year in question, once adding in the loan, this tax will be up to 20% of the amount you received. If you still have some personal allowance spare for that tax year, it could work out as less than 20%. You can find current and past rates and allowances on GOV.UK.

The untaxed loan income amount will be the amount after any umbrella company fees have been deducted (these are not usually recognised for tax purposes so this is somewhat helpful). In addition, if you were an ‘employed’ contractor (most likely) you will not have to pay any of the National Insurance that would have been due had the earnings been paid to you properly (that is, as employment income under Pay As You Earn), in the first place.

If the unpaid tax relates to ‘open’ tax years (generally the last four complete tax years, that is, back to 2014/15, plus any earlier years where HMRC have opened a formal enquiry), then you will have to pay historic interest on the amount of unpaid tax that you owe. The current interest rate is 3.25%. Previous rates can be found on GOV.UK. Interest will be calculated from due date up to 5 April 2019 (or the date figures are submitted to HMRC if earlier).

If any of the unpaid tax relates to earlier ‘closed’ tax years, then HMRC will not charge you interest on them.

HMRC have indicated that penalties, on top of any tax and interest, will be the exception, rather than the norm. This is especially true for people who were ‘passive’ users of loan schemes, that is, people who may not have really understood what was happening with their pay and taxes or who had little choice but to join schemes if they wanted to work.

It is important to note that your settlement figure will include any additional Student Loan Repayments for the years being settled, based on your increased level of income in those years.

In order to get a better understanding of what all this, taken together, might mean for you in practice, you should read the examples that we have set out at the end of this news piece, which look at some likely settlement figures, across a number of different scenarios. We also provide an indication of what might be payable under the loan charge for comparison purposes.

A word of warning – on occasion, you might be better off under the loan charge. You need to weigh things up carefully and come to a conclusion about what option is right for you as set out in our earlier news piece 'Are you affected by the 2019 ‘loan charge’? Help is available'.

I can’t provide information on the amounts of the loans I received. I suppose HMRC will just use an estimate – which won’t be in my favour?

HMRC understand that some people did not even know that they were in a loan scheme and so will not know the amounts that they received in loans. They also appreciate that pay documents and other paperwork may only have been provided online – and are therefore locked away in systems or platforms that you can no longer access.

In these circumstances, you should do everything you can to get the information that HMRC require to be able to actually determine the amount you received in loans. For example, by trying to contact the umbrella company (or even the recruitment agency – who might be able to point you in the right direction) or by looking at the flow of money into your bank account. You should be able to get historic bank statements from your bank or building society. If you have online banking, statements going back several years can usually be accessed easily and for free.

If all else fails, HMRC will try to extrapolate the amount you received in loans by looking at the type of work you were doing (and thus, your likely pay rate) and what they know from their own records. By putting this together with information that they have about how umbrella loan schemes typically worked, they should be able to identify, quite accurately, the amount of money you received in loans.

I want to settle with HMRC but have really limited means – are HMRC able to use any discretion whatsoever when coming to a settlement figure?

Generally, HMRC seek to collect everything that is legally due. They would be quite rightly, open to serious criticism if they didn’t do this.

However, they could also be criticised, if they didn’t act reasonably towards people who want to bring their tax affairs up to date once and for all, but are genuinely in a situation where they cannot pay everything they owe.

For these reasons, although HMRC will never compromise on the amount of tax that you owe and are simply not able to ‘release’ people from tax liabilities, in certain circumstances they may agree to accept a lower amount by way of settlement where it is reasonable to do so, as set out in their manual at EM6210.

These powers allow HMRC to consider the person’s individual circumstances when determining the final settlement amount. So even if the amount calculated as owed is say £50,000, HMRC can agree a contract settlement for £40,000 if circumstances justify such an approach.

HMRC will use these powers occasionally, when there is just no hope of getting the full amount of money, even with an instalment arrangement in place (see below); for example where a person is elderly, sick, long-term unemployed or where there is little prospect of their financial situation improving. You will appreciate that HMRC can only consider this course of action on the basis of a full and frank discussion with you as to your individual facts and circumstances.

HMRC say I can pay the money owed over five years if I settle my affairs ahead of the loan charge coming in – will I have to provide evidence to do this?

No – HMRC say that provided you meet the conditions (such as having income under £50,000 a year and no longer engaging in tax avoidance), a 5-year instalment arrangement will be offered on a ‘no questions asked’ basis. We understand that HMRC do not necessarily require the initial payment to be made on or before 5 April, rather it is the agreement itself which must be in place by 5 April.

Even if HMRC have agreed to accept a lesser amount by way of settlement because of your circumstances (as explained above) you can still ask for a 5-year instalment arrangement over which to pay the agreed settlement amount.

If you need longer than 5 years to pay then HMRC will consider cases on an individual basis. You should be aware that HMRC may not agree to any kind of longer term instalment arrangement, if, for example, there are assets you could sell or other ways of raising the money more quickly (see question below for more information).

You should also be aware that if HMRC accept an instalment arrangement, then they will charge you ‘forward interest’ – which is the normal interest rate plus 1% (it will start running from 6 April 2019).  It is to compensate HMRC for the extra risk and cost involved in an extended payment. The estimated forward interest, based on the progressively reducing balance after each instalment, will be included in the settlement amount.

Will I be expected to sell my house or take a loan to repay HMRC?

You may have seen a letter that has appeared on social media, in which HMRC seem to be suggesting to someone that they need to exhaust every option of paying in one lump sum – such as by seeking a bank loan or selling some assets – before HMRC will even consider an instalment arrangement. However, we understand that this letter was specific to the particular circumstances of the case.

Indeed, while such requirements may be part of their general settlement strategy, HMRC have recognised the need for a more tailored approach in many loan charge cases – hence the introduction of the 5-year ‘no questions asked’ arrangement described above, for example.

Of course raising a loan or selling some assets to pay your settlement bill are options – you may wish to do this to put the matter completely behind you or because you can get a bank loan at an interest rate that is cheaper than HMRC’s forward interest rate. But for those who can otherwise make a 5-year instalment arrangement, they are just that – options.

We know that there are many people online talking about bankruptcy in connection with the loan charge and that this can sound very scary. HMRC will only pursue bankruptcy as a very final option such as where there are valuable assets that could be used towards payment of the debt and they have just been unable to come to any other reasonable arrangement with the taxpayer.

Some people who are facing huge bills to pay may end up in bankruptcy – this may be initiated themselves, because they are insolvent and want a fresh start or it may be as a result of HMRC petitioning for bankruptcy.

For homeowners, HMRC may also consider putting a legal charge on a property, which means that the debt is repaid when the house is sold. These arrangements are dealt with by HMRC’s Debt Management team but current guidance is that they are only used as a last resort in very specific circumstances.

I’ve heard I’ll have to deal with another part of HMRC if I want to arrange to pay over an extended time?

No – the team that you deal with to reach a settlement will also be the ones who will agree an instalment arrangement with you. In fact, the same team, indeed, potentially even the same person, will look after your case from the start of the process to the end. This should save you having to discuss your details over and over again with different parts of HMRC.

If an instalment agreement is made, it is obviously imperative that you meet these payments in full and on time. If you default on the instalment arrangement made, then the debt will be passed to HMRC’s Debt Management team.

Am I too late to reach settlement with HMRC now anyway?

No, you are not. But you need to move quickly. If you are not already speaking to someone at HMRC about your affairs, but want to settle, you should email [email protected] or ask one of the tax charities for help.

Originally, HMRC asked those who wanted to ‘settle’ their tax affairs to let them know and provide all of the information required to calculate a settlement by 30 September 2018. This was to ensure there was enough time to process the settlement before the loan charge comes into effect on 5 April 2019.

But this 30 September 2018 date was set to try and encourage people to contact them in good time. In fact HMRC will still do their utmost to reach a settlement with you to avoid the loan charge, provided you come forward as soon as possible, although as we explained previously this is not guaranteed.

The bottom line however is that it takes time to process settlements, so if you leave things to the last minute, there is very little chance of HMRC being able to deal with you before the 5 April 2019.

Examples – settlement figures

In conjunction with reading these examples, you may wish to familiarise yourself with the tax rates and allowances for the tax years concerned and also, for comparison purposes, the basis on which the loan charge is calculated and collected, as set out in our earlier news piece 'Are you affected by the 2019 ‘loan charge’? Help is available'.

It should be assumed that none of the people below are Scottish taxpayers (to whom slightly different tax rates apply for some of the years). They have no other income, do not have any student loans to repay and unless otherwise stated, either a discovery assessment has been issued or an enquiry has been opened, or HMRC are in a position where they could either issue an assessment or open an enquiry.

Anna

Anna was in a loan scheme during the tax years 2014/15 and 2015/16. In 2014/15, she received a normal salary of £10,000 and an untaxed loan of £12,000. In 2015/16, she received a normal salary of £9,000 and an untaxed loan of £8,000.

In 2018/19, she has income of £19,000.

If Anna chooses to settle with HMRC to avoid the loan charge, the tax due will be £3,680. This is calculated as follows:

2014/15: Spare capacity in personal allowance (£10,000): none (it has all been used up by her normal salary). Full amount of loan (£12,000) to be taxed at 20% = £2,400 tax.

2015/16: Spare capacity in personal allowance (£10,600): £1,600 (£9,000 used up by her normal salary). Amount of loan (£6,400, that is £8,000 less £1,600) to be taxed at 20% = £1,280 tax.

Historic interest due on these amounts = approximately £308.

Total tax and historic interest due to HMRC under settlement = £3,988.

If Anna wants to pay this amount over 5 years, in equal monthly instalments, then HMRC will add forward interest of roughly £424. This means that her total settlement figure will be £4,412, or £73 per month for the next five years.

For comparison purposes, under the loan charge, the £20,000 of untaxed loans will be treated as income in 2018/19. As Anna is a basic rate taxpayer in 2018/19 and the extra income does not push her into a higher rate bracket, this would mean tax of £4,000 (£20,000 multiplied by 20%). This would be due to HMRC by 31 January 2020.

Total tax due to HMRC under the loan charge = £4,000. If Anna was able to negotiate to pay this amount in instalments rather than in one go, then forward interest would be payable in addition to this amount.

Brian

Brian was in a loan scheme during the tax years 2014/15, 2015/16 and 2016/17. In 2014/15, he received a normal salary of £10,000 and an untaxed loan of £18,000. In 2015/16, he received a normal salary of £10,500 and an untaxed loan of £18,000. In 2016/17, he received a normal salary of £11,000 and an untaxed loan of £18,000

In 2018/19, he has income of £24,000.

If Brian chooses to settle with HMRC to avoid the loan charge, the tax due will be £10,780. This is calculated as follows:

2014/15: Spare capacity in personal allowance (£10,000): none (it is all used up by his normal salary). Full amount of loan (£18,000) to be taxed at 20% = £3,600 tax.

2015/16: Spare capacity in personal allowance (£10,600): £100 (£10,500 used up by his normal salary). Amount of loan (£17,900, that is £18,000 less £100) to be taxed at 20% = £3,580 tax.

2016/17: Spare capacity in personal allowance (£11,000): none (it is all used up by his normal salary). Full amount of loan (£18,000) to be taxed at 20% = £3,600 tax.

Historic interest due on these amounts = approximately £702.

Total tax and historic interest due to HMRC under settlement = £11,482.

If Brian wants to pay this amount over 5 years, in equal monthly instalments, then HMRC will add forward interest of roughly £1,220. This means that his total settlement figure will be £12,702, or £211.70 per month for the next five years.

For comparison purposes, under the loan charge, the £54,000 of untaxed loans will be treated as income in 2018/19. Brian already has income of £24,000, so only has some of his basic rate band available (£22,350) to use against the extra income. This would mean the remaining £31,650 of it will be taxed at 40%. This gives a total tax amount of £17,130 (£22,350 multiplied by 20% (£4,470) and £31,650 multiplied by 40% (£12,660)). This would be due to HMRC by 31 January 2020.

It is worth noting that as Brian has two children, and receives child benefit, the High Income Child Benefit Charge (HICBC) would apply for 2018/19 if the loan charge arises. As Brian has over £60,000 of income in this year, the charge would be equal to 100% of the child benefit payments (currently £1,789). This is repayable to HMRC - additional to the loan charge tax.

Total tax and HICBC due to HMRC under the loan charge = £18,919. If Brian was able to negotiate to pay this amount in instalments rather than in one go, then forward interest would be payable in addition to this amount.

Cleaverson

Cleaverson was in a loan scheme during the tax years 2012/12, 2013/14, 2014/15, 2015/16, 2016/17 and 2017/18. In all years, he received a normal salary of £5,000 and an untaxed loan of £20,000.

Cleaverson has now retired and in 2018/19, he has income of £6,000.

If Cleaverson chooses to settle with HMRC to avoid the loan charge, the tax due will be £17,871. This is calculated as follows:

2012/13: Spare capacity in personal allowance (£8,105) – £3,105 (£5,000 used up by his normal salary). Amount of loan (£20,000) to be taxed at 20% = £16,895 (so £3,379 tax)

2013/14: Spare capacity in personal allowance (£9,440) – £4,440 (£5,000 used up by his normal salary). Amount of loan (£20,000) to be taxed at 20% = £15,560 (so £3,112 tax)

2014/15: Spare capacity in personal allowance (£10,000) – £5,000 (£5,000 used up by his normal salary). Amount of loan (£20,000) to be taxed at 20% = £15,000 (so £3,000 tax)

2015/16: Spare capacity in personal allowance (£10,600) – £5,600 (£5,000 used up by his normal salary). Amount of loan (£20,000) to be taxed at 20% = £14,440 (so £2,880 tax)

2016/17: Spare capacity in personal allowance (£11,000) – £6,000 (£5,000 used up by his normal salary). Amount of loan (£20,000) to be taxed at 20% = £14,000 (so £2,800 tax)

2017/18: Spare capacity in personal allowance (£11,500) – £6,500 (£5,000 used up by his normal salary). Amount of loan (£20,000) to be taxed at 20% = £13,500 (so £2,700 tax)

Historic interest due on these amounts = approximately £971. It is worth noting that 2012/13 is a now a closed year (where HMRC have not opened an enquiry or issued an assessment and are no longer in a position where they could do so), so no interest will be due for this year.

Total tax and historic interest due to HMRC under settlement = £18,842

If Cleaverson wants to pay this amount over 5 years, in equal monthly instalments, then HMRC will add forward interest of roughly £2,002. This means that his total settlement figure will be £20,844, or £347.40 per month for the next five years.

As Cleaverson is elderly and only has income of £500 a month from which to pay the debt (and has no other way of paying HMRC), this may be a situation where HMRC may agree to accept a slightly lower amount by way of settlement, as set out in their manual at EM6210.

For comparison purposes, under the loan charge, the £120,000 of untaxed loans will be treated as income in 2018/19. As Cleaverson’s total income in 2018/19 is £126,000, he is not entitled to any tax free personal allowance. Because of his £6,000 income, Cleaverson only has some of his basic rate band available (£28,500) to use against the extra loan charge income. This would mean the remaining £91,500 of it will be taxed at 40%. This gives a total tax amount of £42,300 (£28,500 multiplied by 20% (£5,700) and £91,500 multiplied by 40% (£36,600)). This would be due to HMRC by 31 January 2020.

Total tax due to HMRC under the loan charge: £42,300. If Cleaverson was able to negotiate to pay this amount in instalments rather than in one go, then forward interest would be payable in addition to this amount.