Contractors thinking of joining a tax avoidance scheme should consider risks, as well as the benefits. The scheme may well work, and provide a safe, tax-efficient solution. But there can also be downsides to joining a legal tax avoidance scheme.
James Abbott, founder and head of tax at contractor accountants Abbott Moore, explains: “Contractor tax avoidance schemes could lead to substantial tax savings, and they can also provide cashflow advantages to maximise the value of investments.
“However, there are risks, and HMRC has a high success rate in overturning tax schemes, generally leaving contractors to foot the bill. So contractors with the risk appetite for avoidance schemes should ensure they fully understand the risks before joining any schemes.”
The advantages to consider when entering a scheme
According to Abbott, the primary advantage is that the scheme might actually work: “The scheme could work and there could be a substantial tax saving. This sounds like an obvious point, but with HMRC winning 85% of anti-avoidance cases, only the most ‘cast iron’ schemes can actually save contractors significant amounts of tax. For example, some schemes provide contactors with effective rates of 97% on some types of income.
Contractor tax avoidance schemes could lead to substantial tax savings, and they can also provide cashflow advantages to maximise the value of investments
James Abbott, Abbott Moore
“Not only is there a lot of income tax savings at stake. There is potentially a considerable cashflow advantage, too. The contractor may have the use of significant amounts of cash that would otherwise be paid out as tax for several years that can be used for investments to generate additional income.”
Even if the contractor eventually has to pay back the tax, interest and perhaps fines, they will have enjoyed the use of the money for many years before it needs to be handed back to the taxman.
The downsides: HMRC has an 85% success rate overturning schemes
Abbott emphasises that there are many risks associated with tax avoidance schemes, not least of which is HMRC’s impressive success rate when challenging how specific schemes actually work.
“In many cases the odds are not in the contractor’s favour, with HMRC having an 85% success rate in attacking tax avoidance arrangements,” continues Abbott. “The underlying reasons for a scheme’s failure are many, but it could leave the contractor facing significant bills for back taxes, interest and perhaps penalties.”
Key risk factors for contractors
Abbott highlights that there are many risk factors contractors face when they choose to join tax avoidance schemes, and that contractors will typically be facing many of these risks simultaneously.
Some schemes depend on the very fringes of technical arguments and, even if the technical arguments are correct, there could be a slip-up in execution that means the scheme does not work, leaving the contractor exposed to subsequent HMRC demands for tax, interest and perhaps penalties.
Disputed schemes typically go back many years
Analysing the cases that have been reported shows that most go back many years as they escalate through tax tribunals and courts. As a result, contractors participating in schemes that have been attacked by HMRC may not know their actual tax position for many years.
Following on from the above point, contractors who lose a tax avoidance case may also owe interest and penalties in addition to the unpaid tax. Abbott highlights that HMRC has successfully applied for penalties on top of back tax and interest in some cases.
Clients may use tax avoidance schemes, but their contractors can’t
An increasing number of end-clients are particular about the entity with which they contract. For regular limited company contractors, or umbrella company contractors, this is not an issue. But Abbott has seen many contracts from clients that stipulate no offshore entities can be used, and that they will only deal with UK companies.
The underlying reasons for this are twofold. First is the moral issue of using suppliers that use offshore tax avoidance structures. Second is the liability issue for businesses if tax obligations are not being met by their contractors.
Furthermore, anti-avoidance legislation is growing. This includes, for example, the offshore intermediaries legislation introduced in April 2014, which sweeps up offshore promoters. Abbott says he has seen increasing evidence that end clients are saying, “We’re not using anyone who operates these types of schemes”.
Relying on scheme promoters can be risky
Abbott has experience where tax avoidance scheme promoters have not done what they promised or simply disappeared: “One client joined a scheme and two years later it was investigated, but the promoter had not filed any of the paperwork and went to ground when the contractor tried to contact them.
“Another client had a scheme promoter that simply went bust, and the contractor lost two month’s money.”
Abbott urges contractors using avoidance schemes to choose whoever is managing the scheme with great care: “Many schemes rely on the contractor giving up control of their money for the scheme to work.”
When entering a scheme, contractors should remember that the person selling the scheme is also the person advising them. It is prudent to go to someone independent, such as a qualified tax adviser, and get their view on whether the scheme will work.
Contractors should look at the track record of the scheme’s promoter, as this can reveal a great many facts about the likely risks they are facing.
Using tax avoidance schemes forever blots a contractor’s copybook with HMRC
Contractors using tax avoidance schemes are automatically treated as higher risk by HMRC, and will almost certainly be subject to investigation for the year(s) that they have used the scheme: “If a contractor enters into schemes that HMRC views as unacceptable, then their record is irrevocably stained.
“HMRC makes no secret of this and says that if a contractor has done something it views as high risk, then it is quite within the taxman’s rights to use this as a basis for what might happen in future.”
Beware of the court of public opinion. Abbott notes that if an individual is high profile, then the media will be interested in talking about it. Contractors may find that their private financial affairs are made public by virtue of having to go through the judicial cycle, even if in the end their scheme is proved to work.
Don’t believe in guaranteed schemes
Tax avoidance schemes are not guaranteed, and if a contractor is told that one is, they should run a mile. Contractors should check what any guarantees actually mean.
For example, does it mean that the promoter will fight up to the first two tribunals? “I’ve never come across a scheme where there is a firm 100% guarantee that it will work as it should in its entirety,” warns Abbott.
Previous tax avoidance scheme use could impact on a company’s value
“It is not unheard of for contractor businesses to grow beyond the one or two director shareholders into something bigger,” observes Abbott. “If the business owners then wish to sell or grow the business further, having participated in an avoidance scheme will be flagged during due diligence and for many potential buyers that could be a deal breaker.”
There is a perception that there are loads of tax avoidance schemes out there. This is no longer the case, says Abbott: “The number of schemes registered by the Disclosure of Tax Avoidance Schemes(DOTAS) rules reached a peak of over 200 in 2008/9. By April 2013, only 28 schemes had been registered.”
Abbott concludes: “What is morally wrong is for someone to enter into a scheme not understanding what they are entering into. But if a contractor is someone who understands the risk, then it is the individual’s choice to participate in legal tax avoidance schemes.”