New disclosure rules for tax avoidance schemes

In the Budget on 17 March the Chancellor of the Exchequer announced rules which introduce a new obligation on promoters and users of certain tax schemes and arrangements to disclose details of those arrangements to the Inland Revenue. The Inland Revenue published draft regulations on 17 May setting out further details of how the disclosure rules will operate.

The draft regulations include:

• details of the financial and employment based arrangements that must be notified under the disclosure rules;
  
• procedural rules setting out how and when disclosures need to be made; and
  
• a restriction on the definition of promoter where a group tax department provides tax services to another company in the same group.

Consultation on the draft regulations will end on 30 June 2004. As the covering press release notes, this period of consultation is less than the 12 weeks set out in Cabinet Office guidelines. This is excused on the grounds of needing to meet the Finance Bill timetable and, in particular, to allow sufficient time for the final draft of the regulations to be laid before Parliament to enable the disclosure rules to come into force on 1 August 2004.

New Regulations

The disclosure requirements will be supported by three sets of regulations:

· The Tax Avoidance Schemes (Information) Regulations 2004, which set out the procedural rules for disclosures. They deal with the timing and manner of disclosure and the information that is to be provided to the Revenue.

· The Tax Avoidance Schemes (Promoter and Prescribed Circumstances) Regulations 2004. These set out certain circumstances in which a person is not to be regarded as a promoter for the purpose of the disclosure rules. Their purpose is to ensure that a group tax department providing taxation services to another company in the same group is not treated as a promoter within the disclosure rules. This ensures that all "in-house" schemes are disclosable at the same time.

· The Tax Avoidance Schemes (Prescribed Descriptions of Arrangements) Regulations 2004 prescribe financial and employment based arrangements that must be notified under the disclosure rules, where the arrangements have as a main benefit the obtaining of a tax advantage. These regulations also restrict the application of the disclosure rules to arrangements made in respect of income tax, corporation tax and capital gains tax.

The new rules will require promoters to provide details of certain defined tax schemes and arrangements to the Inland Revenue. They will be required to provide a description of the scheme, including details of the types of transactions involved, the expected tax consequences and the statutory provisions which they rely upon. Inland Revenue will register these schemes and allocate each a reference number.

Promoters will be required to provide this number to all their clients who use the scheme or arrangements. In the majority of cases, taxpayers using schemes and arrangements will only be required to include the reference number of the scheme on their tax return. However, taxpayers will be required to provide details of the scheme or arrangement to the Inland Revenue in two circumstances:

i) where they have used a scheme or arrangement affecting their liability to tax within the UK which was provided by a promoter based offshore who has not registered it with the Inland Revenue. In these circumstances, taxpayers will be required to disclose details of schemes shortly after the scheme was purchased or first implemented; and ii) where they have used a scheme or arrangement which they have devised themselves. In these circumstances, taxpayers will be required to disclose details of the scheme together with the relevant tax return.

The schemes and arrangements subject to the disclosure rules are those which meet three conditions:

i) does the arrangement fall within any description prescribed by the Treasury in Regulations?

ii) does the arrangement give rise to a tax advantage?

iii) is the obtaining of that advantage the main benefit, or one of the main benefits, which might be expected to arise from the arrangements?

The regulations limit the scope of any tax advantage to income tax, corporation tax and capital gains tax.

Promoters

A promoter is defined as any person who in the course of a trade, profession or business provides taxation services to others, and where they:

i) have any responsibility for designing any notifiable arrangements; or ii) if they make a notifiable proposal available to another person (for example by marketing or promoting arrangements designed by another person); or iii) if they have any responsibility for the organisation or management of the arrangements.

In practice, this means accountants, tax advisers, solicitors, lawyers and barristers could fall within the definition of a promoter if they provide services relating to taxation. 'Organisation' or 'management', however, does not include, for example, a bank or other financial service provider which, in the ordinary course of its business, provides an instrument such as a currency swap which is then used in an arrangement designed or marketed by another party.

The borderline between when an arrangement is a notifiable arrangement appears to be somewhat subjective. For example the guidance notes state that certain situations would not require; for example:

i) spontaneous discussion of new ideas which will need more research before any implementation would be possible;

ii) general discussions about different types of tax planning services available;

iii) a general outline presentation at a tax conference which does not go into any of the detailed mechanics of how the scheme would operate, or sets out an 'untested' idea.

This latter example seems particularly worrying for those taxation advisers who lecture extensively as it seems clear that if they outline in detail arrangements that constitute a 'tested' technique then they might be caught by the rules.

The guidance notes go on to illustrate examples of situations that would be caught including:

i) a general discussion with a client about tax planning which identifies that they are interested in a particular type of arrangement. A promoter then discusses an 'off the shelf' arrangement with them in some detail with a view to their implementing it.

ii) a detailed presentation to one or more clients aimed at marketing a particular proposal or set of arrangements.

Promoters who fail to notify details of their scheme to the Revenue within the required time frame face a maximum penalty of £5,000 for failing to comply with any of the obligations described above. Both the imposition and level of the penalty will be determined by the Special Commissioners. There is a right of appeal to the High Court or the Court of Sessions in Scotland against any penalty. If a promoter continues to fail to comply with their obligations after the

Special Commissioners have imposed a penalty, they face further penalties of up to £600 for each day that the failure continues.

Users

In normal circumstances, users of schemes and arrangements are only required to inform the Inland Revenue that they have used or that they intend to use a registered scheme or arrangement, normally on the income tax, corporation tax or P35 return. Users should provide both the scheme reference number and the year in which the tax advantage is expected to arise.

Income tax returns will be modified for the tax year 2004/5 but the form P35 will not be amended until the tax year 2005/6. Until then there will be transitional arrangements for employers to notify the Revenue.

Users are required to notify details of schemes where the promoter is not UK based or where the user has devised the arrangement or scheme themselves.

If a user fails to notify their use of a scheme they will be liable to a penalty of £100 for each failure. A scheme user who fails to comply for a second time will be liable to a penalty of £500 for each failure. Third and all subsequent failures will attract a penalty of £1000 for each occasion. So, for example, if a user is required to notify two scheme reference numbers on the same return, they will be liable to two penalties of £100 each. If a user has used two separate schemes, one in tax year 2004/05 and the other in tax year 2005/06, and fails to notify the Inland Revenue of either scheme, they will be liable to two penalties, one for £100 and one of £500.

Arrangements to be notified

The Tax Avoidance Schemes (Prescribed Descriptions of Arrangements) Regulations 2004 contain a definition of arrangements connected with employment. Where there is such an arrangement, then, subject to the other conditions being met, the arrangement should be disclosed.

The test for an employment arrangement is applied where the main benefit or one of the main benefits expected to arise is the obtaining of a tax advantage. An arrangement connected with employment is an arrangement which might be expected to lead to a reduction in, or deferment of liability to, income tax, capital gains tax or corporation tax of an employer or an employee, or any other person by virtue of an employee's employment.

The arrangements must also include one or more of the following:

i) securities or associated rights;

ii) payments to trustees and intermediaries; or iii) loans.

Certain types of scheme which are currently permitted tax advantages are excluded from disclosure. These include Enterprise Management Incentives (EMI) where they comprise:

i) the grant of a qualifying (tax advantaged) EMI share option; or ii) a grant within (i) above, together with such steps as are reasonably necessary to facilitate the grant of such an option.

Genuine taxed employee share schemes (often referred to as 'unapproved') will not need to be disclosed under the rules since they do not confer any tax advantages and there would not be an expectation that a main benefit of the arrangement is the obtaining of a tax advantage.

'Payments to trustees and intermediaries' are any payment by an employer or a person associated with the employer to:

i) a trust (whether established in the UK or overseas) for the benefit of an employee, a person associated with an employee, or a class of persons including an employee or an employee's associate.

ii) a third party entitled under the terms of an employee benefit scheme to hold or use the payment for the provision of benefits to employees or an employee's associate.

'Intermediary' does not have the same meaning here as in the IR35 legislation.

Certain employment arrangements involving payments to trusts or intermediaries are outside the disclosure rules. These are payments to trusts established for the purposes of an approved pension scheme, an approved share incentive plan, or an approved SAYE or CSOP scheme (or both). This exemption also applies in respect of any arrangements which have been or will be submitted to the Inland Revenue for approval as an approved pension scheme.

'Loans' are any arrangements which include making, releasing or writing off any loan by an employer (or a person associated with an employer) for the benefit of an employee or any other person by reason of an employee's employment. Any arrangement, which is either taxable as a benefit or is not taxable because of the limited exemption for bridging loans is outside the disclosure rules.

The Tax Avoidance Schemes (Prescribed Descriptions of Arrangements)

Regulations 2004 set out three conditions all of which must be met for the arrangement to be a prescribed financial product. These conditions are:

i) that in relation to the arrangements T+B-C is equal or greater than 0;

ii) that T is greater than nil; and iii) that the arrangement is one of the 'Specified Financial Products' included in the regulations.

In the formula T+B-C is equal or greater than 0, i) T is the amount of the expected tax advantages to the user of entering into the arrangements, ii) B is the economic benefit of the arrangements to the user, and iii) C is the cost of the arrangements to the user.

The value of T in the formula T+B-C<0 will generally be a positive figure. If the amount is equal to or less than nil, the arrangement will not have to be disclosed.

A specified financial product arrangement exists where the arrangements include one or more of the following:

i) a loan other than a simple loan;

ii) a contract which is a derivative contract;

iii) an agreement for the sale and repurchase of securities of the kind described in paragraphs (a) to (c) of subsection (1) of section 730A of the Taxation of Chargeable Gains Act 1992;

iv) a stock lending arrangement within the meaning of section 263B(1) of the Taxation of Chargeable Gains Act 1992 v) a share which is not an ordinary share; or vi) a contract which, while not being one of the above, is a contract which, by itself, or in combination with one or more other contracts (including any of the above), in substance represents the making of a loan or the advancing or depositing of money, whatever its form and falls to be accounted for on that basis.

The following are examples of transactions that in substance may represent the making of a loan:-

· factoring agreements;

· finance leases;

· hire purchase agreements;

· annuities or combination of annuities;

· contributions to a partnership;

· capital redemption contracts;

· life assurance policies (apart from non-convertible term assurance policies);

· reinsurance contracts; or

· sale of the right to receive any periodic payments.

Conclusions

Contractors had been speculating whether they could be affected by the new rules. It appears from these new details that merely arranging your business so as to be outside IR35 - for example by the use of IR35 friendly contracts and amending your working practices – will not fall within the new disclosure rules.

Using an IR35 friendly contract does not meet any of the three requirements for an employment arrangement. However, as was expected some of the typical IR35 avoidance umbrella schemes could well be caught if they involve loans or payments to Trustees – for example of employee benefit trust schemes. Other schemes and arrangements that could be caught are those that use complex share structure or leasing arrangements to reduce tax liabilities.

However, being 'caught' by the disclosure requirement does not mean that the scheme is illegal in any way. But it does mean that the Revenue will be aware of the scheme sooner and can take steps to address any perceived tax avoidance earlier.

Overall these new rules seem more likely to impact the major firms of accountants, who have large tax practices that specialize in devising complex tax avoidance arrangements for companies and high worth individuals, than they are the typical contractor.