HMRC has recently published a Spotlight (62) on a tax avoidance scheme relating to school fees. This has caused something of a stir within the tax profession because it attacks planning which most would consider to be acceptable rather than aggressive.
To put this in context, the Spotlight regime was instigated some years ago by HMRC where the department has identified a scheme which they believe does not work. The first Spotlight was published on 5 August 2010. These are schemes which HMRC has not yet had the opportunity to formally challenge but where they are indicating, in advance, that they will look at the tax position of any taxpayer who has utilised the planning. So these are meant to act as a warning and a quicker reaction to the use of a scheme than HMRC could muster with its formal powers, when they would have to wait until a return was received covering the period when the transaction was undertaken. Most of the schemes have, in the past, been quite complex and had a feeling of artificiality about them which many would recognise as being a hallmark of tax avoidance.
There is no record, as far as I am aware, of whether all of the schemes highlighted under this mechanism have been successfully challenged or defeated by HMRC. However, not all schemes highlighted by Spotlights reach the point where they are considered by the Tribunal or GAAR panel. It is unclear why this might be the case – that people are put off or simply settle with HMRC where it has been used or HMRC decide in the end that it does not merit challenging. Of course, we don’t even know if HMRC even identify or challenge these schemes as this would covered by taxpayer confidentiality.
What might happen if you still utilise the planning or have utilised it in the past?
If someone uses a scheme which has been highlighted by a Spotlight, it is likely HMRC will argue that a deliberate offence has been committed and so penalties will be higher if it is shown not to work. This is because the taxpayer is expected to keep up to date with these types of pronouncements, particularly if they are engaging in what is considered to be tax avoidance. It is up to HMRC to prove that any loss of tax is due to a deliberate offence so there is the possibility that a Tribunal (if this was challenged) might disagree that a taxpayer should have known but that is what HMRC could argue.
If you are already using the scheme at the time of publication of HMRC’s view, then the area is a bit murkier. It is likely that HMRC will challenge it if they identify that the scheme is being used. If the taxpayer unwinds the scheme now, then it may be possible to argue that no penalties should be charged if HMRC do try to collect historical liabilities but that may depend on the extent to which the scheme was fully reviewed before implemented.
In addition, the promoters of such schemes may have to comply with DOTAS (the Disclosure of Tax Avoidance Schemes) although it is important to note that there is only a requirement under DOTAS if the scheme meets one of the prescribed hallmarks. It is possible that it falls under hallmark 9 relating to financial products. Any person who has already promoted this scheme to clients may need to consider if making a protective notification under DOTAS as a promoter although one adviser I have discussed this with was very reluctant to do this.
Promoters may also be pursued under the ‘enablers’ regime if this type of scheme is promoted widely. However, that is only likely to be the case if there is a wider pattern of promoting aggressive tax planning.
This Spotlight is interesting because it highlights something which is common enough that many people will have considered this type of planning.
The following outlines (from the Spotlight) how the scheme works:
The arrangements seek to avoid tax by allowing the directors, who are also the main shareholders (the owners) of a company, to divert dividend income from themselves to their minor children.
The arrangements work as follows:
a company issues a new class of shares which usually entitles the owner of the shares to certain dividend and voting rights
Person A, usually a grandparent or sibling of the company owner, purchases the new shares for an amount significantly below market value
Person A usually gifts the shares to a trust or declares a trust over the shares for the benefit of the company owner’s children
Person A or the company owners vote for substantial dividend payments in respect of the new class of share
this dividend payment is paid to the trustees of the trust
as the beneficiaries of the trust, the company owner’s children are entitled to the dividend
The company owner’s children pay tax on the dividend received. However, they pay much less tax than if the company owners received the dividend due to their children’s:
· £12,570 tax-free personal allowance
· £1,000 dividend allowances
· eligibility to the dividend basic tax rate
You can see that the narrative actually makes no reference to the use of the dividends to pay school fees and, in fact, the money could be used for any purpose although you would normally only be paying money out for a specific purpose as most parents would not want their children to have access to huge amounts to income which they could just spend!
Just to give an indication, if you paid out £20,000 to an individual with no other income, the tax would be £562.63 after utilising the personal allowance and dividend allowance. The same income would attract tax of £6,750 at higher rates or £7,870 at additional rates assuming no dividend allowance is available. The figures are interesting as most practitioners I have discussed this with have made the assumption that HMRC would only be concerned with much higher levels of tax loss.
So why are HMRC looking at this? The article goes on to say that it is HMRC’s view that this is caught by the Settlements provisions and also states that arrangements which operate in a similar way may also be caught by this legislation. There are no further details about the specific technical arguments which HMRC might use.
S629 ITTOIA 2005 states that income from a settlement is treated as the income of the settlor where it is paid for the benefit of the relevant children of the settlor. This is a measure to stop a parent shifting income to their minor children to reduce their overall tax liability. There is a deminimis of £100 of income which is unaffected but this really only allows a small amount of money to be put into an interest bearing account for the benefit of the children.
The definition of settlement is ‘any disposition, trust, covenant, arrangement or transfer of assets’ and can include a series of transactions. The use of the word ‘arrangement’ within this definition means that it covers a wide range of situations and it would not be advised to rely on being able to argue that this is not an arrangement. A settlor is any person who makes a settlement. It is well established that this can include someone who is indirectly involved although a person would have to have some involvement in the arrangements – you cannot be an inadvertent indirect settlor.
The use of grandparents to subscribe for the shares and then transfer those to the settlement from which their grandchildren benefit was always thought to avoid the application of those Settlement provisions. It only automatically applies where income is shifted from the parent to their children; no wider relatives are caught. However, the argument which could potentially be made by HMRC here may well derive from the fact that the parents of the children have allowed valuable shares in the company to be issued at less than market value so that they are, in fact, also an indirect settlor in relation to the settlement.
The 1988 case of Butler v Wildin BTC475 considered this argument from a slightly different angle. Two brothers (one who was an accountant and one who was an architect) held shares in a company which also issued shares to their minor children using funds provided by their grandparents. They developed a property and dividends were paid out to their children which the Courts found were caught under the Settlements provisions. The fact that the brothers worked for the company for no consideration, and therefore inflated the profit available for distribution to their children, was found to be an arrangement within these provisions as they had intended to confer a benefit on their children by not being paid for what they did.
There is also an example in the HMRC Trusts Settlements and Estate Manual at paragraph 4300 which states:
Mr J owns 60 of the 100 issued £1 shares in J Limited. Mr J is the sole company director and is the person responsible for making all the company’s profits because of his knowledge, expertise and hard work. On starting up the company, Mr J allowed his mother to subscribe £40 for 40% of the shares and shortly afterwards she gifted them to her grandchildren… The true settlor here is Mr J rather than the children’s grandmother. S629 therefore applies and attributes the dividends received by the children to Mr J for tax purposes.
This example suggests that the ‘scheme’ which is being attacked would include situations where the shares are issued at a time when a company has no value and no distributable reserves. So the narrative of the Spotlight where there is a pre-existing value to the shares is not vital to the potential for HMRC to attack this kind of planning.
Further guidance (at para.4325 of the same manual) states that HMRC will look at situations where the following apply:
disproportionately large returns on capital investments
differing classes of shares enabling dividends to be paid only to shareholders paying lower rates of tax
dividends being waived so that higher dividend
income being transferred from the person making most of the profits of a business to a friend or family member who pays tax at a lower rate.
This is wider than the specific circumstances outlined above but HMRC do acknowledge (as noted above) that other similar arrangements which operate in the same way may also be caught.
On this basis, it would seem that this type of planning may now become too risky. It would certainly seem that any new structures which result in income being paid to minor children could be vulnerable to attack. Advisors may also need to consider if they wish to continue to pay dividends on shares where this structure has been put in place in the past. Of course, because there is some vagueness in the comments about the extent to which similar schemes may be attacked, it is impossible to be able to guess which schemes might be attacked. As noted above, this is planning which, whilst not common, is not an obscure planning idea. Of course, professional standards mean that we cannot ignore these changes in approach by HMRC in the hope that they will not spot that this planning has been utilised!
As a matter of interest, other current Spotlights mostly focus on disguised remuneration, remuneration trusts, umbrella companies and offshore trusts although there are some more niche areas where there is a single Spotlight.