Tax doesn’t have to be taxing – but back-dated?

H. M. Revenue Customs (HMRC) has recently won a case in the High Court against a scheme used by many IT contractors to avoid substantial amounts of income tax. The case was based on a piece of legislation (in the Finance Act 2008) that changed the rules – retrospectively, and the ruling opens the door for HMRC to pursue claims back-dated many years.

The tax scheme in question made use of rules in the double tax agreement with the Isle of Man. Rules that were designed to prevent paying tax more than once on the same income. Those same rules have been exploited to avoid paying any tax at all. A number of similar schemes have been used for many years.

The importance of this case is that it permits the back-dating of changes in tax rules. MPs will be familiar with this concept. Is it right to re-calculate tax for past years based on rules introduced later?

Anyone using the schemes has been well aware that a substantial part of their earnings has escaped tax solely by artificial means. This concept may be viewed differently because it involves ordinary people paying (or not paying) tax, but it has a moral dimension not dissimilar to the ‘inventive’ expenses claims of MPs. They knew it wasn’t right – but if others are getting away with it, ‘I’d be a fool not to, wouldn’t I?’

These and other schemes are sold on the basis that they have been ‘accepted’ by HMRC. Indeed, HMRC have been aware of them and for many years did nothing about them. Doesn’t this give the schemes credence? It was certainly one of the attractions to so many contractors and almost satisfies the moral argument as well. If it’s good enough for HMRC, it must be OK. Should there be an element of sympathy for the taxpayer when the taxman asks for proper contributions for earlier years? Which may mean bankruptcy in some cases?

Beware! If you are making use of any scheme that unduly reduces your tax, however legitimate you are told it is, the chances are you are living on borrowed time. You’d be well advised to save – hard. They are coming to get you.

HMRC have given an indication of aspects of schemes that will attract their attention:

Sounds too good to be true
Artificial or contrived arrangements
Very complex compared with the facts
Includes secrecy or confidentiality agreements
Said to be vetted by a top lawyer/accountant but no details of opinion provided
Said to be approved by HMRC
Delays taxation of income or accelerates tax deductions
Disproportionate benefits to the commercial activity
Involves off-shore companies or trusts for no reason
Pension funds are used inappropriately
Contains exit arrangements designed to sidestep tax consequences
Involves money going in a circle back to where it started
Involves the scheme promoter lending the funding needed