What are tax avoidance schemes and how do they work?

Tax avoidance has once again been in the news in recent days following a high profile case involving members of Take That.

Following several enquiries, including a television interview, our tax experts have put together this important information about tax avoidance schemes and how they work, in order that you are aware of the facts, including the associated risks, before choosing this tax planning strategy:

What are tax avoidance schemes and how do they work?

Tax avoidance schemes are legal arrangements put in place to mitigate tax liabilities. They can apply to both companies and individuals.

Importantly, the fact that a scheme has been disclosed and given a reference number simply means that the promoter has complied with their obligations under the disclosure of tax avoidance schemes and not that the scheme has been approved by HMRC.

 Anne Beech Granada Reports 12 May 2014

WATCH: Anne Beech, Tax Manager, appearing on 'Granada Reports' on Monday 12 May discussing the recent Take That 'Icebreaker' tax avoidance case. See the full video here.

By way of example, a lot of schemes in recent years have involved companies using employees’ benefit trusts, which are designed to reduce income tax and national insurance on salaries to directors and employees and to reduce company profits. The net result is that the company pays less corporation tax. A Discretionary Trust is set up with offshore trustees and the company pays a contribution on behalf of an employee to the Trust, thus the employee does not have to pay tax or a National Insurance Contribution (NIC) yet the company receives tax relief on the remuneration. The contributions are then taken out at a later date when it is tax advantageous.

Another example is when individuals make investments through film partnerships, via their own income and loans. They then claim tax relief on the investments made, to trigger a repayment of tax.

You should be aware that HMRC always opens an enquiry automatically into an individual or company who has invested into a tax avoidance scheme.

While the enquiry may take years to conclude, if the scheme is not successful, HMRC will ask for all the tax back that had been saved by the scheme.

It should be noted that while tax evasion is illegal, tax avoidance is not a criminal activity. However, various anti-avoidance rules exist to stop tax avoidance where the avoidance is clearly the only motive behind a transaction or series of transactions.

In the recent case involving members of Take That, money had been put into schemes purportedly supporting the music industry.  The men were directors of Larkdale LLP - one of 50 partnerships that a company called ‘Icebreaker’ arranged to harness tax reliefs that the government had intended would support those in creative industries. The tribunal found that shortly after money was put in to Larkdale LLP; it reported huge losses of more than £25m. Those losses were then offset against tax, reducing the member’s tax liabilities.

Following an HMRC investigation, it was ruled that: "The underlying, and fundamental, conclusion we have reached is that the Icebreaker scheme is, and was known and understood by all concerned to be, a tax avoidance scheme." The men will now have to repay tax amounting to millions of pounds. In essence, HMRC viewed the lack of genuine commerciality behind the series of transactions to cause the scheme to fail. 

Going forward, the government have proposed to change the rules in relation to tax avoidance schemes so that taxpayers must pay any disputed tax up front, i.e. pending the outcome of the enquiry.  If the scheme is successful, HMRC will refund the tax paid.

Taxpayers who are interested in exploring tax avoidance schemes should always ensure that they are in possession of all of the facts including the associated risks before investing with a scheme provider.

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For more information about Mitchell Charlesworth's tax planning services, contact a member of our tax team or complete a quick enquiry form and we will be happy to contact you directly.

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