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Business Services  •  Personal tax

Beware of ‘tax efficient investments’ involving offshore trusts

By RJP LLP on 26 May 2022

The tightening of the IR35 legislation has made it more difficult for contractors to reduce their tax liabilities by operating personal service companies. Whilst there are many umbrella companies operating that purport to circumvent IR35 and limit tax liabilities, they should be treated with extreme caution and with the knowledge that HMRC will inevitably want to look closely.

There have also been schemes in operation that purport to take UK income outside the UK tax net, but which invariably do not, as a recent test case involving three consultants who were working as financial contractors highlights.

The test case involved three taxpayers, all of whom were all UK taxpayers engaged as freelancers by financial institutions in London. They were all using tax ‘investment’ schemes to avoid the IR35 rules and keep the majority of their contracting income outside of the UK tax regime, or so they believed. Typically, if taxpayers use a scheme like this, HMRC will be aware because the operators are required to notify the arrangements to HMRC under DOTAS (Disclosure of tax avoidance schemes). It means the three taxpayers were already on HMRC’s radar to be monitored more closely.

The tax planning schemes involving these three individuals were highly convoluted and operated as follows:

  • A trust was established in the Isle of Man, of which each taxpayer was the life tenant and under the terms of which was entitled to the income of the trust as it arose. The trustee was an Isle of Man company;
  • The trustee formed an Isle of Man partnership. This partnership entered into a service contract with the taxpayer, under which the taxpayer agreed to provide services to the partnership or, if requested, to third parties in return for a fee payable by the partnership;
  • The partnership then entered into an agreement with the scheme operator and this entity had an agreement with a UK recruitment agent, for the taxpayer to provide services to an end client, with an agreed fee due to each entity under these arrangements;
  • At the end of the chain, the taxpayer received a fee paid by the partnership and a profit share (routed through the trust). This fee equated to the amount the taxpayer expected to receive in return for services provided to the end client, after a fee was deducted by the scheme operator.

For tax purposes, the taxpayers would declare income subject to UK tax from either self-employment or employment (if they were operating as a limited company). They expected their profit shares to be exempt from UK tax but after conducting enquires into the taxpayers’ returns, HMRC took the view that each individual should also pay income tax and class 4 national insurance contributions on their profit share, and the case went to the First Tier Tribunal (FTT).

Surprisingly the legislation that caught these taxpayers out was the ‘transfer of assets abroad’ (TOAA) rule. The FTT found that when the rights in the services agreement were created, this constituted a transfer of assets to the partners in the partnership (who were based in the Isle of Man).

When the partners originally entered into the services agreement, each taxpayer created rights in the relevant partnership which had a value. This meant income became payable to the partners in the partnership as allocated in its entirety to the trustee (the Isle of Man partnership). In return for those rights, each taxpayer was contractually entitled to receive a fixed fee from the partnership.

The FTT found that that the taxpayers were subject to income tax on this partnership profit share under those provisions. Although HMRC also wanted the taxpayers to pay NICs on partnership profits, this was ruled out by the FTT.

It’s a complex case involving complex structuring and complex legislation, but the message is clear. HMRC are carefully scrutinising all arrangements that could be deemed to be tax avoidance and it is always best to proceed with caution – if it seems too good to be true, it probably is!

If you are concerned you may be caught by the IR35 legislation or want to discuss tax planning, please contact us via partners@rjp.co.uk.

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The tightening of the IR35 legislation has made it more difficult for contractors to reduce their tax liabilities by operating personal service companies. Whilst there are many umbrella companies operating that purport to circumvent IR35 and limit tax liabilities, they should be treated with extreme caution and with the knowledge that HMRC will inevitably want to look closely.

There have also been schemes in operation that purport to take UK income outside the UK tax net, but which invariably do not, as a recent test case involving three consultants who were working as financial contractors highlights.

The test case involved three taxpayers, all of whom were all UK taxpayers engaged as freelancers by financial institutions in London. They were all using tax ‘investment’ schemes to avoid the IR35 rules and keep the majority of their contracting income outside of the UK tax regime, or so they believed. Typically, if taxpayers use a scheme like this, HMRC will be aware because the operators are required to notify the arrangements to HMRC under DOTAS (Disclosure of tax avoidance schemes). It means the three taxpayers were already on HMRC’s radar to be monitored more closely.

The tax planning schemes involving these three individuals were highly convoluted and operated as follows:

  • A trust was established in the Isle of Man, of which each taxpayer was the life tenant and under the terms of which was entitled to the income of the trust as it arose. The trustee was an Isle of Man company;
  • The trustee formed an Isle of Man partnership. This partnership entered into a service contract with the taxpayer, under which the taxpayer agreed to provide services to the partnership or, if requested, to third parties in return for a fee payable by the partnership;
  • The partnership then entered into an agreement with the scheme operator and this entity had an agreement with a UK recruitment agent, for the taxpayer to provide services to an end client, with an agreed fee due to each entity under these arrangements;
  • At the end of the chain, the taxpayer received a fee paid by the partnership and a profit share (routed through the trust). This fee equated to the amount the taxpayer expected to receive in return for services provided to the end client, after a fee was deducted by the scheme operator.

For tax purposes, the taxpayers would declare income subject to UK tax from either self-employment or employment (if they were operating as a limited company). They expected their profit shares to be exempt from UK tax but after conducting enquires into the taxpayers’ returns, HMRC took the view that each individual should also pay income tax and class 4 national insurance contributions on their profit share, and the case went to the First Tier Tribunal (FTT).

Surprisingly the legislation that caught these taxpayers out was the ‘transfer of assets abroad’ (TOAA) rule. The FTT found that when the rights in the services agreement were created, this constituted a transfer of assets to the partners in the partnership (who were based in the Isle of Man).

When the partners originally entered into the services agreement, each taxpayer created rights in the relevant partnership which had a value. This meant income became payable to the partners in the partnership as allocated in its entirety to the trustee (the Isle of Man partnership). In return for those rights, each taxpayer was contractually entitled to receive a fixed fee from the partnership.

The FTT found that that the taxpayers were subject to income tax on this partnership profit share under those provisions. Although HMRC also wanted the taxpayers to pay NICs on partnership profits, this was ruled out by the FTT.

It’s a complex case involving complex structuring and complex legislation, but the message is clear. HMRC are carefully scrutinising all arrangements that could be deemed to be tax avoidance and it is always best to proceed with caution – if it seems too good to be true, it probably is!

If you are concerned you may be caught by the IR35 legislation or want to discuss tax planning, please contact us via partners@rjp.co.uk.