HMRC is always keen to tackle tax avoidance and for the past 1-2 years it has focused its attention on “tax avoidance schemes”. Contractors are the most common target for such schemes whilst claims of 90-95% take-home pay may sound appealing, they are a honey-trap that you need to avoid! 

What is a “tax avoidance scheme”? 

Quite simply, any structure or arrangement that is designed to maximise take home pay through illegally avoiding tax is a “tax avoidance scheme”. 

How does a “tax avoidance scheme” work? 

There are various schemes but a typical scheme will involve an agency invoicing the end-client for the contractor’s hourly/daily rate, with a loan agreement stating that the contractor receives most of the income in the form of a loan. The loan agreement suggests that the loan is repayable at some point many years in the future – but in reality, the loan will never be recalled. (This is why they are often referred to as “contractor loan schemes”). 
 
The payslip will show a small, barely taxable salary and an “advance” which is not taxed. This means that the majority of the pay received by the contractor each week or month, is not taxed. 
And, more often than not, there will be a myriad of companies (commonly off-shore) in-between that confuses the whole process as well. 

But don’t contractors avoid tax all the time? 

No. 
 
Sensible contractors use a reputable and qualified accountant who provides them with the best possible advice in order to minimise their tax bill legitimately. They have a full understanding of tax law and work within those rules to make sure you claim all possible expenses and reliefs. 
 
This is not tax avoidance. 

The warning signs 

Tax avoidance schemes often masquerade as umbrella companies – so it is important to know the signs and ensure you are confident on when you should walk away. 
 
1. For me, the biggest warn sign of all is if it sounds too good to be true, it probably is! 
 
Many of these schemes promote themselves on the 80-95% take-home pay that they can “guarantee”. 
 
With income tax rates of 20% (basic rate), 40% (higher rate) and 45% (additional rate) – how on earth can this be possible whilst remaining inside the law? And that is before we even consider National Insurance. 
 
Put it another way – does it seem right that HMRC will be satisfied with receiving only 5-20% of your income in tax and NI? 
 
2. It says it is “HMRC Compliant”. 
 
This is a big myth! HMRC never audits these schemes and certainly doesn’t give approval or awards of compliance. 
 
3. If they can’t explain in plain English how it works and how they can save you so much money, it isn’t right! 
 
If you are considering one of these schemes; maybe a friend has referred you, you saw it advertised online, or one of their sales team approached you – be cautious. 
 
I often hear clients say, “but the website is professional”, “it all sounds legit” or “it has quotes from HMRC QC”. Remember, it is easy to create and publish a professional website and there is very little control or regulation on the content you include. 
 
Ask questions – make sure you are comfortable with the answers. 
 
4. Your payslip includes an “advance”. 
 
As explained above, many of these schemes keep your tax at a minimum by treating the majority of your pay as a loan. By doing so, this part of your pay is not taxed. This will usually appear on your payslip as an “advance”. 
 
This is a big indicator that something isn’t right – and you should ask your agency to provide a clear explanation. If they can’t, or it doesn’t feel right, seek expert help. 

What will happen if you are/were involved? 

As I said at the start of this post, HMRC have a real bee in their bonnet about this right now. They are actively looking at such schemes to identify those involved and have the power to go back many years to charge contractors for the unpaid tax and National Insurance. 
 
At Effective Accounting we have seen a number of contractors caught out in this way 3, 4 or even 5 years after they have left the scheme, and it comes with a significant tax bill. 

What should I do if I think I may be involved in such a scheme? 

If you think you are involved in such a scheme, seek expert help right away. The sooner you identify the problem and extract yourself from the scheme, the better position you will be in. 

What if you think or know you were involved in such a scheme previously? 

Unfortunately, just because you are no longer involved, doesn’t mean you are safe from HMRC’s scrutiny. 
 
If you think, or perhaps know, you were involved in such a scheme, but are no longer involved – you should still seek expert help.  
Effective Accounting are contractor specialists and know how to spot these schemes. Get in touch to arrange a free, no obligation review. 
Further Reading: 
 
 
 
 
 
Written by: 
 
Nicola J Sorrell -  
Effective Accounting 
 
Founder | Xero Champion | IR35 Expert 
 
 
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