PAYE140005 - The PAYE discretion at s684(7A)(b) ITEPA 2003 and contractor loans avoidance schemes: contents: background

Contractor loans schemes
PAYE regulations
Employee of non-UK employer rules
Agency rules
Impact of using the PAYE discretion
Implications for different types of schemes

Contractor loans schemes

Disguised remuneration schemes claim to avoid the need to pay Income Tax and NICs. They normally involve a loan or other payment from a third-party to an individual which is unlikely to ever be repaid. These schemes are used by employers and individuals. 

It is important that an officer can differentiate between an offshore and onshore contractor loans avoidance scheme as there may be different factors for an officer to take into account when considering exercising the PAYE discretion. 

Offshore schemes normally include, but are not limited to, the following features

  • there is an offshore entity with which the individual has entered into either a contract of employment, or a contract to provide services
  • the individual’s services are provided to a UK End Client via the offshore entity and one or more UK intermediaries
  • the offshore entity pays the individual a relatively small amount of income that is declared as taxable
  • where the individual is employed by the offshore entity, PAYE is operated voluntarily on the payments declared as taxable income
  • the individual then receives the majority of the fees they earned for their work in the form of loans, typically from an offshore trust or the offshore entity
  • the individual does not return these loans as income.

Where an individual has signed a contract of employment, they have likely used an employer scheme. Where an individual has signed a contract for services, they have likely used a trading income scheme. 

The features of an onshore scheme are the same as above except references to ‘offshore’ should be read as ‘onshore’. 

PAYE regulations

Money received by individuals for the provision of their service(s) can be taxable under various provisions depending on the facts, as employment income, trading income, or under other provisions. 

Where an individual is employed, an amount taxable as employment income will be PAYE income. The PAYE Regulations apply to relevant payments of PAYE income.  If so, a person in the UK may be required to account to HMRC for tax in accordance with the PAYE Regulations. 

PAYE is a collection mechanism which in normal circumstances simplifies the collection of tax due from most employees on their employment income. It does this by requiring tax to be deducted at source by the person making a relevant payment of PAYE income and reported and paid to HMRC. It achieves this by placing the liability to pay the tax in the first place on the ‘payer’, who deducts the tax due from payments to the employee. However, the person chargeable to tax is the employee, so the ultimate liability to tax remains theirs. 

Where there is an assessment of an individual’s liability to income tax for a tax year, for example an Income Tax Self Assessment return made under s8 Taxes Management Act (TMA) 1970 or a discovery assessment under s29 TMA 1970, the difference between the amount of tax due under the assessment and the amount payable by the employee is the income tax deducted through PAYE.  However, where PAYE ought to have been operated but was not, the amount collectible from the individual is reduced by the amount of tax treated as deducted at source by reason of Regulation 185 or 188 of the PAYE Regulations. The amount treated as deducted at source is the amount which should have been deducted, or accounted for, under PAYE, but was not. This means that, whilst an individual’s liability to income tax payable under an assessment is not altered, the amount they are due to pay, and which can be collected from them is reduced by the amount of tax due under PAYE but not deducted or accounted for. 

Employee of non-UK employer rules

Where there is an employment with an offshore employer which has no presence in the UK, but the employee works for an entity based in the UK (the End Client), s689 ITEPA 2003 ‘Employee of non-UK employer’ provides for who should operate PAYE.

The Finance Act 2014 changed these rules.

Before 2014, where an employer is not obligated to operate PAYE because they are based offshore and their employee’s (the individual’s) services are provided to a UK End Client these rules require the UK End Client to operate PAYE on that employee’s earnings.  

From 2014, these rules require the UK entity that contracts directly with the End Client (the 'UK Agency'), where there is one, to operate PAYE in respect of the amounts paid by the offshore employer.

Agency rules

Where an individual is not employed and provides services to an End Client via a third party under the terms of a contract, the agency rules at Chapter 7 of Part 2 ITEPA 2003 may apply.  

The Finance Act 2014 changed the law such that the agency rules operate differently before and from 2014, leading to a different entity potentially being classed as the deemed employer.

Before 2014, the agency rules may apply where an individual personally provides their services to an End Client through an entity (defined as “the agency” for the purpose of these rules) under the terms of an “agency contract”. The individual is taken to hold a deemed employment with the agency with whom they hold a contract. The remuneration receivable under the agency contract is treated as earnings from that employment. The consequence of this for offshore trading income schemes is that the offshore entity is the deemed employer. The Employee of non-UK employer rules then apply to move the obligation to operate PAYE to the End Client.  

From 2014, the agency rules may apply in any case where an individual personally provides their services to an End Client and those services are provided, or the End Client provides consideration for those services, under a contract between the End Client and the agency.   Where these conditions are satisfied, the individual is treated as holding an employment with the agency and the remuneration receivable by the individual in consequence of providing the services is treated as earnings from that employment. The agency is required to operate PAYE on the payments to the individual. The consequence of this for offshore and onshore trading income schemes is that it is often the UK Agency who is the deemed employer. As the deemed employer is onshore, the Employee of non-UK employer rules do not apply to move the obligation to operate PAYE to another entity.  

There are other less common circumstances where the obligation to operate PAYE may apply differently to the above. For example, from 2014, where there is no UK Agency involved in the supply chain, the End Client may be required to operate PAYE on payments to the individual. Or, in certain circumstances involving the provision of fraudulent documents, a person other than the End Client or UK Agency may be obligated to operate PAYE on payments to an individual. 

This guidance does not apply in these circumstances. Any officer who is considering use of the PAYE discretion to disapply the PAYE Regulations in these circumstances should contact the Counter Avoidance Operational Policy team for advice. 

Impact of using the PAYE discretion

The PAYE discretion gives an officer of HMRC power to exercise discretion to determine that a person paying PAYE income (a ‘payer’) is not required to comply with the PAYE Regulations in circumstances in which an officer of HMRC is satisfied that it is unnecessary or not appropriate for the payer to do so.  

If an officer of HMRC exercises this power, they will collect from each individual the income tax due on the taxable income received through their use of the scheme. This is because there will be no entitlement to have an amount treated as tax deducted at source in respect of that taxable income. So, where there has been an assessment, any amount of the liability to income tax which has not already been deducted or accounted for under PAYE will be payable by the individual.  

Implications for different types of schemes

As outlined above, the Employee of non-UK employer rules and agency rules changed with effect from 2014. It is therefore important to consider the period each avoidance scheme is used for and make a decision as to the use of the discretion separately for the use of each scheme before and after the legislation changed.

Where an offshore employer or offshore trading income scheme has been used before 2014 and the amounts received may represent PAYE income, an officer can consider whether it is appropriate for the PAYE Regulations to apply to an End Client, or whether to exercise the PAYE discretion to determine that the End Client is not required to comply with the PAYE Regulations in relation to the original loans.

Where an offshore employer scheme or, trading income (either offshore or onshore) scheme, has been used from 2014, and the amounts received may represent PAYE income, an officer can consider whether it is appropriate for the PAYE Regulations to apply to the UK Agency (the entity that contracts directly with the End Client), or whether to exercise the PAYE discretion to determine that the UK Agency is not required to comply with the PAYE Regulations in relation to the original loans.

Where a trading income (either offshore or onshore) scheme has been used from 2014, and the amounts received represent PAYE income, an officer of HMRC can consider whether it is also appropriate for the PAYE Regulations to apply to the UK Agency in relation to the Loan Charge, or whether to exercise the PAYE discretion so that the UK Agency is not required to comply with the PAYE Regulations in relation to the Loan Charge.