Tis’ the season of discovery, bringing HMRC worry if you’re a Loan Charge contractor facing the s222 charge

As is customary for April, HMRC started last month issuing Discovery Assessments to the individuals who they believe did not declare income or gains on their tax returns in the previous four years. 

Hard hit

This season has perhaps impacted the contracting world more than usual, as the year that was about to expire for HMRC was 2018/19 – the year of the Loan Charge.

Some of these Discovery Assessments, however, include an additional element to them called a Section 222 (ITEPA 2003) charge, which I explore in this article exclusively for ContractorUK, writes Tom Wallace, tax investigations director at WTT Group.

It is first essential to understand what the loan charge is, before diving into what the s222 charge -- a tax on PAYE tax -- is.

Loan Charge refresher

Historically, loan schemes have been prevalent in the contractor market. The schemes claim to reduce tax by having employees, normally working through an ‘umbrella’ (a term that is perhaps unfair to the many legitimate, compliant umbrellas), receive “loans,” rather than earnings, so tax would not be due. These loans were in reality not repayable, and in any case, we now know that they should be treated as earnings under the principles established by The Supreme Court in ‘Rangers.’  

If these loans were outstanding at April 5th 2019, or settlement of the outstanding tax on them was not made with HMRC by September 30th 2020, under certain circumstances they were subject to a tax known as the loan charge. The loans, which could be from as far back as October 9th 2010, are added together and treated as employment income as at April 5th 2019. This means that where there was an employer in the UK who was still in existence at April 5th 2019, HMRC would have expected them to report the outstanding loans and collect the loan charge via the Pay As You Earn (PAYE) system. That tax would then be due to be paid to HMRC by April 22nd 2019.

Where Section 222 charge applies

However, where an employer was unable to deduct the PAYE tax, perhaps because there was no money in the company to pay it or it was in liquidation, then the s222 charge applies. This is a tax charge on the PAYE tax, which the employer was unable to deduct but was required to pay to HMRC, or where it was paid but not reimbursed by the employee within 90 days of the end of the tax year.

For all intents and purposes, it treats the settling of the tax by the company as a benefit-in-kind and taxes it as additional earnings received. However -- and crucially, it still applies even if the employer does not actually pay the tax to HMRC.

Theoretically at least, that is not a bad outcome. The loan charge liability remains that of the employer, and the employee is being asked to pay the lessor amount of the s222 charge. 

HMRC moving the liability = double-whammy

However, having attempted to collect the loan charge from the employer, if it remains unpaid HMRC can move the liability from the employer to the employee using Regulation 72 or 81 of the PAYE rules -- if certain conditions are met.

This would leave the employee liable to both. It is far from clear that parliament ever intended for s222 to be used in these situations, having been enacted to ensure companies did not settle the employee tax on things like the exercise of share options through the payroll. It is also worth pointing out that we are yet to see HMRC use Reg 72 or 81 in loan scheme cases.

How to potentially beat s222

If you are facing a s222 charge, there are situations in which HMRC may not be able to apply it.

Firstly, check if there is a legally enforceable obligation on the part of the trustee to indemnify the employer for the tax owing, as this may mean that a s222 charge does not arise. If you have an indemnity clause that requires the employee to indemnify the employer for the tax owing, this may also be grounds for the removal of the s222 charge. It is therefore important to check any scheme documentation to see if such clauses are included and seek advice, or refer back to guidance, if you are unsure.

If there is an underlying tax dispute to be settled for the years that the scheme was used, it may be possible to remove the s222 charge by settling any earlier tax on the basis loans were earnings, and this earlier arising tax will then be set against the later loan charge tax that arises. This will reduce the tax due at April 5th 2019 and thus reduce or remove the s222 charge.

Caution, overestimation, and the danger of auto-acceptance

However, if you take this option, you cannot qualify for the residual tax concession which is part of the 2020 settlement terms which in certain circumstances might produce a worse result. Again, specialist advice should be sought as to what it the better route to take.

Finally, all 2018/19 DAs should have been issued by now, and regardless of whether it includes the s222 charge outlined above, our experience tells us that they are, in general, overestimated on HMRC’s part. Even if you intend to settle, it is worth checking the loan claimed to be outstanding and the tax claimed to be due, is correct. Automatic acceptance that HMRC’s figures are correct may well see tax overpaid which cannot be reclaimed in the future.


Profile picture for user Thomas Wallace

Written by Thomas Wallace

Tom is a former HMRC Senior Inspector of Taxes who has worked in and led teams in all taxpayer segments dealing with large multinationals to small businesses.  Tom was appointed Director of Tax Investigations at WTT Consulting in 2020, where he is currently responsible for developing strategies for dealing with HMRC enquiries and client litigation.
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