Guide to Judicial Review, The Loan Charge Review and HMRC

The loan charge

The loan charge was introduced in the Finance Act 2016 as a way for HMRC to recover unpaid taxes that it considered had been lost as a result of tax avoidance schemes where individuals had been paid in the form of a loan instead of salary. Most of these loans were provided by a trust structure, such as an Employee Benefit Trust (EBT), and were designed not to be repaid.

The loan charge was initially implemented to apply to any such loans taken since 1999 and still outstanding on 5 April 2019. Any loans outstanding at that point would be treated as income received in the 2019/20 tax year.

In the build-up to 5 April 2019, HMRC issued guidance proposing two ways to deal with these tax liabilities:

1. Declare all such loans to HMRC and settle the tax liabilities as if the loans had been taxable income in the relevant tax year; or
   
   
2. Repay the outstanding loans.

The loan charge review

Following a lot of pressure from action groups, in September 2019 Parliament commissioned a review on the loan charge to consider “whether the loan charge is an appropriate response to tax avoidance by individuals who have directly entered into loan schemes; and whether the government’s announced changes address the issues that have been raised”.

The review, conducted by Sir Amyas Morse, finished in December 2019. Sir Morse’s report, running to 83 pages, concludes (in brief):

1. The purpose of the loan charge is supported;
2. Elements of the loan charge “go too far in undermining or overriding taxpayer protections”;
3. That the loan charge should “not apply to loans entered into by either individuals or employers before 9 December 2010”; and
4. That “taxpayers who made reasonable disclosure of their scheme usage, but for whom the relevant year is unprotected, should not have that unprotected year in the scope of the loan charge” for tax returns from 2010 to 2016.

Let’s unpack numbers 3 and 4.

Number 3 is simple: where a loan was taken pre-9 December 2010, the loan charge should no longer apply.

Number 4 is a little more convoluted: where:

1. a loan was taken between 9 December 2010 and March 2016; and
2. that loan was reasonably disclosed to HMRC; and
3. HMRC has not opened an enquiry or taken some other steps to protect the relevant tax year, then the loan charge no longer applies.

The Government accepted Sir Morse’s report, implementing numbers 3 and 4 via new legislation – the Finance Bill 2020 (at the date of writing currently before the House of Lords).

As an aside, for any loans relying on number 4 above, the question of what “reasonably disclosed” means is not straightforward. However, if the individual recipients and sums received can be identified on a tax return of some form, it will probably be sufficient.

The impact of the loan charge review

There can be no question that the loan charge review and the subsequent amendments to legislation are good things. However, while the Finance Bill 2020 deals with circumstances where settlements have been agreed with HMRC for loans no longer covered by the loan charge, it does not address situations where individuals have taken drastic steps to repay loans in reliance on HMRC’s guidance and in fear of the loan charge.

An example (based on a real-life scenario):

Mr Smith runs ZYX Ltd - a marketing agency. In 2003/04 ZYX Ltd has a bumper year with profits of £5million. Mr Smith, on the advice of his accountants and tax advisers, pays the £5million to a trust and takes loans in the sum of £4million. This reduces his tax bill to zero.

Fast-forward 15 years. In 2018, following HMRC’s guidance, Mr Smith chose to repay the loans. He no longer has £4million in cash, so re-mortgages his house and liquidates several investments. He then repays the £4million loan to the trust.

If the loan had been outstanding at 5 April 2019, Mr Smith would have had to declare it and would have been subject to the loan charge. However, following the loan charge review in December 2019 and subsequent legislation, he would have no longer been liable for the loan charge. He would not have re-mortgaged his house and would not have liquidated his assets.

But the loan was not outstanding – because Mr Smith had repaid it (following HMRC’s guidance). He, therefore, writes to HMRC, requesting confirmation that he can cancel his repayment of the loan without being subject to a new tax charge. HMRC respond, denying this request, and confirming that if Mr Smith were to cancel his repayment, this would be treated as a “relevant step” for the purposes of Part 7A of the Finance Act 2012, would be treated as income and taxed accordingly.

Mr Smith is just one example of many queries we have received. It cannot be right or fair that individuals who have tried to comply with tax legislation can be left in a significantly worse position following a change in the law that no one anticipated.

What can Mr Smith do? He can pursue a Judicial Review of HMRC’s decision.

What is Judicial Review?

Judicial Review allows the courts to examine decisions taken by public bodies (in this instance, HMRC) to ensure that they act lawfully and fairly. On the application of a party with sufficient interest in the case (Mr Smith), the Court will conduct a review of the process which HMRC (or the public body) followed to reach its decision and assess whether or not that decision was validly made.

There are four grounds on which a Judicial Review can be pursued:

• Illegality: the public body has misdirected itself in law, exercised its power wrongly or acted ultra vires (that is, beyond the scope of its remit);
• Irrationality: where a decision is “so unreasonable that no reasonable authority could ever have come to it” or the decision-maker took account of irrelevant matters (or failed to consider relevant matters);
• Procedural unfairness: where the public body has not followed relevant procedures (for example, a flawed redundancy consultation process); and
• Legitimate expectation: where a public body fails to act in accordance with what the public could legitimately expect based on the public body’s own statements or conduct.

How does Judicial Review work?

The procedure for Judicial Review is straightforward, but the timeframes are very short:

• Follow the pre-action protocol for Judicial Review. The point of this is to avoid unnecessary litigation if parties can agree a way forward instead. The pre-action protocol for Judicial Review includes:
• A preliminary notice and letter of claim as soon as possible;
• A letter of response (within a reasonable timeframe); and
• Negotiations (where possible).

Given the tight timeframes of Judicial Review proceedings, it is common for the pre-action protocol stage not to be fully complied with.

• Issue proceedings. The claim form must be issued “as soon as practicable” after the relevant decision, and in any event not later than three months after the relevant decision. Numerous documents have to accompany the claim form, which take a significant amount of time to prepare.
• Proceedings must then be served (in this case on HMRC) within seven days of the claim form being issued.
• Acknowledgement of service from the respondent. This is due 21 days after service of the claim form and sets out a summary of the respondent’s grounds for opposing the Judicial Review.
• The Court will then consider and assess the Judicial Review and decide whether to permit or refuse the claim. This can take place without a hearing. Where the claim is refused, that is the end (subject to any right of appeal). Where a claim is permitted, any opposing party must file and serve detailed grounds for opposition (together with evidence in support) within 35 days.
• Directions will then be given by the Court setting out any steps required to be taken by the parties before the final hearing.
• The final hearing will then be listed. There will be oral submissions by the parties, following by a judgment.

What are the possible outcomes?

If a Judicial Review is successful, there are three remedies specifically available in Judicial Review proceedings:

1. A quashing order – that is an order setting aside the decision being challenged;
2. A mandatory order – that is an order requiring the public body to retake the decision following the Court’s judgment; and
3. A prohibiting order – that is an order prohibiting the public body from acting beyond its powers.

The most common approach is to seek both a quashing and a mandatory order.

Other remedies available can be a declaration (confirming the rights or legal position of the parties), a stay or injunction (to prevent a decision being acted upon) and damages (in rare circumstances where there is a corresponding claim for damages).

In conclusion

The loan charge review is a good thing. It has rightly reduced the extensive remit of the loan charge to remove loans taken pre-December 2010. It has protected taxpayers who had such loans but had settled with HMRC.

But it has not protected taxpayers who had such loans who have repaid their loans.

Taxpayers who have repaid their loans are now in a worse position. The money is stuck in their trust; trust fees are being incurred, and any attempt to re-withdraw the money will be treated as taxable income.

That is what HMRC has decided. That is what our Judicial Review is challenging.