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K2 successor scheme loses key DOTAS ruling

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K2 successor scheme loses key DOTAS ruling

Hyrax Resourcing Ltd has lost a key First-Tier Tribunal (FTT) ruling on whether their tax avoidance scheme, a new “iteration” of the infamous K2 tax scheme exposed by The Times in 2012, should have been registered with HMRC under the Disclosure of Tax Avoidance Schemes (DOTAS) rules.

The DOTAS regulations force the promoters of tax avoidance schemes to register with HMRC, providing the taxman with a technical explanation of how the scheme works.  The scheme is then given a unique Scheme Reference Number (SRN), which users of the scheme are required to declare on their tax returns in years that they use the scheme.

The DOTAS regime is intended to give HMRC visibility of tax avoidance schemes from the moment that they are conceived, so that they can arrange to amend legislation to close tax loopholes promptly, where necessary.  In the case of flawed schemes it also provides them with a handy list of all of the scheme users.

But the rules are complex, and not all schemes fall into their ambit – Hyrax contended that their scheme was not caught under the DOTAS rules due to a statutory exemption, and told their clients that there was no legal requirement for them to declare it on their tax returns.

Having lost the case, they may now have to provide HMRC with details of all of the scheme users, just weeks before the 2019 Loan Charge is due to take effect on 6th April.  Any list may include some high-profile individuals, given that the majority of K2 users were seemingly migrated into Hyrax after legal changes rendered the K2 product unusable.

The K2 scheme was the subject of an in-depth investigation by The Times in 2012 after they mystery-shopped the company and were told by a salesman that comedian Jimmy Carr sheltered £3.3 million annually through the “solution”.  The Times reported in 2012 that some 1,100 individuals were funnelling £168 million a year through the K2 scheme.  At the time, Prime Minister David Cameron called the K2 scheme “very dodgy” and “morally wrong”.  Jimmy Carr has since made efforts to repay avoided tax to HMRC.

The K2 scheme involved employing scheme users via a Jersey-based employer that then made tax-free contributions to an Employee Benefit Trust (EBT).  The users were then issued with loans from the EBT that were unlikely – but had the potential – to be paid back.  The scheme was then closed, likely due to the introduction of the General Anti-Abuse Rule (GAAR) at Finance Act 2013, and the Hyrax scheme was started, with ex-K2 users migrated into the new scheme.

The Hyrax scheme used a UK resident employer which made loans to its employees via an Employer-Financed Retirement Benefits Scheme (EFRBS).  The promoters of the scheme argued that, because loans from an EFRBS are subject to a permitted tax exemption, they cannot be considered tax avoidance, and thus should not be subject to DOTAS (nor, presumably, the GAAR).

Both the K2 and Hyrax schemes were apparently developed by Kircaldy-based Peak Performance, a firm of “accountants” that had operated at least seven tax avoidance schemes since 2004 according to HMRC: Assignment Solutions (IoM), Penfold, Hamilton, Cirus, Lighthouse, K2 and finally Hyrax.

It appears that they would “phoenix” schemes at the point of key changes in the law that made them unviable.  A few tweaks would be made to try to escape the reach of any new regulations, the name and branding would change, and they would then move their clients en masse from the old product to the shiny new brand, with a familiar roster of staff in the background to support them.

The respondents from Peak Performance et al did not submit any written evidence or call any witnesses, which led the judge, Barbara Mosedale, to infer that any evidence that they could have submitted would not have assisted their case, adding more weight to HMRC’s position.  The judge noted that some of the directors personally attended the hearing, however.

All six of the previous Peak Performance schemes had been notified to HMRC under DOTAS.  HMRC argued that, because Hyrax was simply a new iteration of these schemes, it was also subject to DOTAS.  The judge ruled that whilst the previous schemes were certainly relevant, the existence of the previous schemes was not enough on its own to make DOTAS apply to Hyrax: the scheme had to be assessed, as any other, against the criteria laid out in the DOTAS legislation at Finance Act 2004 (FA2004) Part 7.

Upon reviewing these criteria, the First-Tier Tribunal ruled that the Hyrax arrangements were notifiable under section 314A of FA2004, given the following:

  • The scheme gave, or was expected to give, rise to a tax advantage because it was intended to avoid or reduce the charge to tax on salary which would otherwise have been received by scheme users [s306(1)(b)];
  • The main benefit that might be expected to arise from the arrangements was the obtaining of that tax advantage: “there is no other rational reason for why anyone would implement a convoluted and expensive set of arrangements which left them with a legal (if economically unreal) obligation to repay a sum that they would otherwise have received as salary, save for the expected tax advantage. It seems an obvious and logical inference that the scheme was implemented by scheme users because of the desire to obtain the tax advantage that was at the heart of the marketing of the scheme” [s306(1)(c)];
  • The Hyrax arrangements fell within the Premium Fee DOTAS “hallmark”;
  • The arrangements fell within the Standardised Tax Product DOTAS “hallmark”;
  • The Employment Income Provided Through Third Parties DOTAS “hallmark” was met.

However, of the three companies responding, only the Hyrax entity was found to have an obligation to notify under DOTAS.  Two other Peak Performance subsidiary companies were ruled not to be promoters of the scheme and therefore to have had no DOTAS obligations.  The decision is not appealable.

This was only the second ever DOTAS case and accordingly, the judge considered the evidence and precedents at great length.  The penalties for failure to notify under DOTAS are enormous: a daily penalty of up to £600 per day can be levied in addition to a further penalty of up to £1 million, but the judge noted that “it is clear that the respondents have not yet been penalised, and may never be penalised”, perhaps in consideration that this shell company, specifically set up to facilitate a now-defunct product, is unlikely to have many assets.

19th March 2019.

Sources:

http://financeandtax.decisions.tribunals.gov.uk//judgmentfiles/j10988/TC07025.pdf

https://www.taxjournal.com/articles/hmrc-v-hyrax-resourcing-and-others

https://www.rossmartin.co.uk/sme-tax-news/3941-contractor-loan-scheme-should-have-been-notified

https://en.wikipedia.org/wiki/K2_(tax_scheme)

https://www.thetimes.co.uk/article/times-investigation-the-tax-avoiders-0rkt3fhwtrn

https://www.ft.com/content/4316a2f4-bc4c-11e1-a836-00144feabdc0

https://www.legislation.gov.uk/ukpga/2004/12/part/7

https://www.rossmartin.co.uk/index.php/penalties-a-compliance/553-tax-penalties-dotas

https://www.itv.com/news/update/2012-06-20/how-the-k2-tax-avoidance-scheme-works/