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What is the Loan Charge?

The Loan Charge is a standalone income tax charge introduced by the Finance (No.2) Act 2017 and taking effect from 5 April 2019. It was designed to tackle disguised remuneration (DR) tax avoidance schemes where employers paid employees through structures — typically employer-financed retirement benefit schemes (EFRBSs), employee benefit trusts (EBTs), or similar vehicles — that provided loans instead of salary.

These loans were structured so they would theoretically never be repaid, effectively functioning as tax-free income. The schemes avoided income tax and National Insurance Contributions by characterising the payments as loans rather than employment income. HMRC argued that such arrangements were always ineffective as tax avoidance and that the amounts should have been taxed at the time they were received.

Rather than open enquiries for every individual year in which such payments were made, the Loan Charge treats all outstanding DR loans as a single employment income payment arising on 5 April 2019. This concentrates the tax liability into one year, potentially creating a very large tax bill in that year.

The Morse Review and Scope Changes

Following widespread concern about the Loan Charge's scope and fairness, an independent review led by Sir Amyas Morse reported in December 2019. The review resulted in significant changes. Most importantly, loans made before 9 December 2010 were removed from the Loan Charge scope entirely. Additionally, taxpayers who had disclosed their scheme use under DOTAS (Disclosure of Tax Avoidance Schemes) to HMRC and where HMRC had failed to open enquiries in time were given some protection for certain years.

After the Morse Review changes, loans made between 9 December 2010 and 5 April 2019 that remained outstanding and were not settled before 31 January 2020 remain subject to the Loan Charge.

The Three-Year Spreading Election

Rather than all outstanding loan amounts being treated as 2018/19 income, taxpayers can elect to spread the total loan amount equally across three tax years: 2018/19, 2019/20, and 2020/21. For those with large loan balances, spreading can reduce the marginal tax rate if the loan amount would otherwise push all income into the additional rate band in a single year.

The spreading election had to be made on the 2018/19 Self Assessment tax return (or an amendment thereof). Whether spreading was advantageous depended entirely on individual income profiles across those three years.

Settlements and HMRC DR Settlement Terms

HMRC published settlement terms for taxpayers who used DR schemes. Those who reached a full settlement with HMRC under these terms before 31 January 2020 are not subject to the Loan Charge on settled loans. Settlement under HMRC's terms involved agreeing the amount of tax owed on the loans as employment income, at the marginal rates applicable in the years the loans were received (rather than all in one year as under the Loan Charge).

For many taxpayers, settling under HMRC's terms resulted in a lower overall tax cost than the Loan Charge, particularly where income in the years of receipt was lower than in 2018/19. However, settlement required accessing records going back many years and required legal and tax advice to negotiate.