£1.5m second-hand bond scheme breaks tax rules

The General Anti-Abuse Rule (GAAR) advisory panel has outlawed a disguised remuneration scheme involving employee rewards linked to a second-hand bond, labelling it as abusive tax avoidance

From the outset, HMRC was sceptical about the legitimacy of the scheme and the GAAR panel ruled in the tax authority’s favour.

The complex packaged scheme involved the use of a second-hand bond, gilt options, additional contributions and ‘cooling off’ rights. The aim of a series of transactions was to pass on a reward to a company and an employee - an individual who served as the company’s sole director and shareholder — through their joint acquisition of the bond.

The scheme also involved the use of ‘cooling off rights’ which were, in this case, a 30-day period in which the investor could cancel his position in the gilts option and contributions to the bond.

In outline, a promoter established and invested in an insurance bond which was subsequently acquired by a company and its director shareholder(s) and which included ‘cooling off rights’.

There was then a loan from a partnership, liability which was assumed by a company and satisfied by the individual(s) using steps involving the novation of a gilts option (taken out by the individual) into the insurance bond arrangements and the exercise of the cooling off rights.

The result of these transactions was that the individual had paid a nominal amount to acquire an interest in the bond. In the example considered by the GAAR panel, he had then received a substantial sum from the company which he claimed was not taxable as earnings, and secondly also benefitted from a credit to his loan account, again claiming that this was not taxable.

For its part, the company had claimed a corporation tax deduction for the first transaction but not for the second. The partnership which had made a loan of that same amount had been repaid in full, while the individual had no exposure to loss under the gilts option.

The GAAR panel summarised the substantive result of the arrangements as the individual paying out £1,000 for his share in the offshore bond and receiving £250,000 in the form of a premium under the option. The company’s assets reduce in value by £271,500, representing the price it paid for its share in the offshore bond which becomes worthless as a result of the arrangements.

The panel found that ‘under the arrangements taken as a whole as they were and were intended to be implemented the shareholders have not taken any material financial risk and the company has not been in a position to make a profit’.

For their part, the taxpayers argued the individual acquired a gilt option from a third party and hedged the downside risk through the offshore bond, and that the £250,000 premium is exempt from both income tax and capital gains tax under legislative provisions dealing with financial options and gilts. Various sources indicate that up to £1.5m is at stake for the Exchequer.

These arrangements resulted in the individual receiving a payout from the company that he argued was not earnings under UK income tax and National Insurance contributions (NICs) rules, even though the company claimed a tax deduction for that amount as the director’s remuneration.

The GAAR panel found that the arrangements were similar to a situation in which the company would have paid a cash bonus to the individual as remuneration, while the company would have paid dividend or another cash distribution, and involved ‘contrived and abnormal’ steps.

Its opinion was that entering into the tax arrangements is not a reasonable course of action in relation to the relevant tax provisions, and carrying out the tax arrangements is not a reasonable course of action in relation to the relevant tax provisions.

The transactions had no commercial purpose other than to secure a beneficial tax treatment for the individual by receiving the loan rather than taxable remuneration or dividends in cash. At the same time, the company could claim a corporation tax deduction.

The panel pointed out that its view was consistent with correspondence with an independent in which the individual made it clear that he was acquiring an interest in the offshore bond and entering into the option ‘primarily for fiscal rather than investment purposes’.

It was also consistent with the advice from an independent financial adviser that the taxpayers, from an investment perspective, should not proceed given their limited investment experience with the products in question.

So far, the GAAR panel has issued 12 opinions in under two years, with all those published so far agreeing in favour of HMRC.

GAAR Advisory Panel opinion of 28 May 2019: extraction of value using a second hand bond, gilt options, additional contributions and 'cooling off rights' (company)

GAAR Advisory Panel opinion of 28 May 2019: extraction of value using a second hand bond, gilt options, additional contributions and 'cooling off rights' (individual)

Report by Pat Sweet

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