As a Business Owner, What Should I Know About Anti-Tax Avoidance Laws in England?

As a business owner, you should aim to minimise tax. However, it is illegal for your business to avoid paying taxes. It can be hard to distinguish lawful attempts to minimise your tax liability from unlawful attempts to avoid paying the tax your business owes. Therefore, you should know the relevant law to ensure your business operates above board. This article will provide you with an overview of the anti-tax avoidance laws in England. 

What is Tax Avoidance?

Bending tax rules in a way that is contrary to what the law intends may make you liable for tax avoidance. Most tax avoidance schemes employ elaborate and artificial transactions that produce no commercial value to any party to the transaction. 

For instance, company directors must pay income tax on any compensation they receive for their service to the company. This is in line with general tax rules that govern all employees, as salaries and wages are taxable income. However, directors’ powers mean they can authorise the company to lend money to others, including themselves. 

Therefore, a common tax avoidance scheme Her Majesty’s Revenue and Customs (HMRC) looks for is where directors authorise the company to lend them money at no interest. Later, the directors write this loan off. While directors are allowed to borrow money from the company, they cannot use this power to circumvent income tax rules. 

Further Examples 

Some additional examples of common tax avoidance activities include: 

• umbrella payroll schemes; 
• fraudulent use of employee trusts; and
• transactions involving members of a close company.

These are outlined in detail below.  

Umbrella Payroll Schemes

Umbrella companies are commonly found in short-term and temporary engagements managed by a recruitment agency. Usually, if you are employed through an umbrella company, your employment contract will be with the umbrella company rather than the client of the recruitment agency that is paying your wages. 

Because umbrella companies act as a mediator between you and your employer, recruitment agencies and contractors can use umbrella companies to disguise the source of income and the purpose of certain expenses. 

If you contract through an umbrella company separately managed by a recruitment agency, you can unwittingly assist in tax avoidance. Most laws aimed at stopping tax avoidance require you to have a degree of knowledge that you are evading income. However, you can still be liable in some cases without acute awareness. 

Fraudulent Use of Employee Trusts

Another common tax avoidance scheme is where a company director misapplies money held on trust for employees (such as pensions or funds for employee share schemes). 

Usually, the director will use the money as a long-term, interest-free loan that may or may not ever be paid back. A recent Supreme Court decision ruled that such transactions amount to tax avoidance and are unlawful. 

Transactions Involving Members of a Close Company 

A close company is a legal term that, for practical purposes, refers to any private limited company owned by five or fewer shareholders. Most private companies in the UK are, therefore, close companies. 

Because close companies tend to be owned by shareholders that also act as directors, the law restricts the kinds of transactions a director is authorised to make without paying tax. 

Difference Between Tax Avoidance and Tax Minimisation

As a general rule of thumb, it is difficult to accidentally engage in tax avoidance. Tax avoidance is unlawful, and those that engage in tax avoidance are often guilty of one or more crimes. On the other hand, tax minimisation is where you might use the tax rules as they are intended to gain some benefit while also meeting any tax liability you owe to HMRC. 

For instance, many company directors of small businesses minimise the amount of money they authorise the company to pay themselves as a salary. This is because, after a certain amount, the salary attracts income tax and National Insurance Credits (NIC). Instead, at the point they reach the income tax or NIC credit threshold, they then choose to pay themselves through dividends, which can attract a lower tax burden than the alternative. 

There is nothing wrong with doing this. In fact, most tax rules are structured in such a way as to encourage individuals and businesses to act in a certain way. The government effectively encourages entrepreneurship and innovation by giving directors a more tax-efficient way to pay themselves.  

What Are the Penalties for Tax Avoidance?

The law is quite harsh towards individuals that deliberately engage in tax avoidance. In the most extreme cases, the court has the power to impose a life sentence, though, in practice, most maximum penalties are ten-year sentences. Individuals that receive custodial sentences tend to engage in a pattern of consistent and sustained fraud. 

However, in the alternative to imprisonment, the court has wide discretion to order heavy fines for tax evasion. Additionally, if you hold an office as a director, the law can order you be banned from holding such an office again. 

Finally, HMRC and the government continuously work together to investigate new avoidance schemes and crack down on perpetrators. Therefore, it is worth seeking legal advice before partaking in any atypical tax minimisation schemes.  

Key Takeaways 

Tax avoidance is a crime. In many cases, the punishment can be severe, including a custodial sentence. However, it is distinguishable from tax minimisation, where you use the tax rules in a way that is favourable to your position. An accountant and tax lawyer can advise you on minimising your tax liability without being liable for tax avoidance. 

If you need help with your business, our experienced commercial lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

Frequently Asked Questions