WARNING
New tax avoidance scheme uncovered with PSC’s
HMRC has warned taxpayers against using a new ER-based scheme to reduce tax payable on earnings to 10%.
How it works
The scheme is described in the latest tax avoidance “spotlight” by HMRC: Capital Gains Tax: Entrepreneurs’ Relief tax avoidance scheme. It has three stages:
- A taxpayer who owns a personal service company (PSC) in the UK sells that company to an organisation based in Cyprus. This sale is correctly taxed as a capital gain. If the taxpayer has owned at least 5% of the PSC for a year or more, the gain will be eligible for entrepreneurs’ relief (ER), so will be taxed at 10%
- The taxpayer continues to be a director of the PSC after its sale to the Cyprus entity, and continues to work through that PSC in the UK
- The scheme providers claim that the monthly payments the taxpayer receives in return for his work through the PSC are capital payments subject to ER, and thus taxed at 10%
Why it may fail
HMRC clearly believes that this tax scheme doesn’t work, although it doesn’t specify why. I suggest the potential failure of this scheme is connected with the valuation of the disposal of the PSC and the timing of receipts.
When the PSC is sold in stage one, its value at that point is subject to CGT (assuming small or nil base cost), so ER can be claimed on that gain. The owner may also be paid an “earn-out”, which is an amount based on value the PSC will generate in the future– i.e. the earnings created at stage three.