Cyclops vs. HMRC: tax avoidance using loan notes

Posted by RM2 at 16:00 on 29 Jan 2018


This case did not involve a one eyed Roman god, but it did provide an important ruling on tax avoidance, with a warning to those undertaking complex tax planning. This month two separate appellants, “Cyclops” and “Graceland”, appealed and lost against the ruling that loan notes issued to both director shareholders in 2004 should be subject to PAYE and NIC as they had no commercial purpose.

What was the planning?

This case involved the director shareholders incorporating a company that subscribed for loan notes with their employing company, which were then transferred to the director shareholders. The loan notes would revert to the company on the occurrence of the director shareholder’s death.

This case tried to take advantage of the rules that tax loan notes held by employees, and it was argued that as the loans were forfeitable, an income tax charge should not have arisen on award but when the forfeiture restriction lifted. However, the loan notes were worthless when the forfeiture provision lifted so, it was argued, an income tax charge did not arise at that time either.

Lack of commercial purpose

The First-Tier Tribunal ruled that as there was no commercial purpose for the forfeiture provision on the loan notes that they were not taxed when it lifted but taxed to employment income on the full value of the loan notes on award, subject to PAYE and NIC.

HMRC accept that taxpayers have the right to structure their affairs in the most tax efficient way but where that planning does not have a commercial purpose, or is it being undertaken simply to save tax, it is likely to be successfully challenged in the courts. The courts will look to determine whether the tax planning is within the ‘spirit’ of the legislation.


can we help?

There are a range of HMRC tax-advantaged share schemes which allow companies to deliver value to employees in a tax efficient manner, which give both the employer and employee comfort on the tax outcome. The RM2 Partnership would be happy to discuss which share scheme might be appropriate for your company, give us a call on 0208 949 5522 or email us at