Bayliss – HMRC Seek Extra Penalties From Failed Avoidance Scheme

Another week and another case involving a failed tax avoidance scheme.

This time, perhaps more worryingly, HMRC were arguing that the return was submitted fraudulently or negligently by the taxpayer and therefore sought the extra penalties that would be due in such circumstances. This shows a new aspect of the targeting of anti-avoidance schemes and suggests users of schemes could expect the costs of failure to rise higher, whether in penalties or fees for defending them.

Ultimately, the taxpayer won in this case. Of particular interest was the fact that the Tribunal found that relying on the advice of a trusted accountant was helpful in suggesting that he had not acted negligently. It appears the courts confirm that obtaining suitable professional advice is worth paying for in the long run!

Mr Bayliss participated in a scheme marketed by Montpelier Tax Consultants (Montpelier). The scheme involved a Contract for Differences (CFD) and was sold as generating a £539,000 capital loss for Mr Baylis in 2006–07. It was agreed by all the parties that the scheme had failed and additional tax was due, however the taxpayer appealed against penalties raised by HMRC on the basis that ther return was submitted fraudulently or negligently.

The Tribunal determined that in accordance with established case law, in order to prove fraud HMRC had to prove that the appellant did not have an honest belief in the correctness of the return. The Tribunal was persuaded on the basis of the evidence and facts that Mr Bayliss did believe that his tax return was correct and so there was no fraudulent behaviour.

On the question of negligence, the Tribunal felt that the correct test was that set out in Blyth v Birmingham Waterworks Co (1856), that of ‘the omission to do something which a reasonable man, guided upon those considerations which ordinarily regulate the conduct of human affairs, would do, or doing something which a prudent and reasonable man would not do’. They also considered the test in Anderson (decʼd) [2009], ‘to consider what a reasonable taxpayer, exercising reasonable diligence in the completion and submission of the return, would have done’.

HMRC used a number points to support their argument that Mr Baylis was negligent, including that:

  1. the transaction did not stand up to commercial scrutiny and the appellant failed to check the commercial reality;
  2. the appellant had not kept copies of the documentation, whereas a reasonable person would have done so;
  3. It was a complex financial transaction and the appellant should have obtained proper independent financial advice, but he relied on informal advice.

The Tribunal agreed with HMRC that some of the taxpayer’s behaviour could have been deemed to be careless, but on balance found that HMRC had not done enough to prove that the appellant was negligent in filing an incorrect return.

Interestingly, they felt that relying on his accountant was helpful in this respect, stating “We are persuaded that the appellant relied fully on Mr Mall, a chartered accountant on whom he had relied for a number of years, and on what he believed (based on Mr Mallʼs recommendation) to be Montpelierʼs expertise.”

The tribunal allowed the appeal on the basis that HMRC had not proven that Mr Bayliss acted fraudulently or negligently in submitting an incorrect return.

Comments on Strengthening Tax Avoidance Sanctions and Deterrents Consultation

This Blog is addressed to All Accountants.  The majority of you will give ‘tax advice’, but would you care to pay your clients’ tax bill if it proves to be technically incorrect?  [Under the proposals discussed below the client will pay the newly imposed bill as well so there is at least ‘double jeopardy’].  My worry is a conceptual one.  Should there really be multiple punishments for the same purported ‘offence’?  Would this not be disproportionate?  I do not know if the words are meant to be forceful and intimidating but the ‘deterrent’ seems to envisage liabilities which could lead to the bankruptcy of professional accountants who were merely part of the ‘supply chain’.  Concerned yet?  Read on.

In due course, I hope to give intelligent feedback to HMRC on their Consultative Document; Strengthening Tax Avoidance Sanctions and Deterrents.  In the meantime, I would like opinions from professionals (and others) to the proposals.  I have an open mind, and certainly do not approve of dishonest behaviour = evasion.

However, when I was an Inspector of Taxes the next level up on the spectrum – avoidance was legal.

Initial thoughts for discussion:-

 

  1. Logically, people indulging in ‘avoidance’ are obeying the law.  Why should they be punished in that case?  Even if incorrect on a technicality there is no ‘mems rea’.

 

  1. The definition of ‘tax avoidance’ seems very vague.  It is also the subject of post event review in that a court will judge – probably some years later.  This makes it difficult to judge at the time of giving advice.  Surely, HMRC should be encouraging independent professional advice, not discouraging it.  If clients know the ‘safe harbour’ for accountants is always to advise against a tax saver, they will know they are not getting independent advice.  (See HMRC document on protection against penalties).

 

  1. Should it really encompass ‘any transaction’ as suggested by the discussion document?

 

  1. Should advisors really be subject to such harsh penalties, which may well be orders of magnitude above their fees for client behaviour (not the accountants behaviour) which, after complex litigation, the Courts have found ‘unreasonable’ under GAAR.  This means the behaviour was determined to be technically flawed but probably not illegal?  This is deterrence, but deterrent to giving advice to key entrepreneurs and wealth creators in a highly complex area.

 

  1. Again, initial thoughts for discussion, if the HMRC target is (as stated) a ‘small minority’.  Why try to affect the general economics of professional advice?  Surely, the penalty risk could have a profound impact on PI insurance costs?

 

  1. Could not the HMRC objectives be achieved by:-

a) Stating that a protection from penalties (not tax) may be achieved by getting a written opinion from an appropriately qualified professional (to be defined – but relevant professional qualifications).

b) Stating that a person/firm receiving a monetary benefit/commission based on the scheme may not qualify as ‘independent’.

 

Surely this would be easier and more proportionate.

Beware New Rules on Liquidations – HMRC Refuse to Give Clearance

As you may be aware, new rules are being introduced with effect from April 2016 as part of the Finance Act 2016.  These relate to distributions in a winding-up/liquidation and are designed to target certain company distributions in respect of share capital in a winding-up. Where a distribution from a winding-up is caught, it is chargeable to income tax rather than capital gains tax.

The rules apply where the following conditions are met:

  1. The company being wound up was a close company (or was within the two years prior to winding-up)
  2. The individual held at least a 5% interest in the company (ordinary share capital and voting rights).
  3. The individual continues to carry on the same or a similar trade or activity to that carried on by the wound-up company within the two years following the distribution
  4. It is reasonable to assume, having regard to all of the circumstances that there is a main purpose of obtaining a tax advantage.

Whether or not Conditions C or D are triggered could be a cause for some contention, and so HMRC note that they have received a number of clearance applications relating to these new rules.

In the absence of a statutory clearance procedure under the new legislation, HMRC have clarified that it is not their general practice to offer clearances on recently introduced legislation with a purpose test.  They have instead sent out a standard reply providing some examples of how they think the rules will apply.

Clearly this is a developing area and HMRC’s reaction is somewhat disappointing as taxpayers often require certainty before carrying out commercial transactions which could be caught.  HMRC have stated that further guidance will be published, however in the meantime we advise that care be taken, and seeking professional advice, as always, may save time and costs in the long run.

We would be delighted to assist if you think you may be affected by these rules and have any queries.

Employers Beware! – PAYE Penalties

Typically, PAYE has been described as an ‘approximate’ method of collecting tax due, which remained the ultimate liability of the employee.

Recent judgements, including the case of Paringdon Sports Club, suggest more of the risk may fall on the employer.

In addition the risk may be worse with the current HMRC penchant for penalties. Many advisors will be familiar with their tendency to seek around 15% extra tax for relatively minor ‘careless’ errors. This represents increased risk for business and their advisors.

There are methods related to potentially mitigating or suspending such penalties.

To avoid embarrassment and excessive cost a prudent review may seem sensible?

Whilst most businesses operate routine PAYE relatively easily with the backing of software, experience suggests that ‘unusual’ or one off events can cause problems.

These days such errors can lead to expensive penalties, so procedures should be put in place to check the correct treatment on one off matters and if necessary take advice.

On the penalty front the case of P Steady shows that it can be worth appealing against a penalty imposition. In that recent case the taxpayer managed to get a penalty suspended where, by oversight he had put down bank interest earned in incorrect years. The Tribunal said ‘The mere fact that this is an error in a tax return does not mean that a taxpayer has been careless’. They went on to say, ‘To levy a penalty on a taxpayer who hereto has had a good compliance record over many years and then refuse to consider suspension of those penalties does not reflect well on HMRC’.

As always thinking of the correct technical position makes sense.

VAT Penalty Reduced – J & W Brown

A recent case concerned penalties that arose on a taxpayer due to a technicality. The taxpayer had run a business as a VAT registered sole trader. He brought his son in as a business partner, which was therefore technically a transfer to a partnership and a transfer of a going concern (TOGC) for VAT purposes.

The taxpayer did not realise this and did not notify HMRC until around 2 years later. However, he continued to submit his sole trader VAT returns and pay the tax due through this period. Two of the returns in the period were submitted late.

HMRC therefore sought penalties for late registration by the new partnership of more than 12 months and charged an 18% penalty. They did, however mitigate this by 70% as the VAT returns and tax were submitted through the sole trader registration and there was therefore no loss of tax.

The First-tier Tribunal felt that as the error was a technicality and that there had been no loss or administrative inconvenience to HMRC, the penalty should be reduced by 90% instead and lowered the 18% penalty to 12.5%. They also noted that the taxpayer had made a voluntary disclosure and that HMRC’s protracted case management had been inappropriate, causing “significant inconvenience and expense’” to the taxpayer

Overall the penalty was reduced from £582 to £100 and so the taxpayer’s appeal was allowed in part.

This case shows the continued firm approach that HMRC appear to be taking with penalties for minor mistakes. However, the Tribunals continue to provide a safety net to taxpayers and the comments of the Tribunal showed the importance of taking the first steps and making voluntary disclosure before HMRC find the error. If you would like assistance with making a disclosure or have any concerns about past transactions, please get in touch with us as we would be delighted to assist.

Brexit and European Tax Law

Here are some interesting questions. Well, I think them interesting anyway!

1. If we ‘do Brexit’, will we persist with VAT?

2. If so, how will it be administered, bearing in mind the current cross-border arrangements?

3. Will the European Court remain supreme, in terms of judicial opinion and interpretation?

4. On direct taxes, will we revert to double tax treaties, rather than the various European Directives?

5. If so, from what date?

6. If we do leave the EU, will the Courts go back to the ‘literal’ approach to interpreting tax legislation, a la Justice Rowlatt, or will it continue to dabble in the ‘purposive’ approach?

7. In the context of the above how would anyone define ‘The Purpose of Parliament’, in terms of (say) the formulae in the Emloyee Security/Benefit rules?

Je ne sais pas?

Opinions, s’il vous plait.

Law, Interpretation and Common Sense

Here is a conundrum.

A long, long time ago … in a galaxy far, far away (a.k.a. York, England 1981) I was a newly created Inspector of Taxes.

I was taught that the tax rules were strict and should be followed to the letter. However, that should not mean artificial impositions and ridiculous decisions. In those days (what is now HMRC) had ‘care and management’ of the Tax System.

Hence, my training was that, if during a Tax Investigation (of which I did quite a few!) I ‘discovered’ (see S29 TMA 1970) that some profits from one year, really ought to have been taxed in a different year, I should adjust it accordingly – but on both sides. So, in adding the profit to one year (per the correct accounting) I should then deduct the profit from the year I have moved it from. I should not seek to tax it twice, because that would be blatantly unfair!

A recent case [Ignatius Fessal v HMRC] reached the same conclusion, albeit using complex legal arguments concerning the European Human Rights Act. In this case the question was one of interpretation. In analysing it the Tribunal have resorted to the Human Rights Act to get to a fair conclusion. In other (older) leading cases, Justice Rowlatt, said that there was no ‘Equity’ in tax, you just read the words stated by Parliament and interpreted them strictly. However, the fact that there was no ‘Equity’, did not mean there should be no fairness. It was simply a method of how best to analyse the statute, bearing in mind the underlying fundamental principle that no Government would wish to impose double taxation.

So the answer should be – No Double Tax.

That truly should be the end of the story.

BUT NO!

In the Fessal case (which as Andrew Hubbard rightly says is complex in the 19 May issue of the leading professional magazine, Taxation) the First Tribunal spent 36 rather closely argued and difficult pages, including analysing a key issue as to whether the ‘European Human Rights Act’ should apply?

To be fair to the Tribunal, they gave detailed legal analysis, which is impressive in scope and response. However, should it have been necessary to invoke such complexity on what surely should have been determined as a simple question of fairness? As certain Old-Fashioned English Common Law Chaps might have concluded – You cannot tax a person twice on the same profits!

To use the current jargon “End of …”

Would the Revenue in the days of their duties for ‘care and management of the tax system’ objected to this ‘as a matter of law?’ It would be hoped not.

In present times though – they did. As the Court pointed out, the way HMRC handled the matter put the taxpayer in a worse position than if they had not made a Tax Return at all! Surely, this could not be just and would (fairly quickly) lead the tax system into disrepute? This would cost HMRC far more in lost goodwill and compliance.

In addition, the Fessal case does raise rather interesting issues as to the impact of Double Tax Treaties, where maybe they do not work as well as anticipated. Could the Human Rights principle established against Double Taxation assist in cases where there is effective Double Taxation not strictly protected by a Double Tax Treaty? (See the Anson case?)

Moving on, business needs certainty. If the system is to be strictly on a ‘rules basis’ then surely that should be the same for both sides – taxpayer and HMRC. This brings us on to the latest Finance Bill proposals for penalties under GAAR. Are these well thought out and balanced?

Taxpayers who have indulged in tax avoidance have obeyed the law, by definition. Otherwise they would be guilty of tax evasion – a criminal offence.

I hold no brief for artificial tax schemes. In my experience, many of them fail either because they do not meet the underlying commercial requirements, or in truth they depend upon a sham. Some are correct under the law though. Surely they should not be punished severely because the opinion of a bureaucrat finds them objectionable? The Finance Bill proposal for a tax geared penalty of up to 60% may seem disproportionate? Could this be challenged as a breach of ‘Human Rights’?

My opinion is that to protect Government Revenue, HMRC do not need greater powers, nor heavier penalties. They need more, better trained personnel, so that cases can be dealt with and if necessary investigated properly.

I believe the issue is an administrative one – not one for even more legislation.

Opinions please?

Entrepreneurs’ relief – What is an ordinary share?

We have written in previous blogs about the need to take care over Entrepreneurs’ relief (ER) and preference shares (see Entrepreneurs’ Relief – 5% Test and Preference Shares) and a recent case heard by the First-Tier Tribunal has shed more light on how the rules are to be interpreted.

One of the conditions for ER is that the taxpayer must hold at least of 5% of the company’s ordinary share capital and voting rights. For these purposes, ordinary share capital is defined as all share capital excluding fixed rate preference shares.

However, in the recent case of M & E McQuillan v HMRC [2016] TC05074 redeemable non-voting shares which did not carry rights to dividends were found to not constitute ordinary shares for ER purposes.  It was found that shares with no rights to dividends could be considered as having a right to a fixed rate of 0% and therefore could be excluded from the calculation of ordinary share capital.

In this case, this provided the right outcome for the taxpayers as they were selling their ‘ordinary’ shares in the company, of which they had 33% each.  Another couple had made a loan of £30,000 which had been converted into the 30,000 preference shares which were redeemable non-voting share capital with no rights to dividends.

Had the 30,000 extra shares have been treated as ordinary share capital, the taxpayers would not have had the required 5% holding.

The case highlights the importance of checking through all the details before making a sale of shares in your company.  In this case, the taxpayers were successful but others will not be so fortunate.  Eaves and Co have extensive experience advising on share sales and Entrepreneurs’ relief and would be delighted to hear from you if you are considering a sale in the near future.

Farce: Manchester United and HM Treasury

Hello,

1)      Sorry for the informality of the greeting but if you were doing a training exercise on fake bombs and security, would you not (at least) count up the number of imitations you had hidden – and then count them back in to avoid scaring/annoying 75,000 people?  See Manchester United and fake security issue?

2)      Secondly, if you were trying to convey ‘good news’ about the ‘initiative to automatically exchange information on beneficial ownership’ (See HM Treasury Press Release), there may be ‘marginal’ concern about the absence of countries [on HM Treasury List dated 13 May 2016] such as China, Russia and the USA (for example)

3)      Thirdly, by definition, dishonest people are going to tell lies, especially if they can get away with it.  Hence, how (for example) is a relatively poor country (say the UK (?)) going to enforce disclosure?