Manuel alive and well and working in Whitehall – Tax Avoidance Deterrents

After the recent tragic death of Andrew Sachs, there are rumours that his spirit for competence lives on in our legislation.

 TAX AVOIDANCE DETERRENTS

An open question for the above.  How do the current proposals (published on 5 December 2016 as Sanctions and Deterrents) fit with The Rule of Law?

I believe in the vital importance of the Rule of Law.

I believe it can only work with;

a) Clarity

b) Independent Judgement

c) Consent

Naively; having been trained as an Inspector of Taxes, I believe that the intention of Parliament was as set out in the words they enacted.  There is a lot of case law which supports this.

With 17,000+ pages of legislation the situation is complex.  There may be a dispute as to interpretation.  That arises, almost certainly, through lack of clarity (see (a) above).  The disputing parties are then dependent upon ‘independent judgement’ which hopefully they can both trust – effectively the Rule of Law (cf Tom Bingham).

If they do not trust the independent judgement then (c) Consent is lost.  That is dangerous.

Probably with good intentions (I am told they pave the Road to Hell) HMRC are saying that certain professionals need their behaviour modifying.  To quote the ‘Strengthening Tax Avoidance Sanctions and Deterrents in their paragraph 5.4:-

The government noted the views and responses provided. It recognises that the avoidance market is not static but is constantly evolving. HMRC will further develop the options set out in Chapter 5 of the discussion document to supplement the important work undertaken in this area to date, whilst looking at new and emerging threats in the avoidance market. Alongside this, HMRC will continue to explore ways to further discourage tax avoidance by:

  • working collaboratively with businesses, individuals, industry and representative bodies to identify opportunities to further shrink the avoidance market
  • exploring how behavioural change techniques can positively affect decisions and choices for enablers and users
  • tailoring communications and engagement with users to support them to make the right choices and decisions including outlining the risks and consequences of entering into these kinds of arrangements
  • meeting the challenges and opportunities that current and proposed legislation, HMRC’s Making Tax Digital Programme and other cross-sector initiatives may present

In paragraph 5.5 they go on to say:

The government will continue to take decisive and necessary steps to ensure that those who seek an unfair tax advantage, or provide services that enable it, should bear the real risks and consequences for their actions.

So that is clear now?

Quite apart from their appalling grammar, and resulting lack of clarity, the proposed result of this appears to be:

i) An advisor may introduce a client to (say) a Queens Counsel who suggests a course of action he believes to be legal.

ii) Sometime – [likelihood, at least 10 years from final date of action bearing in mind current complex litigation process] – advice and action may be proven correct.  End of story.

iii) Alternatively, in the litigation lottery of the Courts (talk to lawyers!) the advice may prove to be incorrect.  In this case penalties would be sought against the person who introduced the QC, in all good faith!  Is asking for professional advice to be subject to a penalty?

iv) The proposed legislation encompasses virtually all commercial arrangements, not just ‘artificial’ ones.  ‘Tax Avoidance’ is not properly defined.  It rests on ‘losing’ under untested legislation.  There is no safe harbour.

v) The level of penalties (see time line) may be after the advisor retired.  If the professional involved advised clients wealthier than him, which I am sure the majority do, then they could result in severe financial embarrassment, perhaps even bankruptcy, of said pensioner.

The tone of the HMRC document of 5 December 2005 suggests that would be [perhaps in Chairman Mao’s words?] a good behavioural adjustment.

vi) Maybe?  In contrast, if the advisor had introduced his client say to a robber or a drug dealer, rather than a (presumably respectable) Queens Counsel, then these sanctions would not apply.  In considering this, what is ‘the Clear Intention of Parliament’ to quote a phrase.

I would be grateful if any of the parties to whom this is addressed could explain to me how it fits in with the idea of any penalty fitting in with the criteria proposed in HMRC’s 2015 penalties discussion document:

  • The penalty regime should be designed from the customer perspective, primarily to encourage compliance and prevent non-compliance.  Penalties are not to be applied with the objective of raising revenues.
  • Penalties should be proportionate to the failure and may take into account past behaviour.
  • Penalties must be applied fairly, ensuring that compliant customers are (and are seen to be) in a better position than the non-compliant.
  • Penalties must provide a credible threat.  If there is a penalty, we must have the operational capability and capacity to raise it accurately, and if we raise it, we must be able to collect it in a cost-efficient manner.
  • Customers should see a consistent and standardised approach.  Variations will be those necessary to take into account customer behaviours and particular taxes.

From an initial review, the proposed penalties fail all counts.  Specifically, they do not seem

1)     Fair

2)     Proportionate, nor even remotely consistent.

They are potentially an invite for state bullying.

An easy way around the problem is the one which worked for many years historically.  It was for independent, disinterested advice with proper, well-resourced HMRC review.  In such a case ‘reasonable care’ all round could be provided by someone, properly qualified, who was not rewarded as to outcome and gave independent advice as to the law, with subsequent full disclosure of any relevant arrangements.

Open letter to John Pugh MP, House of Commons

UPDATE:  Please See Below for Response from Mr Pugh MP

Dear John,

We have met before some years ago to discuss tax and the financial situation generally.

I realise you are no longer in power, but I would draw your attention to two of the consultations released by HMRC over the Summer with the following comments:

Strengthening Tax Avoidance Sanctions [HMRC 17 August 2016]

1. I fear the proposals put forward by HMRC are disproportionate, ill-defined, with a gap of potentially years between the behaviour HMRC allege they have a problem with and ‘punishment’. Further the proposed punishment would not necessarily fall on the person who may benefit from the behaviour, which encompasses ‘any agreement, understanding, scheme, transaction or series of transactions (whether or not legally enforceable)’ but, it is proposed by HMRC, would be imposed on an independent advisor.

2. Tax rules are incredibly complicated. Surely it is not in the public interest to discourage a market for independent, professional advice?

3. The above definition would seem to encompass every commercial action, unless I am mistaken? Can you think of anything not caught in the proposed rules. Thus, under these proposals, every commercial action appears to be within the scope, if (probably many years later litigation finds they have been caught by a technicality). This means what amounts to an offence would only be determined ‘ex post facto’? Surely, wrong in principle, constitutionally. How can any responsible person act professionally and be sure they are compliant?

4. The proposal from HMRC is that an advisor would have a defence if they followed the opinion of HMRC(!) How is that ‘independent advice’? What about the occasions when HMRC are proven wrong by the Courts?

5. In addition to the proposed penalties being wrong in principle, the level suggested is such that an individual advisor could be made bankrupt and thus losing their professional membership and livelihood without actually performing nor even suggesting any action with illegal intent. Surely, this is disproportionate?

The HMRC consultative document actually says that it does not expect those devising what they see as ‘artificial schemes’ to be caught by the penalties. Apparently they ate typically companies based offshore. Is it fair to punish UK professionals when the authorities believe that the true problems lie elsewhere?

Conclusion

It seems to me to be a much simpler and more equitable system to be to allow a ‘reasonable defence’ for both taxpayers and advisors that they had received/given independent advice (with appropriate professional qualification/experience) without that advice being in any way compromised by being rewarded as to results.

If desired, this could be combined with professional rules to prohibit fees being linked to outcome. That way there would be no incentive to bias any advice towards ‘aggressive’ behaviour.

Making Tax Digital

This sounds as though it might be a good idea. Certainly, it has some sound points in terms of efficiency. However, there is an underlying principle of compulsion which is disturbing, especially when the computer systems referred to do not yet seem to exist, have not been fully tested, and seem to anticipate that all businesses will have to pay for them.

Points

a) A big concern is the idea that businesses will have to file every 3 months in ‘real time’. The current requirement is that businesses have to file an annual return within 10 months of the year end. The new proposal represents an enormous extra burden, which in practice would fall particularly hard on small businesses many of whom are currently not even aware of the consultation.

b) As an accountant, I would generally encourage keeping good management accounts. This though should not be compulsory, nor be State monitored. The idea seems to come from someone with no empathy for the pressures on running a small business. No lack of work/sickness benefits for the owner, etc. etc. Compulsion on this scale would have to cover such items as:-

  1. Serious business disruption through unanticipated economic events
  2. Illness, death of a parent/spouse/child.
  3. Emotional/financial impact of divorce.
  4. Internal commercial problems, such as management disputes, employee problems, fraud etc.

These are serious issues which can hit everyone, and create further potential for subjective interpretation and ultimately undesirable court cases. HMRC suggest the 3 month filings may not be used for anything as this stage. If so, why impose an unnecessary burden?

There are a number of points of detail which need to be addressed, but fundamentally, with such huge powers on their side already I do not believe HMRC are short of powers. Giving arbitrary powers such as suggested would be counter-productive. Not everyone has access to/is comfortable with a computer, perhaps especially the elderly. Suggesting family help may seem good as a ‘sound-bite’, but then how much family tension/concern may it give rise to, particularly in cases where family finances are a sore subject?

I realise some of the points above are probably somewhat deliberately provocative. I believe the process though is important. Key issues as far as I am concerned is that the proposals are too vague to enable honest compliance and in addition risk stilting economic progress by imposing State burdens for no benefit and (according to the HMRC commentary on the 3 month reporting) to no required end.

I look forward to your considered reply.

Yours sincerely,

Paul Eaves

cc Consultation body

Response from John Pugh MP:

“Dear Paul,

Thank you for your email regarding the two recent consultations launched by HMRC.

The proposals on strengthening tax avoidance do seem broad and vague. It appears that the punishment for avoidance would fall not on the person who is benefitting from tax avoidance but on those who facilitate it. Moreover, the Government is not at all specific on what constitutes avoidance. I hope that the Government’s response to the consultation will define what constitutes facilitating tax avoidance more clearly in order to give firms such as yours better guidance on how the law will change.

On quarterly reporting, I have had a number of Southport businesses and accountancy firms contact me in recent weeks who are concerned about the increased administrative burden this will have on them. They are also worried about reporting their accounts incorrectly under this new system.

I accept that quarterly reporting may make it easier for HMRC to identify accounting errors, ensuring that businesses pay the taxes they owe. However, I do not think that the benefits it provides are enough to justify the extra administrative burden it places on companies, independent of the requirement to keep records digitally. It seems to run against the Government’s stated aim of “putting people and profit, not paperwork, first”.

The Government must ensure that companies pay the tax they owe, but their approach must recognise two things. First, it must minimise the additional burden placed on businesses. Second, the enforcement of new regulations should not be a cash cow for HMRC.

Because of the large number of companies who have contacted me on this issue, I will be raising my concerns with the Minister in the next few weeks, and I will let you know what response I receive.

Many thanks and best wishes,

John”

Thank you for your response.

Fishing for A Commercial Rationale – Avoidance Motive in A Fisher, S Fisher, P Fisher  v HMRC

A recent case was heard at the First-Tier Tribunal regarding the conflict between commercial decisions and tax avoidance motives (A Fisher, S Fisher, P Fisher  v HMRC).  It can clearly be seen that legally reducing a tax liability could be a commercially sensible decision, but it was previously assumed that this would not be enough to override the anti-avoidance provisions that apply where there is a tax avoidance motive.

The case in question involved a family bookmaking business, who took the decision to move the business to Gibraltar in the 1999/2000 take year, in order to obtain more favourable treatment regarding betting duties than applied in the UK.

HMRC took issue with this and challenged the, under the anti-avoidance provisions on the transfer of assets abroad.  They raised assessments charging income tax the years 2000/01 to 2007/08 under the rules in force during those years.

The taxpayers appealed claiming that there was no avoidance as they had moved the business to Gibraltar as a commercial decision in order to compete with other bookmakers.  Saving tax was therefore a side effect and not the reason for relocating.

The First-tier Tribunal did not agree, finding that the transfer would not have gone ahead if it were not for the lower betting duty in Gibraltar.  This did not conflict with the decision to move being made for sound commercial reasons, however this did not prevent there being a tax avoidance motive.

The taxpayers made a further argument regarding the EU rights of freedom of establishment and freedom of movement of capital applied, but the tribunal determined that the rules were not relevant for movements between the UK and Gibraltar.  They did, however, apply to one family member who was an Irish national.

The taxpayers also made a claim that HMRC’s assessments were not valid, under the discovery provisions in TMA 1970, s 29, as the tax officer should have been aware of the relevant information as a result of responses to their enquiries.  The tribunal agreed that the conditions for making a discovery assessment were not satisfied for 2005/06 and 2006/07.  The appeals for the remaining years were dismissed.

Whilst the Tribunal confirmed that a tax avoidance motive could also be part of a commercial decision, it is clear that the anti-avoidance provisions are drafted widely enough to catch such situations.  This is because the existence of commercial reasoning does not overrule the fact that there was a tax avoidance motive as well which was inextricably linked.

Courts Find Against Another Avoidance Scheme – Do HMRC Really Need More Powers?

The courts continue to find in favour of HMRC in cases involving avoidance schemes, with the most recent example being Vaccine Research Limited Partnership and another v CRC at the Upper Tribunal.

With so many cases going against such scheme providers, questions are raised as to whether the various new powers that HMRC is seeking on avoidance and other matters are really necessary?  Perhaps using the existing HMRC powers to more effectively challenge such schemes is all that is really needed.

Vaccine Research Limited Partnership and another v CRC

The case in question concerned an R&D avoidance scheme, with a partnership being established in Jersey. The taxpayer partnership entered into an agreement whereby it paid another entity, Numology Ltd, £193m to purportedly carry out research and development (R&D).

Numology paid a very small proportion of this (£14m) to a subcontractor, PepTCell, who actually undertook the work and then contributed £86m to the taxpayer business itself.  The partners claimed for a loss of £193m in respect of R&D capital allowances.

The Upper Tribunal unheld the First-Tier Tribunal’s decision, finding that the funds were put into an artificial loop and effectively only the £14m paid to the subcontractor was genuinely incurred for R&D.  The Tribunal noted that the FTT was right to conclude “that Numology Ltd’s contribution represented funds put into a loop as part of a tax avoidance scheme, and [was] not in reality spent on research and development”.

The evidence of recent case law suggests that the existing provisions available to HMRC are sufficient to close down avoidance schemes and yet they continue to seek new powers in the name of cracking down on tax avoidance.  It is concerning that HMRC continue to amass new powers, such as attempting to take funds directly from bank accounts and issuing non-appealable tax demands, on the premise that they are needed when it appears that they are not.  Please feel free to share your own thoughts below.

Courts find against two avoidance schemes – are new rules really needed?

We wrote recently about HMRC’s consultation on ‘Raising the Stakes on Tax Avoidance’, with new proposals to target the promoters of avoidance schemes.

Two recent cases heard by the courts considered whether two such complex schemes were actually effective.

Tower Radio

The First Tier Tribunal (FTT) ruled that PAYE tax and National Insurance Contributions should have been paid on bonuses paid to directors through companies which were specially set up to receive funds, and then be liquidated, paying out the cash in the process.

The scheme was promoted by accountancy firm Barnes Roffe LLP, and would presumably be the target of the new rules, with the scheme having been used by 104 other companies to try to avoid PAYE/NICs on bonus payments.  The scheme was DOTAS registered however.

The defendants’ case revolved around the Ramsay principle but this was dismissed; the tribunal ruled that the scheme had no commercial purpose, other than the intended obtaining of a tax advantage.  As such PAYE/NICs was found to be payable on the bonuses.

P&O avoidance scheme

British shipping company P&O also lost its case, concerning a convoluted international tax avoidance scheme, designed to avoid paying corporation tax.

P&O had attempted to gain £14m in tax relief by artificially boosting the tax credit due on dividend income.

The scheme was found to fail by the FTT, who ruled that the transactions were all part of an “elaborate trick” that was “designed and implemented for no reason other than tax avoidance.”

Conclusion

In both cases, the fact that the schemes were implemented for no reason other than tax avoidance was found to be of importance by the courts.  This is before the new General Anti-Abuse Rule (GAAR) is even taken into account.

With the courts already finding against such schemes, and the new GAAR set to undermine such schemes still further, it is reasonable to question whether any new provisions on avoidance are really needed.

HMRC Criticised in Share Scheme Tribunal Case – Benedict Manning V HMRC

HMRC were criticised for their handling of a recent employee share scheme case by the tribunal judge, who noted that they had conducted their investigation “without apparently troubling to look at the scheme rules”.  The recent case is not the first time tribunal judges have been critical of HMRC’s conduct.

 

The case in question involved an employee share option scheme.  The taxpayer exercised his share options in October 2007, paying £7,636 for shares worth £111,579.  The scheme rules stated that the taxpayer should pay over the PAYE due on the exercise within 90 days, but he was not told the amount to pay by his employers until March 2008.

 

HMRC charged tax on under ITEPA 2003, s.222 on the basis that this was not within the 90 day limit imposed by the scheme rules.  The taxpayer appealed as he could not have paid the PAYE before being told the amount to pay.

 

The tribunal allowed the appeal, agreeing with the taxpayer that the date of exercise could not be the relevant date as he was not informed of the amount to pay until March 2008.

 

The tribunal judge stated that s.222 was introduced to target grossly abusive schemes and that there was nothing abusive about this scheme.  The case again shows that it often pays to challenge HMRC, especially when they are being over-zealous in their application of the law.

Budget 2013: Loan to Participators (Overdrawn Directors Accounts) – s.455 Tax Charge

Budget 2013 announced various anti avoidance measures aimed at the loan to participators/overdrawn directors accounts s.455 tax charge .

Repayment Provisions Amended To Deny “Bed & Breakfasting”

Certain owner managed companies have previously been extracting funds from the company through overdrawn directors loan accounts, which are then repaid by crediting the loan account just before the date when tax would become due under s.455. They would then subsequently recreate a similar debt to the company. Such tactics are now being targeted by HMRC as previously there were no specific rules to prevent it.

The repayment provisions are to be amended so as to deny relief for the loan to participators s.455 tax charge where repayments and re-drawings are made within a short period of time of each other, or there are arrangements (or an intention) to make further chargeable payments at the time repayment is made (and there are subsequent re-drawings).

The effect of this being that the loan to participators s.455 tax charge can no longer be avoided by repaying the loan within 9 months of the accounting period end if a loan is taken out again soon after or there is an intention to do so.  Therefore such ‘bed and breakfasting’ is no longer a possibility.

Loans via Relevant Partnerships & LLPs

Legislation will be introduced in Finance Bill 2013 to apply the loan to participators s.455 tax charge to any loans from close companies to participators made via partnerships (including LLPs) in which the close company and at least one partner/member is a participator (or associate of).

Extractions of Value

Where there is an extraction of value from a close company and the value is transferred to a participator, there will be a 25% tax charge on the close company on the amount of the payment to the participator.

Film partnership avoidance scheme was mis-sold – Horner v Allison

A recent case was heard at the High Court (Horner v Allison) concerning the sale of a film partnership avoindance scheme.

In this case, the Claimant, was Mr Horner who was a chartered accountant as a managing director at Atos KPMG Consulting Ltd.

On recommendation by a colleague (whom received commission for the recommendation), Mr Horner attended a presentation by Taipan Creative LLP.  The scheme was described as ‘a unique low risk high return investment proposition’.  One of the directors, Miss Allison called herself a specialist in film tax investment schemes and led him to beleive that the scheme had been approved by HMRC.

Under the scheme, Mr Horner initially received a refund from HMRC which was paid over to Taipan who deducted 80% of the refund as their fee before paying it over to Mr Horner.  A tax refund of £168,756.30 was received and Mr Horner was given his 20% by the defendants (£33,750).

HMRC investigated the scheme and, found that the scheme failed to meet the necessary requirements for the relief for film patnerships. Mr Horner therefore faced a demand to repay the whole tax rebate with interest and penalties;  at a total of £207,000. There had been no HMRC approval of the scheme.

The court found in favour of Mr Horner, finding that Miss Allison had made representations which she knew to be untrue and as a result was liable to Mr Horner in deceit. Mr Horner was entitled to recover damages from Miss Horner amounting to £185,832.25.  However it appears unlikely that Miss Allison will be able to pay over the sum.

General Anti-Avoidance Rule a Possibility

A general anti-avoidance tax rule has been muted as being appropriate for the UK for a long time.  It now looks a genuine possibility following the Aaronson Report.

The idea of such a rule is to draw a line akin to a test of what the tax rules are intended to achieve ie their spirit.  If a transaction crosses that line, even though it is within the wording of the legislation, it will be caught.

Any general rule of this nature must be drawn at the right level so as to not impinge on innovative but “within the spirit” planning.

If such a rule was implemented it would be interesting to see whether the specific anti-avoidance rules in the existing legislation will be scrapped.  This would probably more than halve the content of the legislation.