This article briefly discusses the key points arising out of the decision of the UK Supreme Court in HMRC v Tooth [2021] UKSC 17. The case considered (1) whether a discovery assessment could become “stale” and (2) the meaning of the phrase “deliberate inaccuracy”.
The facts
Mr Tooth entered into a tax scheme designed to create an employment-related loss. Although the arrangement ended up being ineffective, this was not certain at the time, so Mr Tooth incorporated the loss into his 2007/08 tax return. However, as the software used to complete his tax return was not working correctly, he had to use a box meant for partnerships instead of employment, explaining that in the corresponding “white space”.
In August 2009, HMRC attempted to open an enquiry using their powers under Schedule 1A TMA1970 to examine Mr Tooth’s “claim outside a return” (as HMRC saw it), however following the Court’s decision in Cotter v HMRC [2013] UKSC 6 the correct mechanism was under s9A TMA1970 and HMRC were left without a validly open enquiry. Therefore, in October 2014, HMRC gave notice to Mr Tooth of a discovery assessment. HMRC argued that they had discovered an insufficiency in Mr Tooth’s return and that the return contained a deliberate inaccuracy.
“Deliberate inaccuracy”
The standard time limit for a discovery assessment is four years, but it is extended to 20 years if the insufficiency is brought about deliberately. HMRC argued that (1) this included cases where the statement containing the inaccuracy was deliberately made and (2) that to determine whether there was an inaccuracy, the statement containing the inaccuracy should be read independently and without regard to the rest of the tax return.
The Court rejected both arguments and held that the natural meaning of “deliberate inaccuracy” was a statement which, when made, was deliberately inaccurate and which intended to mislead HMRC. The Court also considered a point that has concerned many practitioners since the Court of Appeal judgment: that on HMRC’s interpretation, taxpayers could be exposed to the 20-year time limit to raise a discovery assessment “by making an honest but in fact inaccurate statement” and would be exposed to greater financial penalties for any loss of tax. This was another factor in the Court concluding HMRC’s interpretation was incorrect. A slight note of caution is found in paragraph 47 of the judgment, in which the Court said that “for there to be a deliberate inaccuracy”, HMRC would have to prove “an intention to mislead” by the taxpayer, or “perhaps (…) recklessness as to whether it [the inaccuracy] would do so”, potentially widening the scope of a “deliberate inaccuracy”.
Secondly, the Court held that there were no inaccuracies in Mr Tooth’s tax return. Although he used the “wrong” partnership box to include his employment loss, he explained why he did so in the “white space” of the tax return which is part of the document. HMRC had argued that their computers would read each box individually without considering other parts of the return. The Supreme Court rejected this argument as “very unattractive” and held that whether there was an inaccuracy in the document depended upon reading each section in the context of the whole return. When read as a whole there was no inaccuracy in Mr Tooth’s tax return due to his full and frank white space disclosure.
”Staleness”
This decision also finally concludes the question which has consumed the lower courts for much of the past decade: can a discovery become “stale”. In 2012, in Charlton v HMRC [2013] STC 866, the Upper Tribunal held that if an HMRC officer concluded that a discovery assessment should be issued, an assessment might become stale if not made within a reasonable period. HMRC has never accepted the concept of “staleness” and there have been a significant number of (sometimes conflicting) judgments on this topic.
The Court rejected the concept of “staleness” entirely, holding that it was incompatible with the statutory scheme and that the only time limits were those set out in statute. This means that even if an HMRC officer found an error, went on holiday, and forgot to issue an assessment, another officer could issue an assessment years later (assuming, of course, that they were still within the statutory time limits).
HMRC can sometimes be quick to assert that a taxpayer has been careless and thus opening the possibility of the application of the longer six-year time limit for the issuing of a discovery assessment in place of the standard four years. The Court has reasserted that the threshold for conduct to be considered deliberate is a very high bar for HMRC to reach. This should therefore reserve the 20-year assessment time limit for only the most serious cases.
On 12 July 2021, the First-tier Tribunal (Tax Chamber) (“FTT”) released its decision in Scanwell Logistics (UK) Limited v HMRC [2021] UKFTT 261 (TC), rejecting the taxpayer’s claim for onward supply relief (“OSR”).
Whilst OSR is now limited, post-Brexit, to goods imported into Northern Ireland for onward supply to the EU, the FTT’s discussion of agency under section 47 of the Value Added Tax Act 1994 (“VATA”) is of broader interest.
The case serves as a reminder of the significant financial consequences that can result from errors in tax planning, as Scanwell was ultimately held liable for £5.7 million in unpaid import VAT despite the fact that the imported goods almost immediately left the UK (which, if properly planned, could have meant Scanwell was relieved from liability to import VAT).
The Facts
Scanwell acted as an ‘import agent’ in relation to the import of goods from China into the UK (which at the time was still an EU member state) and their onward transport to end customers in other EU countries.
On importing the goods into the UK, Scanwell claimed exemption from import VAT under the OSR provisions. HMRC, however, considered that the relief was not available to Scanwell and subsequently assessed Scanwell to import VAT. Scanwell appealed the assessment to the FTT.
The Law
Where goods are imported into the UK, import VAT is typically charged under section 1 of VATA.
At the relevant time, OSR provided a relief from import VAT where the goods imported into the UK were subsequently re-despatched to a VAT-registered entity in another EU country, generally within one month of importation.
Scanwell accepted that it had never acquired title to the goods from the Chinese suppliers. Instead, it argued that, since it acted as agent for the end customers in the EU, it fell to be treated as part of the supply chain under section 47 VATA, so as to meet the requirements for OSR.
The FTT’s decision
After careful consideration of the legislative provisions, the FTT (Judge Hellier) concluded:
Section 47(2A) VATA
Whilst the FTT considered various provisions within section 47 VATA, its main focus was on section 47(2A), notably rejecting HMRC’s contention that it was limited to purely domestic transactions.
Section 47(2A) provides that “where… goods are supplied through an agent who acts in his own name, the supply shall be treated both as a supply to the agent and as a supply by the agent”.
The FTT decided that this did not apply on the facts, as Scanwell was neither (i) an agent through which goods were supplied nor (ii) did it act in its own name for the purposes of the provision. Specifically, it held:
The FTT dismissed Scanwell’s concern that the denial of OSR would lead to double taxation on the supply to the end customers: import tax in the UK and tax again in the destination member state. This was because there existed an alternative procedure by which the goods could have been transported which would have avoided double taxation, but which had not been used. There was therefore no need to construe the legislation in the appeal any differently.
The full text of the FTT’s decision is available here.
What is the background to the draft Finance Bill 2022 clauses on tax avoidance published on 20 July 2021?
In the wake of Sir Amyas Morse’s Independent Review of the Loan Charge back in December 2019 the government committed to implementing further measures to tackle promoters of tax avoidance schemes (POTAS) and reduce the scope for marketing of such schemes.
In March 2020 HMRC published its Promoter Strategy which looked at ways of disrupting the business model of those still marketing such schemes.
The July 2020 consultation Tackling Promoters of Tax Avoidance introduced some new measures which were included in Finance Bill 2021 that strengthened the existing anti-avoidance regimes and these were complemented by the November 2020 paper which called for evidence on raising standards in the tax advice market.
Despite all of this, HMRC is still concerned that promoters (and others in the tax avoidance supply chain) continue to fail to comply with their voluntary obligations and are still managing to sidestep HMRC compliance activity and sell their schemes.
What further provisions does FB 2022 contain to target POTAS?
The draft FB 2022 clauses include four new provisions to further address promoters of tax avoidance:
• giving HMRC the protective mechanism to freeze a promoter’s assets to prevent dissipation before payment of potential penalties. There were talks of giving HMRC powers to apply to the court for security payments in addition to these new asset freezing orders, but this is on the backburner for now
• tackling offshore promoters by charging additional penalties (of up to the total amount earned by the scheme) against UK entities that facilitate tax avoidance via these offshore promoters
• allowing HMRC to present winding-up petitions to close down companies that promote avoidance schemes and thus operate against the public interest, and
• enabling HMRC to publish details of promoters and their schemes to raise public awareness and give taxpayers the opportunity to identify and exit any arrangements—the policy objective is to protect the taxpayer while also getting the tax in
When will the FB 2022 changes take effect?
The FB 2022 (which implements proposed measures announced in the March 2021 Budget) draft legislation was published on 20 July 2021. The consultation on the Finance Bill measures will run until 14 September 2021 and Royal Assent is expected to be forthcoming in time for the new tax year in Spring 2022.
The new clauses will generally have effect in relation to all penalties assessed or determined or arrangements enabled on or after the date of Royal Assent but note that any information or non-compliant behaviour ongoing prior to this time could form part of HMRC’s case.
What guidance has been published?
The new clauses each include a helpful explanatory note published on the government website. The results of the consultation (that ended on 20 July 2021) regarding the implementation of the proposed legislation are also available to read on the government website.
Why does HMRC continue to try to strengthen these regimes?
HMRC is committed to disrupting the business of any promoters still operating and are determined to impose harsh sanctions. The concern is that as new measures are introduced, companies and promoters find new loopholes to bypass these measures, making it necessary to incorporate further regulations. These individuals are only able to operate because of the naivety of the taxpayer so the plan is to also do more to support the taxpayer and ensure that they can steer clear of and exit any tax avoidance arrangements.
What evidence is there of the disclosure of tax avoidance schemes (DOTAS), POTAS or enablers regimes having been effective so far?
When the General Anti-Abuse Rule (GAAR) Report was published in 2011, it found that the existing tools, including DOTAS (which requires promoters of avoidance schemes to give HMRC information about the schemes they are promoting and who their clients are) had been incapable of dealing with some abusive tax avoidance schemes.
Subsequently, the POTAS regime, accelerated payments and follower notices were introduced by the Finance Act 2014. The POTAS rules are aimed at changing the behaviour of promoters and deterring the development and use of avoidance schemes by monitoring the activities of those who repeatedly sell schemes which fail.
Since 2014, the number of Scheme Reference Numbers allocated by HMRC under the DOTAS rules appears to have decreased significantly. HMRC has also said that thanks to anti-avoidance measures, about 25 significant promoters have ceased all activity. The very fact that new sanctions continue to be introduced suggest that there is still a problem to tackle, although this is now considered to be very localised and indeed by 2018/19 the tax avoidance gap had shrunk to 0.3% of the total theoretical liabilities for that year—this is a small problem in the scheme of things but may still be a big problem from a policy perspective.
What further measures or changes to the draft legislation do you expect to be announced at the next Budget or fiscal statement?
There may be yet further measures mooted if the existing ones prove to be insufficient, but it is unclear at this stage what these might look like.
There is a real concern about whether the constant ebb of new rules is really addressing the problem. It seems clear that there is a stubborn disconnect between the language spoken by HMRC and the policy advisers and some so-called tax advisers. If schemes still exist it is because there is still a market for them and a desire for taxpayers to pay as little tax as possible, albeit sticking within the confines of a particular interpretation of the tax rules.
HMRC considers that the policy objectives should override any contrary interpretation of the legislation and the intention is that many of these new rules are principles-based in a bid to overcome this ‘policy vs interpretation’ disconnect.
We may see yet more targeted attempts to stamp out those that attempt to sail too close to the wind. Another option might be for the GAAR to become a point of first, and not last, resort going forward.
There must also be consideration of whether resource is better directed at enforcement, such as more large scale investigations of aggressive tax avoiders, rather than new anti-avoidance measures.
On 1 July 2021, US Treasury Secretary Janet Yellen announced that countries representing over 90% of global GDP had agreed to a global minimum tax on corporations (“GMCT”). The GMCT seeks to put a floor on tax competition on corporate income through the introduction of a minimum corporate tax of at least 15%. Whilst certain elements give rise to positive expectations, some caveats should be noted. Much will depend on (1) the outcome of future political negotiations and (2) the detail of the drafting at international and national levels.
The key advantages of the agreement so far
The key caveats so far
1 IMF, ‘The Rise of Phantom Investments’ (September 2019).
2 OECD, ‘130 countries and jurisdictions join bold new framework for international tax reform” (1 July 2021).
3 Conseil d’analyse économique, ‘Taxation of Multinationals: Design and Quantification’ (29 June 2021).
4 IMF, ‘What Is Real and What Is Not in the Global FDI Network?’ (11 December 2019) IMF Working Paper No 19/274.
On 17 June 2021, the European Court decided the joint cases K (C-58/20) and DBKAG (C-59/20) regarding whether the supply of certain services constituted the “management of special investment funds”, benefiting from the VAT exemption enshrined in Article 135(1)(g) of Council Directive 2006/112/EC.
The cases
In the first case, K computed the taxable income of unit holders in the funds. In the second one, DBKAG acquired the right to use software used for risk management and performance measurement. The Austrian tax authorities argued that the exemption could not cover these services since: (a) they were not specific to and essential for the management of special investment funds; and (b) they were not sufficiently autonomous to come within the scope.
The European Court decided that the exemption did apply to these services. First, it clarified that VAT could not be said to apply only because the services are not outsourced in their entirety. Secondly, the Court emphasised that the list of Annex II to the UCITS Directive is not exhaustive, so whether certain services are included or not in that list is not conclusive.
The impact for the UK post-Brexit
Following the European Union (Withdrawal) Act 2018 (the “WA”), UK courts are no longer bound by principles laid down by the European Court, whilst general principles of EU law are not part of UK domestic law if they were not recognised as such in a case decided before Brexit. In addition, Chapter 5 of the Trade and Cooperation Agreement between the UK and the EU, which governs tax issues, does not establish any exceptions regarding VAT legislation but only obligations related to fraud.
However, the WA does allow UK courts to consider European Court decisions post-Brexit if they are relevant to any matter before a UK court. UK VAT rules remain the same after Brexit, including the investment management exemption (Group 5, Schedule 9 of the VAT Act 1994), so UK courts could take the DBKAG & K decision into account if they considered it relevant.
What does this mean for UK taxpayers?
The European Court decision widens the scope of services that benefit from the exemption, although it is unclear how far it goes, particularly considering that the Annex II list is not exhaustive.
Certain services which had not previously been considered to be within the scope of the exemption could arguably now be included. Where input VAT has not been deducted by customers, suppliers of the relevant services could potentially seek to recover the VAT charged on those services from HMRC and then reimburse it to the customers under HMRC’s reimbursement arrangements.
On 2 July 2021, the Supreme Court delivered its judgment in R (on the application of Haworth) v HMRC [2021] UKSC 25, finding unanimously in favour of the taxpayer and upholding the Court of Appeal’s decision to quash the follower notice issued to him.
What it Means for Taxpayers
The Supreme Court held that HMRC can only issue a follower notice where they consider that there is “no scope for a reasonable person to disagree” that an earlier judicial decision would deny the taxpayer the advantage claimed. This test is both (i) more precise and (ii) imposes a higher threshold than the Court of Appeal’s formulation that required HMRC to only have “a substantial degree of confidence in the outcome”. This reformulation of the test is apt considering the severe consequences which such measures can have for taxpayers.
The Court’s decision is likely to be of primary relevance to cases with less uniform fact patterns or where the issues involved are fact sensitive. Tax avoidance schemes which are mass marketed are likely to be harder to distinguish from those addressed in earlier decisions and thus remain more susceptible to follower notices. Nevertheless, taxpayers may still be able to point to differences in the legal arguments raised, so a thorough assessment of such arguments would be sensible.
The Court also confirmed that follower notices are not automatically invalidated by defects. Taxpayers should therefore be wary of ignoring such notices simply because they consider them to be non-compliant, particularly on formal or technical grounds.
The Follower Notice Regime
The follower notice regime is contained in Part 4 of the Finance Act 2014 (“FA 2014”). It applies where HMRC contend that an advantage claimed by a taxpayer depends on a particular interpretation of a taxing statute which a court has already decided is wrong.
Where HMRC issue a follower notice, the taxpayer has two options: they can either (i) accept HMRC’s interpretation, concede the advantage and pay tax on that basis, or (ii) refuse to do so and maintain the claim. If they do the latter and HMRC are ultimately proven to be correct, the taxpayer may be liable not only for the tax owed but also an additional and substantial penalty calculated by reference to the value of the claimed advantage.
Furthermore, the existence of a follower notice forms one of the bases on which HMRC can issue an accelerated payment notice, which requires the taxpayer to pay the disputed tax to HMRC on account, in advance of the substantive issues being determined.
Background to the Case
The taxpayer sought to make use of what is commonly referred to as a ‘round the world’ scheme to avoid the payment of UK capital gains tax on the disposal of shares by a trust of which he was the settlor. It aimed to do this by taking advantage of provisions in the Taxation of Chargeable Gains Act 1992 and the UK/Mauritius double tax convention to ensure that Mauritius (which did not charge capital gains tax) had the sole taxing rights.
HMRC issued the taxpayer with a follower notice on the basis that the scheme was materially the same as the one which had been held to be ineffective by the Court of Appeal in the prior case of Smallwood v HMRC [2010] EWCA Civ 778 (“Smallwood”).
The taxpayer’s challenge by judicial review was initially rejected by the High Court but upheld by the Court of Appeal, which quashed the follower notice. The case then came to the Supreme Court to finally resolve the issue.
The UK Supreme Court’s Judgment
The main issue
Before HMRC can issue a follower notice, they must be of the opinion that “the principles laid down, or reasoning given, in the [earlier] ruling would, if applied to the chosen [tax] arrangements, deny the asserted advantage or part of that advantage” (emphasis added) (sections 204(4) and 205(3)(b) FA 2014).
The main issue before the UKSC concerned the degree of certainty that this test requires from HMRC as to the application of the prior ruling. The UKSC held that it is not sufficient for HMRC to opine that the earlier ruling is likely to deny the taxpayer’s advantage; instead, they must consider that there is “no scope for a reasonable person to disagree” that it would. Since this threshold was not met, the follower notice was quashed.
The Court’s decision was based, in part, on the fact that the follower notice regime restricts taxpayers’ constitutional rights to have their case determined by a court by imposing the risk of a significant financial penalty. As such, the provisions had to be interpreted narrowly to reduce the interference with those rights to the minimum extent necessary, whilst still being consistent with the aim that Parliament wanted to achieve by enacting the regime, namely to reduce the resources needed to deal with unmeritorious claims. It was therefore appropriate to give full weight to Parliament’s use of the word “would” in the legislation.
Having set out the relevant test, the Court identified four factors that it said would be relevant to whether HMRC can reasonably form the opinion that the earlier ruling would deny the claimed tax advantage. These were: (i) how fact sensitive the application of the previous decision is (i.e. whether a small difference in the taxpayer’s facts as compared with those of the earlier decision would prevent it from applying); (ii) HMRC’s view of the truthfulness (or otherwise) of the taxpayer’s evidence; (iii) whether the taxpayer raised any legal arguments not considered in the earlier decision; and (iv) the precedential value of the earlier decision (e.g. whether the taxpayer was legally represented and the reasoning in the decision was clear).
The remaining issues
The Court also determined three other issues, holding that:
The full text of the Supreme Court’s judgment is available here.
The Fidelity case concerned claims brough by three undertakings for collective investment in transferable securities (UCITS) for the repayment of Danish withholding tax on dividends received from companies resident in Denmark between 2000 and 2009. The Supreme Court rejected the claims on the grounds that the Fidelity UCITS did not fulfil the conditions for the exemption provided by Danish law.
Background
Danish law allowed UCITS resident in Denmark to apply for an exemption from withholding tax on dividends received from Danish companies. The granting of the exemption turned on two conditions being met: (1) the UCIT must be resident in Denmark; and (2) the UCIT must have Article 16 C fund status. The first condition (UCITS is resident in Denmark) had been held to be contrary to the free movement of capital in 2018 (see ECJ decision here). The second condition (Article 16 C fund status) was met if the UCITS undertook to make a minimum distribution and to withheld from that distribution the tax payable by its members or, after June 2005, if the UCITS calculated a minimum distribution which was taxed in the hands of the members by means of a deduction at source.
The Fidelity UCITS were not resident in Denmark and had not applied to the Danish tax authorities for Article 16 C status. They argued that it was impossible, or extremely difficult, to satisfy the Article 16 C fund status condition, and that they had no incentive to do so, because as non-resident UCITS they did not meet the first condition and were thus ineligible for the exemption in any case.
The judgment of the Danish Supreme Court
The Supreme Court held that the incompatibility of the first condition (UCITS resident in Denmark) with EU law did not mean that the funds were entitled to a repayment of the amounts of dividend taxes withheld. Turning to the second condition (Article 16 C fund status), the Court held that the condition was justified by the need to safeguard the coherence of the tax system and the need to ensure a balanced allocation of taxing rights between Member States, and that it was not a disproportionate restriction on the free movement of capital. The Court added that because the Fidelity UCITS had not applied for an Article 16 C fund status, their claims for a repayment failed because the second condition set out in the legislation for the granting of the exemption had not been complied with.
The Professional Footballers’ Association (“PFA”) has waded in on the long running tension between HMRC and the way that footballers and their agents are remunerated. The PFA is pushing for a dialogue with HMRC to consider a joined-up approach to establishing some clear and agreed principles and parameters particularly in the realm of dual representation of agents. It has become quite common for an agent to act for both the club and the footballer (as specifically permitted by FIFA) when it comes to negotiating transfers. The agent will be compensated handsomely by the club on behalf of both the club and the player for his efforts. The footballer can mitigate the correspondingly hefty tax liability on the agent fee by treating it as a benefit in kind and the footballer is exposed to tax on only half of the total sum paid by the club given the fee is shared between both parties. Given the tax at stake, plus interest and penalties, if HMRC disagree with the position taken by the parties, any headway that the PFA can make will be most welcome and might avoid an emotional penalty shoot-out once an investigation is started.
HMRC have for a long time paid close attention to the tax compliance of footballers likely due to the huge sums involved. In the tax year 2018/19, 87 professional footballers were under investigation by HMRC, this rose to 246 for 2019/20. For agents, the numbers under investigation went from 23 to 55 over the same two tax years and for the clubs themselves from 23 to 25. The additional tax yield following the outcome of the investigations into footballers alone was over £73m in 2019/20.
As well as agents’ fees, image rights payments continue to be scrutinised by HMRC. Images rights payments can be substantial amounts paid to the player on top of salary for use of their image by the club or other parties for advertising and endorsements such as Messi’s controversial Danone/Adidas/Pepsi deals. As a form of intellectual property, the image rights can be owned by a UK company thus taxable at the corporation tax rate of 19% rather than at the 45% rate of earnings for additional rate taxpayers. For non-UK domiciled footballers paying tax on the remittance basis, image rights payments are often split between a UK and non-UK company sheltering an agreed proportion from UK tax entirely.
HMRC have always been uncomfortable with the agreed UK versus offshore split arguing that more falls in the UK tax net than has been declared as UK source hence it is vital that this split is properly documented and justified. HMRC also continue to challenge the commercial reality of the actual payment itself. Buoyed by recent successes before the tax tribunal in relation to their argument that the image right payment is essentially just additional salary and should be taxable as such, HMRC are certainly on the attack and footballers on the defensive. The pandemic adds to the Government’s need for cash so even if you thought it was all over, it’s not yet! Hopefully the PFA can make some inroads in agreeing a universally applied and accepted stance in relation to both agents’ fees and image rights payments but until then advisers must assume a robust and clearly established position and accept that the receipt of image rights payments over and above what a player’s profile might reasonably merit will be ripe for HMRC investigation.
Key Points
In the context of tax disputes, privilege as referring to the fundamental is commonly understood legal right which allows individuals and companies to resist disclosure of confidential evidence. Under English law, there are strict rules on when privilege may apply and this article explores two distinct categories of legal professional privilege: legal advice privilege and litigation privilege.
Another form of commonly encountered privilege is ‘without prejudice’ privilege, which operates to prevent statements made in a genuine attempt to settle an existing dispute from being put before the court as evidence of an admission against the interest of the party making them.
Legal advice privilege
Legal advice privilege only applies to communications between a lawyer and client which have come into existence for the dominant purpose of giving or receiving legal advice. Legal advice privilege is narrower in ambit than litigation privilege but is claimed more commonly. The communications remain privileged at all times unless privilege is waived by the client or inadvertently lost; for example, when confidential information is unintentionally disclosed.
The underlying purpose of legal advice privilege is to ensure that the lawyer’s professional skill and judgment is given freely and is not subject to any constraints. The risk areas in the context of legal advice privilege lie in:
Litigation privilege
Litigation privilege applies to confidential communications between a lawyer and the client or a third party created for the dominant purpose of litigation, which is existing, pending or reasonably contemplated.
The burden of proof in establishing privilege is on the party claiming it. Litigation privilege exists in order that a potential litigant is free to seek evidence without being obliged to disclose their research results.
Recent case law
Two recent pertinent cases address how privilege can be maintained and also so easily lost. These are both worth examining.
Frasers Group: protection by litigation privilege?
The first case is FRC v Frasers Group Plc (formerly Sports Direct International Plc) [2020] EWHC 2607 (Ch). The background to this case was the investigation by the Financial Reporting Council (FRC) into Grant Thornton’s 2015/16 audit of the financial statements of Sports Direct International Plc (SDI), controlled by UK billionaire Mike Ashley.
In 2014, Sportsdirect.com Retail Ltd (SDR), SDI’s subsidiary, received an email from the French tax authorities asking SDR, amongst other things, whether it had paid English or French VAT. The email was interpreted as being in contemplation of a potential enquiry and possible ensuing litigation, and SDR instructed SDI’s solicitors and accountants.
As instructed, SDR’s professional advisers prepared a series of reports on:
The issue for the judge to consider was whether these reports in the hands of SDI were protected by litigation privilege and therefore not required to be disclosed to the FRC. The High Court held that the advice was not protected by privilege as it was ostensibly not prepared for the sole or dominant purpose of litigation.
In his judgment, Lord Justice Nugee made it clear that the ‘sole or dominant purpose test’ for litigation privilege was an extremely high hurdle which could not be overcome in this context simply because, at the time the reports were produced, SDR expected there to be litigation with respect to its VAT arrangements. He said:
‘A taxpayer who takes advice as to how to structure his affairs does not do so for litigation purposes. He does so because he wants to achieve a particular result for tax purposes… Even if it is contemplated that the particular structure will be likely to be attacked by the relevant tax authorities and that there will be litigation, the advice as to how to implement the new structure … is not primarily advice as to the conduct of the future possible litigation. It is primarily advice as to how to pay less tax.’
Advice about a potential course of action may not be covered by litigation privilege, even if that course of action is expected to lead to litigation. However, where the document or advice in question is legal advice given by lawyers, legal advice privilege (rather than litigation privilege) is likely to apply.
The Supreme Court in R (Prudential plc) v Special Commissioner of Income Tax [2013] UKSC 1 confirmed that legal advice privilege does not apply to advice from other professionals. Until Parliament decides otherwise, it continues to be the case that legal advice privilege can only protect legal advice given by members of the legal profession to their clients. The same advice emanating from accountants or other non-lawyers is still vulnerable to disclosure.
Civil Aviation Authority: protection by legal advice privilege?
The judgment in the case of Civil Aviation Authority v R (on the application of Jet2.com Ltd) [2020] EWCA Civ 35 is essential reading for companies relying on the advice of in-house legal teams.
In this case, Jet2 brought judicial review proceedings against the Civil Aviation Authority (CAA) in relation to the CAA’s publication of material critical of Jet2’s lack of participation in a consumer complaint scheme. Jet2 argued that the CAA made the materials public for an improper purpose and applied for disclosure of all relevant drafts and discussions relating to the disclosure. The CAA asserted that such were protected by legal advice privilege.
The Court of Appeal concluded that drafts of the materials should be disclosed unless specifically drafted by lawyers for the ‘dominant purpose’ of obtaining legal advice. Documents circulated to or by in-house lawyers, or the mere presence of a lawyer at a meeting, did not automatically satisfy this dominant purpose test.
Where the dominant purpose is to obtain or give advice, even if in a commercial context, then this should satisfy the dominant purpose test. Communications addressed to lots of different recipients need to be considered very carefully so as not to dilute the legal advice and render it merely a subsidiary purpose. Where external lawyers are appointed, legal advice privilege will clearly apply.
Points to take away
In order for litigation privilege to apply, the relevant document must have been created for the dominant purpose of obtaining advice in relation to litigation that is reasonably in contemplation. This does not include litigation that may possibly arise in future as a result of a particular course of action.
It is always difficult where a communication has a mixed commercial and litigation purpose. A safe way to protect such communication is to ensure that it is also covered by legal advice privilege.
Legal advice privilege is also subject to the dominant purpose test. Where not inextricably intermingled, it may be possible to separate out the component parts of some advice but if there are commercial as well as legal issues being discussed great care is recommended.
Draft legislation for inclusion in Finance Bill 2021 was published on 21 July 2020, the day before Finance Act 2020 received royal assent. The draft measures include detailed proposed legislation to further reduce the scope for promoters and enablers to market tax avoidance schemes and to strengthen the sanctions against those who continue to promote or enable such schemes. The government published a consultation in conjunction with the draft clauses on 21 July 2020 which closed on 15 September 2020. The consultation ran alongside a call for evidence on disguised remuneration wherein the government is seeking insight as to the drivers for any continued use of disguised remuneration tax avoidance, what if any schemes are not presently covered under current legislation and what the government can do to further tackle disguised remuneration tax avoidance with a closing date for comments of 30 September 2020.
The proposed new clauses also form part of the House of Lords Economic Affairs Finance Bill Sub-Committee inquiry (deadline for submissions 7 October 2020) which seeks written evidence on:
• How effective are the existing powers of HMRC in tackling promoters and enablers of tax avoidance schemes?
• What experience do practitioners have of the promoters of tax avoidance schemes (POTAS) rules and the enablers rules in practice?
• How effective will the proposed measures be against those who promote aggressive tax avoidance schemes, and in informing and deterring potential scheme users?
It is evident that significant government time and resource is being channelled into this area, which is of course very reassuring. HMRC is clearly of the view that promoters continue to frustrate and try to circumvent their obligations under POTAS, DOTAS and GAAR, and thus further action is required. Still more powers are expected to be bestowed upon HMRC in the next Budget (which will now be next spring) to tackle those in persistent default. There is no doubt that this is an ever-evolving area that needs to be kept under constant review.
Proposed changes
The new rules contained in Finance Bill 2021 apply to three distinct areas of existing legislation, namely POTAS, DOTAS and the GAAR. It should be acknowledged from the outset that there is concern among the professional bodies that any newly drafted legislation ought only be enacted to the extent that it is properly and specifically targeted, so as not to increase compliance burdens on those already conforming.
The new draft rules are framed in the following way.
POTAS
The government is keen to strengthen the promoters of tax avoidance schemes (POTAS) rules, contained in FA 2014 Part 5, by giving HMRC power to issue a stop notice (to stop the scheme being marketed while HMRC investigate) at an earlier stage and in a wider range of circumstances, as well as enabling HMRC to name and shame where a stop notice has been issued.
The conditions in the draft legislation, incorporating new s 236A into FA 2014, are very widely drawn as they presently stand and the threshold for HMRC to issue a stop notice is very low. The definition of ‘arrangements’ within the new clause would potentially apply to many commercial arrangements simply by virtue of conferring a ‘tax advantage’ (as widely drafted). A similar concern is that the power to issue a stop notice would be based on whether the authorised HMRC officer merely ‘suspects’ that a person promotes arrangements; this is a very low bar which creates scope for its misapplication. Some tweaks might be needed to these rules before they reach the statute book, and we are yet to see how the internal review and appeals process would apply to these new sections, so as to protect those that are explicitly not the target of these new rules. It is important
not to over burden those legitimate and honest advisers who should simply not be within the ambit of the rules.
In addition, the intention is to widen the POTAS rules to include individuals who control, or significantly influence, entities that carry on promotion activities. This should prevent errant scheme promoters from using a corporate vehicle to circumvent the existing rules.
The legislation also introduces a range of technical amendments in relation to conduct notices, including extending their application up to a maximum of five years (currently two years) to take into account the promoter’s behaviour, and further conduct notice threshold conditions have been added.
As the draft legislation stands, it is notable that noncompliance with DAC 6 may lead to the issue of a POTAS conduct notice, which is especially surprising given that some DAC 6 hallmarks do not even require any tax avoidance or advantage motive. This will no doubt add to the current anxiety over the looming onerous compliance obligations of DAC 6.
DOTAS
The draft legislation would also introduce yet more HMRC information powers under the FA 2004 Part 7 disclosure of tax avoidance schemes (DOTAS) and enabler regimes.
The DOTAS changes would enable HMRC to act more promptly where promoters fail to disclose or provide information about their scheme within 30 days, primarily by introducing a new information notice which could be issued in a broader range of circumstances. If the information required is not forthcoming or insufficient, HMRC would have the power to issue a scheme reference number (SRN), which in turn may be published.
Advocating and legislating for the use of early intervention tactics is a good policy; however, under the current draft rules, there would be no right of appeal against a new information notice under FA 2004 new s s31D, so even compliant advisers would need to safeguard themselves against the potential for these new rules to inadvertently bite.
F(No.2)A 2017 Sch 16 would be amended to enable HMRC to use its Sch 36 information powers as soon as a scheme has been identified. Advisers would need to be more vigilant than ever in ensuring that HMRC strictly adheres to the limits of these powers and only requests such information that is reasonably required.
GAAR
The ambit of the general anti-abuse rule (GAAR) in FA 2013 Part 5 would also be amended, so that it would apply to partners and partnerships who enter abusive arrangements. This is intended to operate on a similar basis to the representative partner approach that currently exists for enquiries conducted under TMA 1970.
Interaction with PCRT
The professional bodies are frustrated by the perceived need for yet more legislation targeted at a small number of boutique firms or individuals that bring the profession into disrepute. Over the past few years, the Chartered Institute of Taxation (CIOT) and other professional bodies have spent a significant amount of time and effort on the professional conduct in relation to taxation (PCRT) rules to ensure they set a minimum industry standard on professional behaviour expected of their members when undertaking tax work, such as forbidding tax planning on a generic basis. Failure to comply with PCRT may expose a CIOT member to disciplinary action. The problem, of course, is that scheme promoters may not be affiliated with a professional body.
Tackling disguised remuneration
As discussed, the new draft provisions sit alongside the call for evidence on tackling disguised remuneration. Appreciating this context is important in understanding the perceived need for and scope of the proposed new rules. Back in 2016, the government announced the introduction of the loan charge which it intended would draw a line under disguised remuneration schemes. The subsequent Morse review that looked into the controversies surrounding the loan charge highlighted concerns that such schemes were unfortunately still being used and henceforth the government set out that further action would need to be taken. In fact, reportedly as late as December 2019, over 20,000 new schemes had emerged with 8,000 of those in 2019/20. The recent HMRC call for evidence in tackling disguised remuneration focuses not only on promoters but on how to disrupt the employment supply chains where such schemes are being used and how to help taxpayers avoid schemes. To its credit, HMRC is hosting a series of virtual roundtables on this call for evidence to better understand how to tackle the continued use of schemes.
The tax gap
The National Audit Office (NAO) entitled report Tackling the tax gap, published on 22 July 2020, examined the effectiveness of HMRC’s approach in reducing the tax gap. The tax gap is certainly diminishing; however, given the inevitable significant fiscal impact of Covid -19, the House of Commons Public Accounts Committee inquiry furthered the work of the NAO questioning senior members of HMRC and HMT in relation to inroads being made to further reduce the tax gap on 7 September 2020.
It should be borne in mind that the tax gap attributable to avoidance is low compared to the gap attributable to error and non-payment, and evasion is the real issue which is a criminal offence. In relation to taxpayer error, the NAO highlighted that significant tax is lost as a result of mistakes, undoubtedly attributable to the complexity of the tax system so adding more legislation arguably is not the answer. Anti-avoidance legislation trying to squeeze diminishing returns from this area might be a vote winner and grab the headlines, but perhaps it is time for a change of direction or the compliant risk being overburdened.
Where does this leave us?
The reality is that there are still determined profiteers from certain schemes who are able to quickly bring these schemes to market, realise a hefty profit and then disappear. As some of these individuals or outfits are committing fraud and undertaking serious criminal activity, it is questionable as to whether yet more legislation will discourage their behaviour. Perhaps a better way to tackle this residual abuse would be for HMRC to more effectively use the information it has available via RTI and take more effective enforcement action. HMRC could consider applying a PAYE or VAT security notice at an early stage.
Ultimately, we need to see a clear and strong public message that these promoters can no longer get away with such tactics (HMRC spotlights arguably do not reach their intended audience), perhaps coupled with more leniency for whistleblowers. HMRC should also work harder to ensure that the unwary taxpayer is not fooled by these schemes. HMRC s counter avoidance and fraud investigations teams need to communicate and work on a more rapid response. Efforts should be concentrated on better policing, as many tax evaders may still undertake illegal activity on the basis that they are unlikely to be caught.
