On 27 October 2021, the Rt Hon Rishi Sunak MP, the Chancellor of the Exchequer, unveiled the contents of the Autumn Budget 2021. This comes after the International Monetary Fund (IMF) published its world economic forecast on 12 October 2021. The IMF expects the British economy to grow 6.8% in 2021 and 5.0% in 2022.1 During 2021, the UK GDP is expected to grow more strongly than that of France (6.3%), the US (6.0%), Italy (5.8%), Spain (5.7%), and Germany (3.1%). In this context, the UK government is in a good position to strengthen the protection of the public revenue whilst tackling the growing inequalities intensified by the pandemic.
The present article focuses on those specific measures that might have an effect on tax disputes.
Promoters of tax avoidance
First, the government said that FB 2022 will include provisions aimed at promoters of tax avoidance arrangements. Under the new legislation, the Revenue will be able to (1) seek freezing orders to prevent promoters from hiding their assets before paying penalties;2 (2) publish details of suspected tax avoidance schemes and those connected to them; (3) impose an additional penalty of up to 100% of the total fee earned by the scheme, to UK entities that facilitate the promotion of tax avoidance by promoters overseas, and (4) file winding-up petitions to the court for companies and partnerships if this is convenient for the public interest and protects the public revenue. It is up to the court to decide whether this is beneficial for the public interest. The new legislation is expected to be published on or around 4 November 2021.
Diverted Profits Tax (DPT) and Mutual Agreement Procedures (MAPs)
A MAP is a mechanism – promoted by the OECD – by which tax authorities seek to reach a solution regarding cross-border taxation of certain transactions. Under s 124 of the Taxation (International and Other Provisions) Act 2010, HMRC has to give effect to solutions reached under a MAP. Nevertheless, it has been uncertain whether DPT is covered. In Glencore Energy Ltd v HMRC [2019] UKFTT 438 (TC), the Revenue argued that this depended on the MAP discussions. In this context, the government announced that it will amend current legislation to enable MAP decisions on DPT to be implemented by the Revenue, terminating uncertainty on the matter.
DPT and its interaction with corporation tax closure notices
On 27 September 2021, the First-tier Tax Tribunal (FTT) issued a decision in the case of Vitol Aviation v HMRC [2021] UKFTT 353 (TC), which referred to an international corporate group. Before the case, HMRC had opened an enquiry into their returns and issued DPT charging notices. The companies applied to the tribunal for the issue of closure notices, which the Revenue claimed would mean deciding the tax that should apply to the transfer pricing adjustment – something beyond the FTT’s jurisdiction. At the end, the tribunal rejected HMRC’s argument.
The government said that it will add a new section 101C to Finance Act 2015, precluding the issue of a final or partial closure notice regarding any matter potentially relevant to the DPT charging notice. It also leaves without effect any future decision such as the one taken in Vitol Aviation. These modifications will apply to DPT review periods that are open on 27 October 2021.
Research & Development reliefs
In 2019, the UK only spent 1.8% of GDP in R&D, i.e. lower than France (2.2%), the US (3.1%) and Germany (3.2%). The OECD average is 2.5%.3 R&D is defined in s 1138 of the Corporation Tax Act 2010 as “activities that fall to be treated as research and development in accordance with generally accepted accounting practice”. After consultation, the Rt Hon Rishi Sunak MP announced the extension of the scope of qualifying expenditure for R&D tax credits. This would include data and cloud computing. However, it has also revealed plans to tackle abuse of R&D tax reliefs, which could produce a higher number of related tax disputes, where the judiciary would decide whether or not a tax relief should be granted.
Uncertain tax treatment
In order to “reduce the legal interpretation portion of the tax gap”, Finance Bill 2022 (FB 2022) will establish a requirement for big companies and partnerships (those with a turnover of more than £200m per year or balance sheet total over £2bn) to notify the Revenue when they take an uncertain tax position in their returns for corporation tax, income tax or VAT. Although only two notification triggers have been included, the government is expected to add a third one, which will be particularly important for tax litigation, i.e. where there is a substantial possibility that the judiciary would find the position of the taxpayer to be wrong in material aspects.
Discovery assessments
On 30 June 2021, the Upper Tribunal (UT) decided in HMRC v Jason Wilkes [2021] UKUT 150 (TCC) that HMRC could not issue discovery assessments in relation to a higher income child benefit charge (HICBC). Taxpayers welcomed this ruling, especially after the Supreme Court’s dismissal of the concept of “staleness” in HMRC v Tooth [2021] UKSC 17. The UT chose not to apply a purposive statutory interpretation, as the outcome did not constitute absurdity or injustice.
The government has announced that FB 2022 will include provisions that would reverse the effect of the Wilkes decision. These provisions will extend the scope of the tax charges able to be recovered utilising discovery assessments, including HICBC, charges relating to gift aid and certain pension provisions. The legislation will have retrospective effect because, according to the Revenue, this was the position widely accepted before Wilkes.
Additional points to note
The budget also announced a number of changes which, although of more general interest, might be potential areas of dispute in the future.
[1] International Monetary Fund, “World Economic Outlook Database”, accessed 28 October 2021.
[2] The new legislation would apply to all relevant anti-avoidance penalties under the Promoters of Tax Avoidance Scheme (POTAS).
[3] Organisation for Economic Co-operation and Development, “Gross domestic spending on R&D”, accessed 28 October 2021.
On 23 July 2021, the Supreme Court (“UKSC”) delivered its decision in Test Claimants in the Franked Investment Income Group Litigation v HMRC [2021] UKSC 31. This is the third judgment given by the UKSC in this long-running litigation concerning the tax treatment of dividends received by UK-resident companies from non-resident subsidiaries, compared with those paid and received within wholly UK-resident groups of companies.
This note discusses the three most significant issues – in financial terms – that were decided by the UKSC: (1) the remedy for claims in respect of unduly levied Advance Corporation Tax (“ACT”), which had been set off against lawful mainstream corporation tax (“MCT”); (2) the lawfulness of the UK statutory provisions which prevented double taxation relief (“DTR”) from being carried forward; and (3) whether HMRC could set off payments of tax credits which had been made to the claimants’ shareholders against the restitution due to the claimants for unlawful ACT.
Remedy for claims – Unlawful ACT which had been set off against lawful MCT
First, the UKSC established that the claimants’ remedy for claims related to the time value of the unlawful ACT, which had been set off against lawful MCT, was governed by section 85 of the Finance Act 2019 (the “FA 2019”). The UKSC decided that neither compound interest nor simple interest under section 35A of the Senior Courts Act were available.
The UKSC rejected the claimants’ contention that they should receive an award of compound interest for the time value of money in the so-called “period of prematurity”, i.e. the period between the date of payment of unlawful ACT and the date on which that ACT was set off against lawful MCT. The UKSC also rejected the claimants’ alternative petition for simple interest under section 35A of the Senior Courts Act. The distinction between an award of simple interest under the Senior Courts Act, and under section 85 of the FA 2019 was important because the latter imposes a 6-year limitation period, whilst section 35A claims to interest could, it was claimed, benefit from the extended limitation period available under section 32(1)(c) of the Limitation Act 1980.
The UKSC concluded that HMRC were not barred from contesting an award of compound interest due to action estoppel, issue estoppel, abuse of process, lack of jurisdiction, or by HMRC’s concession that compound interest was due following the judgment in Sempra Metals. The UKSC noted that, in Prudential, the company’s claim for compound interest would have been rejected if HMRC had not accepted the claim. The circumstances were different in this case because HMRC had sought, and been given permission to, resile from the concession that compound interest was due to the claimants.
The claimants’ alternative argument (that interest under section 35A of the Senior Courts Act was due) was also rejected, on the basis that section 35A only applied where proceedings for the recovery of a debt or damages had been instituted before the High Court. Since restitution of the unlawful ACT had been made without that type of proceedings being instituted, the UKSC concluded that section 35A did not apply.
Remedy in respect of unused DTR
UK statutory provisions which prevented DTR from being carried forward were held to be in breach of EU law. The UKSC concluded that any unused DTR (calculated on a Foreign Nominal Rate basis) must be available to be applied against other income in future years – notwithstanding any provisions to the contrary in UK law. Furthermore, the UKSC held that the claimants could seek restitution of taxes which had already been paid because of the inability under UK law to carry forward unused DTR, plus an award of interest.
Shareholders’ credits
Finally, the UKSC decided that HMRC was not entitled to set off payments of tax credits paid to the claimants’ ultimate shareholders against the restitution due to the claimants for unlawful ACT. The UKSC concluded that the levy of ACT had no bearing on the shareholder’s entitlement to a tax credit under section 231 of the Income and Corporation Taxes Act 1988. Therefore, it could not be considered in the calculation of the claimants’ compensation.
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.
