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HMRC as regulator, investigator and litigator

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HMRC’s recently revised departmental plan sets a long-term target of raising an additional £5bn a year by 2020 through tackling tax evasion avoidance and non-compliance. HMRC’s existing process for risk profiling large businesses is subject to review and a new business risk review (BRR) will be piloted for specific taxpayers during 2018. One of the most significant developments in the last year was the introduction of strict liability corporate criminal offences for the failure to prevent the facilitation of tax evasion under the Criminal Finances Act 2017. The regulatory burden on corporates is increasing in relation to tax and Finance (No. 2) Act 2017 introduced a new regime empowering HMRC to impose a civil financial penalty on so-called enablers of defeated abusive tax arrangements. The number of investigations opened by HMRC in the short to medium term is likely to increase and are likely to cover...

Setting the scene: HMRC’s departmental plan

1. What is HMRC’s business plan for 2018?

On 23 May 2018, HMRC updated its departmental plan. There have been no significant changes since the plan was published last year, and it will come of little surprise that HMRC’s first strategic objective is to ‘maximise revenues due and bear down on avoidance and evasion’. To achieve this, the government had previously committed to investing £800m into additional work led by HMRC to challenge tax avoidance and tax evasion, with a further £155m of investment to be made available for investigations in future years up to 2019/20.

HMRC’s long term target is to raise an additional £5bn a year by 2020 through tackling tax evasion, avoidance and non-compliance. It intends to achieve this through the implementation of a host of criminal, civil and regulatory measures.

2. How is this impacting on the tax risk and disputes environment?

To a large extent, corporates, high net worth individuals (HNWIs) and tax practitioners would be correct to view the HMRC’s department plan as merely an affirmation of the current tax environment, in which HMRC no longer acts solely as a tax collection authority but also as a regulator. Of course, a number of other factors also inform today’s climate, in which tax has become a regular front page story in the media. Echoing HMRC’s statement in its departmental plan, the common mantra is that everybody must pay their fair share of tax. The governance and tax behaviour of multinationals and large corporates has become subject to acute scrutiny by HMRC, the media and politicians. This has had the result that tax is now a board-level issue and reputational risk has become an important concern for all corporates.

In practical terms, this means that the tax landscape will continue to be characterised by heightened regulatory obligations for corporates; a greater risk of HMRC investigation for both corporates and HNWIs; and a more challenging environment in which to negotiate settlement of a dispute on favourable terms to the taxpayer, leaving litigation as the only option in some cases. The remainder of this article examines each of these stages of the contentious tax life cycle in turn.

HMRC as regulator: the tax compliance landscape

3. Can you highlight a recent measure intended to encourage better tax governance?

By now, all large businesses within scope should have published their first tax strategy as required by FA 2016 Sch 19. The legislation prescribes that the strategy must set out certain information for the relevant company or corporate group, including:

  • its approach to UK tax risk management and governance arrangements;
  • its attitude towards UK tax planning;
  • the level of UK tax risk which it is prepared to accept; and
  • its approach towards its dealings with HMRC.

The broad policy underlying these rules was to change corporate behaviour through the promotion of greater transparency around a corporate’s approach to tax planning and risk. However, a review of the tax strategies published by corporates in a range of sectors indicates that, to date, the measure has had a more limited impact on compliance than was envisaged by HMRC. Many of the businesses within scope have published only very generic, short strategies, with minimum detail about their approach to tax planning and risk. This is most likely a strategic decision, as the consequences of adopting a different approach to that articulated in the tax strategy could include both reputational damage and an adverse impact on the relevant corporate’s risk profile and relationship with HMRC.

4. How does this interact with HMRC’s large business risk review?

As readers will be aware, HMRC’s existing process for risk profiling large businesses is subject to review, and a new business risk review (BRR) will be piloted for specific taxpayers during 2018. The enhanced BRR is further intended to change the tax compliance and behaviour of large corporates.

At present, large businesses are classified as either low risk or high risk. This classification impacts on the level of resource and scrutiny which each business receives. Following a consultation process last year, HMRC has accepted that this binary classification should be changed to include more risk categories, which more accurately reflect the differences in risk across the large businesses within scope of the programme.

It is expected that the new BRR will take account of the existing risk management work already undertaken by large businesses, including the senior accounting officer regime and the publication of tax strategies. Some of the respondents to the consultation proposed that a distinction should be drawn between those businesses which have published only a high level, generic tax strategy, and those which have given genuine thought and commitment to the content of the strategy. Respondents also recommended that in determining a business risk rating, HMRC should ask for evidence that the relevant corporate is complying with its published tax strategy. If these recommendations are adopted, this could have material implications on the approach taken by large businesses towards the content of tax strategies in the future.

The other clear theme emerging from the consultation is that businesses require additional resources and more timely support from HMRC to assist in reducing tax risk. Very often, delays in receiving a response from HMRC can lead to deterioration in the relationship between a corporate and its customer compliance manager. The government has accepted this and the enhanced BRR will provide clear actions and timelines to be regularly updated and discussed between the parties.

5. What has been the impact of the Criminal Finances Act on the tax regulatory environment?

One of the most significant developments in the last year was the introduction of strict liability corporate criminal offences for the failure to prevent the facilitation of tax evasion under the Criminal Finances Act (CFA) 2017 Part 3. The effect of the legislation is that a corporate will be criminally liable where a person associated with it deliberately and dishonestly facilitates the evasion of UK or overseas tax, subject to the defence that the corporate had in place reasonable procedures to prevent the facilitation. Accordingly, since September 2017, to protect themselves from criminal liability, all corporates within scope should have undertaken risk assessments and put in place policies to mitigate against the risk of associated persons facilitating tax evasion.

Firms which are authorised by the FCA have long been required to develop systems and controls in order to ensure that their firms are not used as vehicles for financial crime. The additional requirements under CFA 2017 will comprise another layer, albeit with their own specific requirements and nuances, within this financial crime framework. However, outside the regulated sector, corporates have not been subject to the same level of compliance, and are perhaps less well set up to deal with the increased regulatory burden arising as a result of this legislation.

While there is no general obligation under CFA 2017 to develop reasonable prevention procedures, HMRC has taken the view that corporates should be willing to undertake risk assessments in order to test whether the services and/or products they provide could be used by an associated person to facilitate a tax fraud, on the basis that employees and contractors of well run corporates should not be involved in fraud. Although this is correct, a number of practical difficulties have arisen for some corporates. For example, where a large multinational has a small branch office in the UK through which a very limited amount of work is conducted, the risk assessment must nevertheless be conducted on a global basis. Experience indicates that it has not always proved straightforward for the UK branch to receive engagement from senior stakeholders in overseas jurisdictions during the global assessment process, resulting in a time consuming compliance exercise.

6. Is it fair to say that the regulatory burden on corporates is increasing in relation to tax?

Yes. We are seeing an emerging trend towards the government requiring businesses across a range of sectors to effectively police not only themselves but also their users, with a particular focus on online VAT fraud and customs duty evasion at present. This is leading to an additional compliance burden in terms of management time, administrative resources and expense.

7. Can you give us some recent examples which highlight this trend?

Below are three examples which highlight the trend identified above, although there are several more which could be added to this list.

  • On 29 May 2018, HMRC published a list of the initial signatories to its VAT compliance agreement with online marketplaces. Under this co-operation agreement, the online marketplaces have voluntarily committed to assist HMRC by providing support on VAT compliance to their customers; to provide HMRC with data about their users; and to put in place appropriate systems to act where there are grounds to suspect that there may be VAT non-compliance by their customers.
  • Running in parallel, HMRC is consulting on the role of online platforms in tackling tax non-compliance by their users. The consultation, which closed on 8 June 2018, is not restricted to VAT. It is likely to result in additional compliance obligations on online platforms in due course.
  • Fulfilment houses will shortly be subject to increased compliance obligations following the introduction of the Fulfilment Businesses Regulations, SI 2018/326, which came into force on 1 April 2018. The regulations impose a range of obligations on fulfilment houses, which will be required to notify customers about their VAT and customs duty obligations, keep records relating to customs duty compliance by their customers, and notify HMRC where they suspect that there has been non-compliance.

8. How else is HMRC seeking to drive behavioural change?

F(No. 2)A 2017 Sch 16 introduced a new regime empowering HMRC to impose a civil financial penalty on so-called enablers of defeated abusive tax arrangements, and to publish details of the enabler where the amount of the penalty exceeds a certain amount. The stated aim of the legislation is to change the behaviour of professional advisers, intermediaries and any other person involved in designing, facilitating or marketing abusive arrangements, thereby complementing existing anti-avoidance measures aimed at the taxpayer itself or at promoters of tax avoidance schemes.

Under the regime, an ‘enabler’ is liable to pay a penalty if they enabled the arrangements of any person who enters into abusive tax arrangements and that person incurs a defeat in respect of the arrangements or they are otherwise counteracted.

As the legislation only applies to a person if they enable abusive tax arrangements that are entered into on or after 16 November 2017, we are unlikely to see the first penalties under the regime for some time. However, in the meantime, the legislation should achieve its intended effect of deterring tax avoidance. Advisers should think carefully about its application in particular when advising on arrangements which may fall within the scope of the GAAR.

HMRC as investigator: the investigations landscape

9. Is there likely to be an increase in the number of investigations opened by HMRC in the short to medium term?

Yes. This will be one of the direct consequences of the investment made by the Treasury to achieve HMRC’s objective as outlined in its departmental plan.

The financial secretary to the Treasury Mel Stride has confirmed to Parliament that at least 50% of the 2100 corporates which fall within the large business sector will be under investigation at any one time. This is not necessarily because they have engaged in tax avoidance or aggressive planning, but because their tax affairs are complicated. He has also confirmed that HMRC intends to treble the number of investigations into the wealthiest individuals in the UK, to ensure that they are paying the correct amount of tax.

The investigations into both corporates and individuals’ tax affairs are likely to cover a wide range of taxes and both criminal and civil issues; a selection of these are highlighted below.

10. Corporate tax disputes: are remuneration arrangements still under scrutiny?

The taxation of remuneration arrangements involving employee benefit trusts (EBTs) has been the subject of investigation by HMRC for over ten years, with one of the first reported decisions in Sempra Metals v IRC [2007] STC 1559. It has recently been cast back into the spotlight with the high profile decision in RFC 2012 plc (in liquidation) v Advocate General for Scotland (Respondent) (Scotland)[2017] UKSC 45.

Following the decision in Sempra, many taxpayers continued to implement planning designed to avoid or defer a liability to income tax or NICs through the use of EBTs or employer financed retirement benefits schemes (EFRBS). Consequently, Part 7A of ITEPA 2003 was enacted in 2011 to block future remuneration structures involving third parties intermediaries such as EBTs or EFRBS which sought to avoid tax.

However, significant numbers of these structures which were implemented pre-2011 remained in existence, and promoters of tax avoidance also sought to take advantage of loopholes in Part 7A as originally enacted by marketing new schemes which purport to get around these rules.

The consequence was that many arrangements became subject to challenge by HMRC, resulting in many hundreds of ongoing investigations. Although some of these investigations have been settled under earlier global settlement opportunities, substantial numbers remain open.

The government has amended Part 7A so that a charge to tax will arise on any loan received after 6 April 1999 through a disguised remuneration arrangement which remains outstanding on 5 April 2019. Users of disguised remuneration arrangements can prevent the loan charge arising on 5 April 2019 by accepting the most recent settlement opportunity released by HMRC in November 2017. The deadline for registering an interest in the opportunity recently passed on 31 May 2018.

However, despite the settlement opportunity, it is expected that some cases will not settle. In those instances, HMRC will continue to investigate and the issue of follower notices and/or litigation is likely to follow soon.

Outside of the traditional planning involving EBTs or EFRBS, there remain many other structures designed to avoid PAYE and NICS which are also subject to ongoing investigation. These include schemes involving the artificial establishment of an LLP alongside an existing limited company, pursuant to which employees of the company receive reduced salaries but become members of the LLP and receive most of their remuneration through drawings and share schemes which seek to avoid income tax on bonus awards.

11. SDLT: will FA 2003 s 75A remain a focus area for HMRC?

Yes. Where HMRC seeks to challenge the stamp duty land tax (SDLT) treatment of a transaction, it is increasingly reliant on the application of FA 2003 s 75A. The statutory provision is extremely widely drafted and, until fairly recently, its scope had not been tested in the courts. Case law has now clarified that the provision can bite even where the taxpayer’s motive in entering into the transactions was not to avoid tax (Project Blue Ltd v HMRC [2018] UKSC 30) or where the vendor of the property had no knowledge of any subsequent transactions effected by the purchaser after the original disposal (Geering v HMRC [2018] UKFTT 233).

However, questions remain about the construction of the provision, which was recognised by Lord Hodge in the recent Project Blue decision as a ‘difficult provision[s] to interpret and to apply to particular transactions’. HMRC’s current practice appears to be to apply the section in a mechanical way to challenge the SDLT treatment of genuinely commercial arrangements involving a number of transactions where there is some degree of tax saving. This is unlikely to change until we have greater clarity on the construction and application of the legislation to arrangements which fit within the scheme of the tax and which do not result in ‘unintended tax losses’.

12. SDLT: can HMRC rely on extended time limits to issue assessments on the basis of s 75A?

A related issue of which taxpayers should be aware is that HMRC is now seeking to extend the time period during which it can apply s 75A. Following the filing of an SDLT return, HMRC usually has nine months to raise enquiries and challenge the SDLT treatment adopted by the taxpayer. If it fails to open an enquiry during that window, then (assuming all relevant disclosures have been made) the SDLT will be final.

However, if no SDLT return is filed, HMRC has four years to issue a ‘determination’ of the SDLT that should have been paid (or potentially 20 years to issue a discovery assessment in certain circumstances). This is potentially a more powerful weapon than a simple discovery assessment, because a determination can only be appealed on relatively limited grounds. HMRC is increasingly issuing determinations to re-open transactions that may be caught by s 75A, on the basis that the taxpayer should have filed a return in respect of the notional transaction created by s 75A. This is despite the taxpayer having filed an SDLT return in respect of the actual transaction.

13. Which principles are HMRC using to challenge the VAT treatment of arrangements?

In the VAT sphere, HMRC continues to use the principle set out by the CJEU in the case of Newey (t/a Ocean Finance) (Case C-653/11) to challenge contractual arrangements which, whilst not clearly abusive, lead to a VAT advantage. In the Newey case, the CJEU made it clear that, when determining the nature of a transaction for VAT purposes, one must look to the commercial or economic purpose of the transaction as a fundamental factor. That approach is, self-evidently, a powerful tool in HMRC’s hands to challenge arrangements which it sees as objectionable, without necessarily meeting the threshold for being abusive on Halifax principles. What HMRC sometimes appears to overlook is the other face of the Newey principle; namely, that the starting point for the VAT analysis is to determine what the parties have agreed. Arguably, the correct reading of Newey is that HMRC can go behind the contract only if the contract does not reflect the true agreement between the parties.

14. Which customs duty issues are subject to investigation?

Although there is no coherent evidence that HMRC is focusing on any specific new areas of investigation at the present time, it continues to pursue, with some determination, disputes on the classification of goods for duty purposes. This was exemplified in the recent decision of the Court of Appeal in Hasbro European Trading v RCC [2018] EWCA Civ 1221, where the issue was whether Beyblades are correctly classified for duty purposes as games or as toys. Taxpayers should always be mindful of the potential costs, or benefits, of classifying imported goods under one heading or another. There may be extremely significant savings to be made, on the one hand; on the other, the time and cost of correcting errors can be a huge burden for businesses, given the rather antiquated administrative system for dealing with customs duties.

15. High net worth individuals: is HMRC’s approach to HNWIs changing?

In 2009, HMRC set up a unit to focus on the tax affairs of HNWIs and by 2015/16 was investigating cases involving around one third of these individuals with a value of around £1.9bn of extra tax revenue that might be due. Despite this, the amount of tax paid by HNWIs had fallen by £1bn by 2017.

A 2017 House of Commons Public Accounts Committee (PAC) report examined HMRC’s approach to HNWIs. It recommended that HMRC should publish information on its approach to tackling non-compliance, including the number of criminal investigations in progress; and that it should move away from its current approach to dealing with HNWIs, which suggests an ‘overly close and inappropriate service to the wealthy’.

The PAC also considered that HMRC is hampered by not having the power to demand more information about what assets HNWIs hold; and, in particular, not being able to make connections between offshore structures and HNWIs. HNWIs’ affairs nearly always involve offshore assets or structures, which HMRC argues makes it more difficult to investigate their affairs and ensure they are paying the right amount of tax. HMRC proposes to extend the time limits for assessing tax in cases of mistake or non-deliberate offshore tax non-compliance to 12 years, arguing that it can take much longer for HMRC to establish the facts concerning offshore transactions, particularly when a complex offshore structure is involved. For deliberate behaviour, the current time limit of 20 years will remain. The new legislation will not apply retrospectively but will apply to any case that is still in date for assessment when the new legislation comes into effect. The requirement to correct (RTC) rules have already extended the time limits for income tax, CGT and IHT assessable at 6 April 2017 until 5 April 2021, but the new proposals will bring more cases within the scope of the new legislation. RTC is a statutory obligation for taxpayers with overseas assets to correct any issues with their historic UK tax position before 30 September 2018; failing to do so may result in punitive financial penalties and other severe sanctions.

HMRC’s bid to tackle offshore non-compliance has received a significant boost from the dramatic increase in the automatic exchange of information between jurisdictions (under the common reporting standard (CRS)) and the introduction of beneficial owner registers which are accessible to revenue authorities. HMRC is now beginning to receive information which connects HNWIs with offshore assets and structures where HMRC was not previously aware of those connections. This is already resulting in HMRC raising new enquiries, often in cases of fully compliant taxpayers. After 30 September 2018, more than 100 countries will have committed to automatically exchange data on financial accounts under CRS. The requirement of trusts, including non-UK trusts, to register with HMRC’s trust registration service (launched earlier this year) and provide details of the beneficiaries of those trusts, is further fuelling a new line of enquiries into the affairs of HNWIs.

16. HNWIs: which issues are under enquiry by HMRC?

There has been a marked increase in the number of domicile enquiries raised by HMRC, despite the significant revisions to the UK tax rules for non-UK domiciled individuals introduced by the last two Finance Acts.

High-value UK residential property held by HNWIs through offshore structures has long been and remains a target of HMRC, resulting in several new tax charges being introduced over the last few years. However, HMRC’s inability to identify the beneficial owners of some such structures has continued to frustrate HMRC, resulting in the proposed publicly accessible register of beneficial owners of UK real estate to be available from 2021. Non-UK companies and other non-UK legal entities that fail to comply will not be able to transfer legal title to UK real estate held by them, or obtain unrestricted title to UK real estate they purchase; criminal sanctions could also be imposed for failure to comply.

17. What is the outlook for criminal investigations by HMRC?

In general, we can expect to see an increase in criminal investigations by HMRC in the next two years. This is due to HMRC’s target of conducting more investigations into serious and complex crime with a view to increasing prosecutions in this area to 100 a year. In particular, we are likely to see the first investigations under CFA 2017 initiated later in 2018 and 2019.

HMRC referred 1,135 cases of suspected tax evasion to the Crown Prosecution Service in 2015/16. Given the political importance of being seen to prosecute tax fraud, it is expected that HMRC will carefully examine the facts relating to suspected facilitators of tax evasion in the course of its investigations into tax evaders. Through this analysis, HMRC will seek to identify any corporate with which the facilitator is associated, in order to commence a simultaneous investigation into the relevant corporate for failing to prevent the facilitation of tax evasion.

HMRC has access to numerous sources of information which will inform such investigations. One likely source is suspicious activity reports (SARS) relating to tax evasion. It is understood that such SARS filed with the National Crime Agency will be passed to HMRC for investigation. In addition, it is understood that the Financial Conduct Authority, the Serious Fraud Office and HMRC are all planning to exchange information concerning suspicions around facilitation of tax evasion.

HMRC as litigator: the litigation landscape

18. What is the litigation and settlement strategy?

HMRC’s litigation and settlement strategy (LSS), the related commentary on the LSS and its code of governance for resolving tax disputes provide the overarching framework under which HMRC resolves tax disputes through civil procedures. Most recently updated in October 2017, some of the key issues of which taxpayers should be aware include the following:

  • The strict governance processes and number of different stakeholders required to approve the resolution of sensitive, strategically important or high value disputes, including the terms of any settlement, means that taxpayers are frequently met with substantial delays in progressing enquiries towards resolution. It is therefore critical to involve HMRC officers with the requisite level of authority at the earliest stages, to improve the prospects that any settlement can be approved on the agreed terms and without delay, or to force HMRC to issue an assessment against which an appeal can be initiated.
  • The updated LSS places considerable emphasis on the need for HMRC to establish and analyse the facts underlying the dispute in question. In practice, we have seen an increase in formal and informal information requests requiring the production of extensive documentation. Taxpayers should seek to engage collaboratively with HMRC to limit the scope of such requests where necessary because the request is unduly onerous. However, in other cases it will be in a taxpayers’ interest to invest the time in fact gathering and preparation of evidence at the outset of a dispute as this may achieve earlier resolution, depending on the nature of the dispute.
  • The LSS also emphasises that HMRC can only resolve disputes in a way that is consistent with the law and on a basis that determines the correct amount of tax. It has been clear since the LSS was first published in 2007 that HMRC’s historic practice of agreeing a package deal to settle multiple disputes, or agreeing a settlement on terms more akin to that typically seen in commercial disputes, would not continue. Accordingly, taxpayers wishing to settle a dispute would be well advised to prepare a detailed technical analysis to underpin the offer. HMRC accepts that there may be a range of outcomes in some cases and is permitted to settle on one of the alternative bases provided that this would be one of the ‘likely outcomes’ in litigation.

19. Is HMRC held to a different standard of conduct in litigation?

It is not uncommon for taxpayers engaged in litigation against HMRC to experience delays by HMRC in complying with procedural deadlines; refusal by HMRC to agree directions (often necessitating case management hearings in which HMRC then adopts a neutral position); or pleadings which lack substantive detail as to the factual and legal basis for HMRC’s case.

Two court decisions in the last year have considered the standard of conduct to which HMRC should be held in litigation. The case law helpfully confirms that it is not acceptable for HMRC to pursue cases unnecessarily, without properly analysing the facts and legal basis of the case or without exploring appropriate opportunities to resolve the dispute through negotiation prior to a hearing.

  • In BPP Holdings v HMRC [2017] UK SC 55, the Supreme Court strongly rejected HMRC’s argument that as a public body, it should be subject to a lower standard of compliance with procedural rules than a private party, holding that HMRC should be held to account for its repeated failures to comply with procedural directions. The Supreme Court therefore upheld the decision of the lower courts which had debarred HMRC from the proceedings by way of sanction for its non-compliance.
  • In P Cannon v HMRC [2017] FTT 859 and [2018] FTT 160, the First-tier Tribunal (FTT) made a costs award against HMRC for its unreasonable conduct in the proceedings. In reaching its decision, the FTT considered that HMRC had taken an entrenched position with a closed mind and that it was unreasonable for HMRC to have declined an offer from the appellant to engage in negotiations in the circumstances of the case.

These decisions are to be welcomed, although it is likely to take some time before a change in practice is seen by HMRC.

20. What is HMRC’s approach to privilege?

HMRC’s stated position in the LSS is that it will not typically expect a taxpayer to waive privilege and that a refusal to waive privilege will not be viewed as a sign of non-compliance. This can be contrasted with the approach of other agencies, such as the FCA or the SFO, where a corporate’s decision to waive privilege is often taken into account in enforcement action.

However, in practice, HMRC is challenging taxpayers’ claims to privilege on a regular basis. The recent decision in Conegate v HMRC [2018] UKFTT 82 serves as a timely reminder to taxpayers to consider whether it would be in its best interests to waive privilege to support its case and if not, to take care to ensure that privilege is not waived impliedly. 

The author thanks her colleagues, Alan Sinyor, head of VAT, and Alison Cartin, private client associate director, for their contributions.