By Paul White

Britain is proposing stiff penalties for tax advisers who help with aggressive tax schemes.

The proposals go far beyond penalizing promoters, tax lawyers and accountants for working on transactions that the government has warned go too far.

Anyone found to have worked on a transaction that the UK tax authorities successfully challenge later could be “named and shamed” and forced to pay a penalty equal to 100% of the tax assessment.

Tax avoidance continues to be a hot topic in the UK media and one that politicians are more than happy to address. The rich and famous who avoid tax are bad people, right? Successive governments have introduced new tax regimes, then changed them, and changed them again, all aimed at preventing the avoidance of tax. Until now the primary aim of the changes has been to increase compliance by building on the self-reporting duties imposed on firms that market avoidance schemes and their clients.

In August, the UK tax authority, HM Revenue & Customs — called HMRC — launched a two-month open consultation on “strengthening tax avoidance sanctions and deterrents.” Consultations on anti-tax avoidance and the ensuing strengthening of the UK tax code in relation to compliance have been regular events over the last few years, so the latest is not in itself surprising.

What is surprising is the potential reach of the proposals and the stinging financial sanctions on parties who have not actively participated in the avoidance of tax, including accountants, lawyers and other professional service providers involved in the execution of schemes, even though they played no role in the avoidance and received only a standard fee for their services.

Before reviewing the latest proposals, it is worth considering why HMRC is looking to make these changes now and why it is targeting more or less passive participants.

Background

Historically, HMRC’s ability to challenge avoidance was hampered by two factors. First, the inevitable time lag, often a matter of years, between the tax-avoiding transaction and the point at which HMRC would have an opportunity to identify the avoidance in the taxpayer’s tax returns. Second, HMRC lacked the analytical personnel and the technical means to reverse engineer convoluted schemes developed by highly paid teams of professionals.

Both those problems were addressed a little over 10 years ago by the introduction of the “DOTAS” regime. The acronym stands for disclosure of tax avoidance schemes. The regime applies to “notifiable arrangements” and “notifiable proposals” that are designed to effect a UK tax advantage as a main expected benefit and that fall within any one of the legislative categories or “hallmarks.”

The reporting obligation falls on the scheme “promoters” who market the scheme, but may extend to the professional advisers who devise the scheme or provide the tax structuring advice and even, in some cases, to the scheme users.

The main purpose of regime is to provide HMRC with early notice of new tax schemes and details of how they operate. This enables HMRC to challenge the effectiveness of the schemes before there is wide-scale use and also to legislate to the close loopholes exploited by the disclosed schemes.

HMRC considers the DOTAS regime to have been a great success, and the Treasury confirmed that 42 amendments to the tax code were made between 2010 and 2014 as the result of HMRC’s analysis of disclosed schemes. But, perhaps inevitably, fewer schemes are being disclosed each year: 84 in the 2012-13 tax year, but just 40 the following year. While this may be a testament to the regime’s success, the view persists that avoidance continues on a major scale, so HMRC has been looking for new ways to deter the scheme promoters.

In 2014, the Cameron government introduced a new “POTAS” regime, targeting promoters of tax avoidance schemes, with the intention of curbing the activities of high-risk tax scheme promoters. Under POTAS, a serial promoter of tax avoidance schemes may be served a “conduct notice” by HMRC requiring the promoter to act or cease to act in a particular way. For example, a notice may require a promoter to comply with its disclosure obligations or to desist from activities that might tend to prevent others from complying with DOTAS.

If a recalcitrant promoter fails to comply with a conduct notice, HMRC may apply to the first-tier tax tribunal for approval to issue a monitoring notice. If a monitoring notice is issued, and is not appealed or the promoter’s appeal rights are exhausted, HMRC will publish the name of the promoter and other related information, and the promoter is bound to notify its existing and new clients that it is subject to a monitoring notice.

Key to the structure and effectiveness of POTAS is the assumption that taxpayers will be wary of using tax mitigation products that are being marketed or structured by firms or individual advisers who are already the subject of HMRC’s targeted compliance procedures and sanctions. And, therefore, a promoter who is at risk of being the subject of a published monitoring notice can be expected to modify its activity to comply with the tax code and, in particular, with DOTAS.

Despite the two compliance regimes already mentioned and a variety of other anti-avoidance initiatives since the 2008 financial crash, the idea persists in the UK media and, it appears, in HMRC that a significant number of taxpayers are avoiding tax.

In recent years, the media, and especially the tabloid press, have suffered a barrage of criticism from the rich and famous for phone tapping and other invasion of privacy issues, and that has resulted in Parliamentary investigations and criminal prosecutions. Over the same period, tax cases brought by HMRC have revealed the extent to which celebrities from the entertainment and sports worlds have invested in tax avoidance schemes, particularly those related to movie finance and offshore holdings. Not surprisingly, the newspapers have taken every opportunity to highlight the alleged hypocrisy of celebrities who avoid paying their “fair shares” of tax.

Latest Proposals

Britons often like to talk about what is fair or unfair. It is a topic almost as interesting as the weather. And they make frequent use of idioms about fairness, most of which are related to sports and especially cricket, while cricketers themselves are expected to play not only in accordance with the arcane written rules of the game, but also “the spirit of the game.” At this point you might be wondering what any of this has to do with taxation; surely no one has suggested that tax should be paid not only according to the published code, but also “the spirit of the code.” Actually, that is almost exactly what is happening.

While one should not be surprised when the tabloids vilify celebrities for not paying their “fair shares” of tax, it is disappointing that the tax authority adopts the same language when announcing new initiatives.

The tone of the latest proposals is set in the very first paragraph of the discussion paper. According to HMRC, a minority of taxpayers “attempt to pay less than their fair shares by using tax avoidance schemes” that have been “developed, marketed and facilitated by a persistent minority of promoters, advisers and other intermediaries.” The discussion paper even alludes to those who operate outside “the spirit of tax law” in order to identify those to whom the proposals are intended to apply.

Another, perhaps more valid, fairness issue in relation to defeated avoidance schemes is that while the taxpayers will eventually have to pay their “fair shares” of tax, together with late-payment interest and penalties, the firms that market the schemes do not suffer financially for the schemes’ failure.

The proposals represent a step change in HMRC’s approach in that they target all participators, not only the promoters, and they introduce both financial and non-financial, “name and shame,” penalties for enablers of tax avoidance schemes that have been defeated by HMRC.

Some of the proposals are vague while others would seem to face significant practical difficulties in operation, but presumably HMRC is aware of those issues and is not concerned by them. Although the proposed rules will only apply to tax schemes that are challenged and defeated by HMRC, they will inevitably affect the activities of advisers when transactions are being structured and undertaken.

The object of the proposals is clearly to deter lawyers, accountants, company formation agents, trust companies, financial intermediaries, banks, etc. from participating in business arrangements that might be challenged by HMRC as tax avoidance schemes.

HMRC has cleverly turned the time lag between execution and challenge to its advantage. A “defeated scheme” will likely be one about which there is a final determination of a tribunal or court that the arrangements do not achieve their purported tax advantage, or, in the absence of such a decision, there is an agreement between the taxpayer and HMRC that the arrangements do not work. So, at the time of execution, there is no way of knowing whether a transaction may eventually become a “defeated scheme.”

It is foreseeable that some advisers may decline to act on transactions that may be defeated under challenge. Or, they may seek indemnities from their clients, so in the event of a successful challenge by HMRC, the client would be liable not only for its own tax, but also the penalties applied to other participants.

The proposals target the “enablers” as everyone in the “whole supply chain” for tax avoidance arrangements and schemes. The discussion paper notes that these participants bear limited risk or downside when the avoidance arrangements are defeated by HMRC. There is little acknowledgement that most enablers do not benefit from the upside either, but simply receive standard fees for their services.

HMRC says that sanctions would not apply to an enabler who was unaware that the services it provided were connected to wider tax avoidance arrangements, but this is just one of the areas where the practical details of operation seem not to have been fully considered.

According to the discussion document, “the purposes of a penalty for those who enable tax avoidance is to influence behavior and discourage the design, marketing and facilitation of avoidance generally.” Although conceptually similar to POTAS, this time the sanctions are proposed to include significant financial penalties.

The consultation document briefly considers a variety of sanctions, including the Australian model of fixed-sum penalties and penalties based on one or both of the amount of tax avoided and the financial benefit enjoyed by the relevant enabler.

The approach favored by HMRC is a combination of fixed sums or, if higher, as much as 100% of the tax avoided plus the non-financial sanction of publishing the names and offenses of sanctioned enablers. Although, HMRC acknowledges that the size of the penalty needs to be proportionate to the services provided by the enabler and the financial reward it received, discussion of the quantum misses the point of the latest initiative.

The proposals are aimed at making professional service providers think twice before becoming involved, however tangentially, in arrangements that may prove in time to be a “defeated scheme.” Even if the economic cost of the penalty is borne by another party, the “naming and shaming” sanction is unavoidable. If challenged by HMRC, the adviser may seek to avoid sanctions by pleading ignorance of the scheme’s effect, but that is almost like admitting that, “provided we are paid, we do not care what we are involved in,” which could be even more damaging to the adviser’s market reputation than admitting involvement in a defeated scheme. Some commentators fear that in their current form the proposals will affect the willingness of advisers to participate in any tax advantaged transactions, besides bringing additional costs and time delays to structured deals.

With Brexit looming, the new Prime Minister and her Chancellor have been loudly proclaiming that Britain remains “open for business,” so perhaps HMRC’s proposals will either be dropped or significantly curtailed before they become law. We may not have long to wait for an answer. The Chancellor will make his first autumn statement on November 23, a sort of mid-tax year mini-budget, in which he is expected to outline the government’s vision of the UK’s fiscal future outside of the EU and hopefully will not reference “the spirit of tax law.”