Tax planning to be wary of

The Spotlights page on HMRC's website remains as it was before the change of Government. It's purpose is to clarify what activities HMRC "are likely to see as [unacceptable] tax avoidance."

The page identifies the types of arrangements and schemes which HMRC say they are likely to challenge. I've mentioned some of these before. The page also sets out 17 indicators of tax planning that HMRC suggest you should be wary of.

I've divided HMRC's list into 2 parts and added some additional comments of my own below.

Even HMRC accept that none of these features, of itself, is a problem. However the more of these features that are present, the more likely it is that HMRC would see the arrangements as [unacceptable] tax avoidance. And, I would add, the greater the likelihood that the promised tax savings are more risky and less certain. This is not simply because of the prospect of the taxpayer being subject to a challenge by HMRC. It is also because the more of these features that exist, the more likely it is that HMRC's challenge will be successful. This is especially the case when the promoters have had no previous connection with the taxpayer - ie: the taxpayer has been encouraged to use a marketed scheme rather than simply undertaking commercially driven tax planning.

So watch out where a marketed scheme is involved and any of the following apply:

1. There are guaranteed returns with apparently no risk.
2. It sounds too good to be true.
3. There are secrecy or confidentiality agreements.
4. Upfront fees are payable or the arrangement is on a no win/ no fee basis.
5. The scheme is said to be vetted by a top lawyer or accountant but no details of their opinion are provided. [In the past I saw schemes where the opinion was from a different Barrister to the one addressed in the instructions - suggesting that the promoters had to keep looking to find someone who would provide the desired opinion]
6. It involves money going in a circle back to where it started.
7. Low risk loans to be paid off by future earnings are involved.
8. The scheme promoter lends the funding needed.

And be cautious about structured arrangements where 2 or more of the following apply:

1. Artificial or contrived arrangements are involved.
2. It seems very complex given what you want to do.
3. Tax benefits are disproportionate to the commercial activity.
4. Taxation of income is delayed or tax deductions accelerated.
5. The scheme is said to be approved by HMRC (it does not follow that this is true).[HMRC make the point that when they issue a Scheme Reference Number this does not mean either that HMRC 'approves' the scheme or that HMRC accept that the scheme achieves its intended tax advantage].
6. Offshore companies or trusts are involved for no sound commercial reason.
7. A tax haven or banking secrecy country is involved without any sound commercial reason.
8. Tax exempt entities, such as pension funds, are involved inappropriately.
9. It contains exit arrangements designed to sidestep tax consequences.

For the record I have previously noted that HMRC's spotlights page contains an example of how: HMRC confuse tax avoidance and tax evasion again

Guardian suggests no more tax relief for interest

Was surprised to read this at the end of a piece in the Guardian online yesterday. The journalist, Nils Pratley, began his piece by referencing Vince Cable's recent speech which proposed a review aimed at curbing short-termism in the City. Towards the end of his piece Nic then says:

"if the coalition really wanted to reverse the trend towards short-term thinking, it would change the rules on the tax-deductibility of interest since the current rules encourage companies to load up with debt to reduce their tax bills"

Nic goes on to explain the impact that a change in the rules would have on leveraged buyouts and takeovers.

At first I was confused. After all, the fact that interest is tax deductible simply reduces the cost of servicing debt. The full amount of the interest payable still has to be funded out of cashflow. If the business is not generating sufficient cash to cover the interest cost the tax relief is irrelevant. It simply reduces the corporation tax payable at a later date - and if the business is loss making there is no tax payable anyway.

On reflection I assume that some takeovers and leveraged buyouts are funded by special debt instruments. The interest accrues as normal and can (indeed 'must') therefore be deducted from annual profits. But perhaps payment of the interest is deferred until the new projects, that are being financed, generate sufficient cash. And as this is so risky for the lenders the interest rate is high and so the tax deduction is particularly valuable. In such cases I can accept the rationale for Nic's argument.

There are also situations where the borrowings are drawn from a group company which will not pay tax on the interest earned (eg: if located in a tax haven). So the group as a whole simply reduces it's UK tax bill by reference to the intra-group interest payable to the offshore group company. So far as I can recall the 'loan relationship' rules do not prevent this type of mismatch.

Such fancy arrangements are not common however in the SME marketplace. Indeed I'm sure that the vast majority of SME businesses only build up debt if they absolutely have to do so. The fact that tax relief is available for the interest is not the motivation as the interest has to be paid in full to a third party regardless. Taking on more debt increases the costs of doing business. SMEs do not do this unless they have no other option. It's not "short-termism", it's business.

Fortunately there is no realistic prospect of tax relief being removed in respect of the interest payable by SMEs (or larger businesses).

The IoD needs to be careful what it wishes for re IR35

According to AccountancyAge the Institute of Directors:

"has labelled IR35 as a "serious problem" in its submission to the Office of Tax Simplification."

The article references the usual observations about IR35 but omits one key point. That being the risks to Companies (including those run by members of IoD) of engaging self employed contractors. If the Company does this directly the Company runs the risk of HMRC arguing that the terms under which the contractor is providing their service is akin to that of an employee. In such cases the Employer Company would be liable to employers' NICs and for the tax deemed to have been deducted from the sums paid to the contractor.

It is no wonder then that many Companies require contractors to provide their services through the medium of a personal services company. This removes all risk from the (employing) Company. Many Companies are also known to have made staff redundant and then re-engaged them through their individual personal services companies so as to reduce employment costs. In many such cases I understand this facility is also used to reduce pay rates to less than the National Minimum wage.

The rules we know as IR35, and which date back to the turn of the century, only come into play when contractors provide their services to (employing) Companies on terms that would otherwise render them as employees. But IR35 does not affect the (employing) Company. It simply(?) reduces the facility for the contractor to benefit from the arrangement.

I would have thought the majority of members of IoD are Directors of employing Companies rather than owner managers of IR35 companies. And I accept that the IoD may well support a simplification of the IR35 rules. However I doubt they want to create a situation that obliges their members to employ all contractors. This would oblige the employing Companies to pay employers' NICs on what were previously consultancy fees paid to personal service companies.

As and when the IR35 rules are simplified I would expect the obligations on employers to increase - especially those those who encourage employees to provide their services through personal service companies.

As I said on this blog back in July: If IR35 is to be abolished - Beware son of IR35

Do you have to organise your affairs to pay the maximum tax?

My attention was drawn to a Q&A in the House of Lords on 19 October. It was clearly an attempt to challenge the legitimacy of pronouncements by Government ministers that confuse tax avoidance and tax evasion.

Lord Ashcroft: To Ask Her Majesty's Government whether they expect citizens to organise their tax affairs in order to maximise tax payable.[HL2125]

The Commercial Secretary to the Treasury (Lord Sassoon): The Government expect citizens to pay tax that is due by law. The Government will take action against tax avoidance schemes that claim to produce results completely at odds with the intentions of Parliament. That is why the Government support the Code of Conduct on Taxation for banks and is asking them to adopt it by the end of November 2010.

On this blog I have taken an objective stance when sharing my views on the issue of legal but artificial tax avoidance schemes. I'm no fan and I'm skeptical of many of the claims made about the prospect of success of such schemes. But I equally understand the rationale for Lord Ashcroft's question (leaving aside his personal position etc). It comes down to the extent to which citizens can take action to reduce their tax bills as long as when doing so they remain within the law.

I don't imagine Lord Ashcroft expected a fully reasoned reply to his question. At it's simplest the answer has to be 'no'. Of course there is no legal or moral obligation to organise one's affairs in order to maximise the tax payable. And that then begs the question as to how far can one go to reduce the tax payable as long as one remains within the law?

I've explored previously the difference between tax evasion, legal but "morally questionable" tax avoidance and uncontentious tax planning. And I asked just last month: Doesn't everyone try to avoid or evade taxes? The problem is that different people will draw the line between what is acceptable or unacceptable in different places.

I know that many advisers struggle with this. The challenge is whether they can honestly and objectively advise their clients as to the risks and downsides as well as the prospective benefits of tax avoidance activities.

Prudential case confirms no Privilege (LPP) for accountants

Accountancy Age have published my comments on the Prudential judgement that was handed down by the Court of Appeal this week. Here's what I said:

I’ve long thought it unfair that lawyers and accountants are subject to different rules when advising clients on tax matters. The distinction relates to the facility afforded by the rules of Legal Professional Privilege (LPP).

LPP is a common law right that has developed over the past 400 years. It is intended to ensure that anyone can seek advice in confidence about their legal rights and obligations and in particular advice about litigation or potential litigation. Where LPP applies the lawyer is not required to report or pass on the information shared with them with any third parties (eg: the police or HMRC). LPP also permits the client to refuse to disclose documents or answer questions, and to require the adviser and others so to refuse as well.

The problem is that this rule only applies to legal advice provided by a qualified lawyer. Not when provided by accountants or tax advisers.

The Prudential case, heard by the High Court last year, decided that LPP should not be extended to other professionals who provide advice on tax matters, in particular accountants. The Court rejected Prudential’s appeal even after accepting that accountants are the main providers of advice of a taxation nature. The Court had little discretion here due to a 1985 Court of Appeal decision on a similar issue (allbeit involving patent agents). So the Prudential appealed.

The ICAEW, quietly supported by the CIOT, intervened and set out arguments for the Court to consider in reaching its decision. Unsurprisingly though, in my view, the Court of Appeal has determined that LPP only applies to lawyers. I admire the ICAEW’s attempts to persuade the Court that the rule should be extended. Legal advice no doubt confirmed that such an attempt was worthwhile. And the members would have been delighted by a successful outcome.

I’m no lawyer so may be accused of naivety in such matters. But my gut feeling throughout was that there was no prospect of success. I take no pleasure in finding out I was right. I could see no circumstances in which the Court would, effectively, extend the range of advisers who could help tax cheats escape prosecution. For that would be the outcome if the rule of LPP were extended.

Clearly it’s wrong that different rules apply to lawyers and accountants when advising on the same issues. It’s also wrong that tax cheats can secure advice from anyone with the protection of LPP. But of course our legal system requires the assumption of innocence rather than guilt – until proven. And that’s why the Courts consider LPP to be “a fundamental condition on which the administration of justice as a whole rests."

It’s not easy to see how the unfairness can easily be resolved. However, let’s assume, for a moment, that the rules are changed and that accountants (chartered or otherwise) can claim the protection of LPP as regards their advice. There is another key difference between lawyers and accountants. The former are trained in legal analysis and interpretation. The latter are not.

Of course plenty (but not all) accountants have an in depth understanding of tax law. But that’s only one aspect of the legal system. It hardly qualifies accountants to emulate lawyers in the interpretation of wider legal principles such as LPP and to properly understand when it does or does not apply. The ICAEW’s failure to persuade the Court to extend the LPP rule may be a blessing in disguise.

What view would Tax Counsel take of a General Anti Avoidance Rule?

The Tax Journal has published the results of a readership survey that reveals two conflicting views. On the one hand a clear majority (55%) of the 175 respondents do not favour the introduction of a GAAR. And the published comments from respondents largely reflect this.

On the other hand almost two-thirds' (64%) would support a GAAR if there was a pre-transaction clearance procedure. This is surprising as a smaller majority (53%) would only support a GAAR if all existing targeted anti-avoidance rules were repealed.

It would be interesting to know whether there is any difference in view between those Tax Journal readers who are accountants in practice, lawyers in practice or in-house Tax Directors. I suspect their views could be quite different. Indeed, in July I wrote a piece: Would a GAAR mean less work for accountants? In it I referenced a recent conversation with a Tax Director that had prompted that idea.

I'd like to raise a different issue now. That is: the reaction of Tax Barristers (Counsel) who advise on tax schemes.

If a GAAR is introduced the reaction of Tax Counsel will be key. I would expect that the more bullish members of the Tax Bar will continue to give their robust opinions. These will include a note that the Courts may take a different view and that (even after it has come into force) the effect of the GAAR is, as yet untested.

Thus the introduction of a GAAR will not stop the creation or marketing of tax schemes. Only the application of the GAAR will do this. Just as now, promoters of schemes only move onto the next one when the law is changed or after HMRC has succeeded in challenging the old one in court. This often takes many years.

In this context Tony Beare, Head of Tax at Slaughter and May, writing in the Tax Journal recently suggested that HMRC might not litigate the GAAR:

"One can easily foresee the possibility that HMRC might use a GAAR in a similar way to its past practice in relation to the TAAR in CTA 2009 s 441, which is to raise the possible application of the provision in any ongoing dispute but not take the matter to litigation, with the result that the exact parameters of the provision are never circumscribed by a court."

Which takes us back to my earlier point. If the rationale for introducing a GAAR is to limit the promotion of structured avoidance schemes, much will depend on the views of Tax Barristers. Until then the promoters will continue to proudly announce that they have yet to lose their arguments in court.

The 300th blog post on TaxBuzz - tax insights and clarity

A little self celebratory I know. But an achievement worth recognising anyway I think.

I started this blog at the end of 2007, to coincide with the launch of the Tax Advice Network.

There were 86 TaxBuzz posts in 2008 and 113 in 2009. We already have over 100 posts so far this year - which should mean this becomes a bumper one - easily beating my initial target of an average of 2 posts a week. Although, to be fair, I have slowed down a little over the last month!

Readers(?) feedback as to topics to address here are always welcome.

"The taxman is happy with my return' - Sure?

As we move towards the first filing deadline for 2009/10 personal tax returns you may find it helpful to reflect on a key aspect of our tax system. Many people seem to misunderstand how things work. They mistakenly assume their affairs are in order long before they have any real evidence that this is actually the case.

The concept of "Process now - check later" - is a key element of our self assessment tax system. It means that tax returns are processed by computer long before a real person checks them. In most cases the computer then generates statements showing the tax payable or repayable based on the entries on the tax returns as submitted.

At this point no one has reviewed any exception reports generated by the computer and no real person has checked any of the entries or disclosures on the tax returns. So little comfort can really be drawn from the statements issued confirming that a tax return has been 'processed'.

And it is especially important to keep this in mind when you hear stories about how people have supposedly got one over on the taxman. This includes those who have claimed what might be spurious deductions on their tax returns, omitted to report potentially taxable income or secured the hoped for tax treatment of a tax avoidance scheme.

So when you hear anyone boasting about their own success or that of their clients just remember that the real timescales are much longer than they might imply. This is especially true for anyone who is referring to transactions they have undertaken since 6 April 2009. Transactions undertaken from that date through to 5 April 2010 will be reported on tax returns that need to be filed (online) by 31 January 2011. HMRC then have 12 months from the date the return was filed (so potentially until 31 January 2012) to start asking questions.

So it's a little premature to determine your own attitude and approach by reference to the way that someone else has supposedly beaten the taxman on a tax return that has yet to be checked or challenged.