The recently released decision of the First-tier Tribunal ("FTT") in Litman & Newall v HMRC [2014] UKFTT 89 (TC) should be read by those who are contemplating using, or have used, a tax avoidance
The recently released decision of the First-tier Tribunal ("FTT") in Litman & Newall v HMRC [2014] UKFTT 89 (TC) should be read by those who are contemplating using, or have used, a tax avoidance structure in an attempt to mitigate tax liabilities.
Facts
In 2004/5, the Appellants participated in a capital redemption policy ("CRP") structure, marketed by the Montpelier group, in an attempt to reduce the capital gains tax liability arising on the disposal of a business. A fundamental aspect of the structure was the provision of an interest free loan to enable the purchase of the CRPs by the Appellants. Following the decision of the Court of Appeal in Drummond v HMRC [2009] EWCA Civ 608, the Appellants accepted that the structure was ineffective and in July 2009 they paid the tax and interest. In 2012, penalty determinations (for negligently delivering incorrect returns under s.95, Taxes Management Act 1970) were issued by HMRC and appealed by the Appellants to the FTT.
The issue before the FTT was whether or not the Appellants had been negligent.
The Appellants argued that they had done "what a reasonable taxpayer exercising reasonable diligence in the completion and submission of the return would have done" (Anderson (deceased) v HMRC [2009] UKFTT 206). They had included all information that was considered relevant to the claim capital losses, on the basis of advice from Montpelier and their accountants, Barnes Roffe, with such information including a DOTAS number; and they had properly relied on professional advice. That that advice was incorrect could not lead to a conclusion that the Appellants had been negligent.
HMRC argued that the transaction was a sham; and that the Appellants should have been aware that: "the scheme documentation was flawed, contained glaring omissions and did not demonstrate that the transactions portrayed were actually carried out, or not in the way described in the documents."
The FTT's decision
The FTT said that:
"The critical question … is how much enquiry should a sophisticated taxpayer be expected to make in respect of a packaged scheme in which advice has been provided by professional advisers and all documents have been drafted by them. We have concluded that the level of due diligence required of a taxpayer in respect of the technical and legal aspects of such a scheme is low, when professional advisers are involved and the relevant areas of law are technical, as is the case here."
That which particularly concerned the FTT was that there was no evidence that the loans had in fact been advanced:
"We have concluded that the Taxpayers were negligent in signing their tax returns reflecting transactions which relied on significant levels of financing which they had no evidence had ever been advanced or re paid. We do not think that any statements or advice from their professional advisers can or should remove the obligation on a taxpayer to consider whether the proposed transactions stand up to some basic level of commercial scrutiny. To decide otherwise would be to suggest that it is reasonable for a taxpayer to enter into a transaction believing that it can obtain £400,000 of tax losses for doing nothing other than signing a number of documents provided by their advisers and paying a fee."
The FTT concluded that it was not reasonable for the Appellants not to have done even basic due diligence to ensure that the transaction was not a sham and upheld the penalty determinations (but increased the penalty reductions primarily by reason of the Appellants' co-operation).
Commentary
In our view, the decision of the FTT, broadly, is right. However, it is, to an extent, infelicitously expressed. That is unfortunate, given the public importance of it being determined when a taxpayer may rely on the advice of professional advisers in relation to a packaged avoidance structure in the context of filing a tax return. Section 95, Taxes Management Act 1970 has been repealed and replaced by paragraphs 1 to 3, Schedule 24, Finance Act 2007. "Negligence" has been replaced by "carelessness". But, as it is accepted that the two terms are, effectively, synonymous, the FTT's decision has relevance to an interpretation of Schedule 24.
A sham is a fraud. The classic test is that enunciated by Diplock LJ in Snook v London & West Riding Investments Ltd [1967] 2 QB 786 at 802D: the words used, the documents employed or the acts done appear to create legal rights and obligations that are different from the actual legal rights and obligations that the parties intended to create. That is a fundamentally different concept to that of recharacterisation of a transaction, by applying the Ramsay or Westmoreland approach. The fact that a transaction is solely for the purposes of tax avoidance, its relevant steps are preordained and it has no commercial motive or effect other than the incurring of fees and commissions does not make the transaction a sham. That fact does not seem to have been appreciated properly by the FTT. In broad terms, the essence of the CRP structure that the Appellants were seeking to rely on was a perceived anomaly in s.37(1), Taxation of Chargeable Gains Tax Act 1992 that would create the magic of £400,000 tax losses being conjured from the signing of a number of documents provided to them by their advisers. That the interpretation of s.37(1) required for CRP structures to be effective has not been adopted by the courts (either for individuals or for companies (see Drummond and AbbeyLand Ltd v HMRC [2013] UKFTT 287 (TC) respectively)) does not have the consequence that CRP structures are sham. To be sham, there must be an intention to deceive.
Signing up to a CRP structure does not per se mean that the resulting return has been negligently delivered, even if it is decided subsequently that the structure is ineffective. In our view, the fundamental issue to be determined in order to answer the question whether there had been negligence by the Appellants was whether or not they failed to appreciate that the documents were so badly drafted that, even if the structure 'worked', the intended tax consequences would not occur, because the transaction had not been implemented properly (or perhaps even at all). In that regard, we agree with the FTT's statement that: "the level of due diligence required of a taxpayer in respect of the technical and legal aspects of such a scheme is low, when professional advisers are involved and the relevant areas of law are technical"
We consider that the decision raises two matters that taxpayers should be aware of.
1. It is not clear from the decision as to what happened during the 3+ years between the Appellants concluding that the structure did not work and paying the tax and interest due (Summer 2009) and HMRC raising penalty determinations (31 August and 17 October 2012). However, we would recommend that any settlement discussions with HMRC pertain not only to tax (and interest), but encompass also whether or not HMRC consider that penalties are exigible. Ensuring that a contract settlement addresses all three elements should prevent future uncertainty (and sleepless nights).
2. Whilst taxpayers entering into tax avoidance structures are not required to understand all the legal and tax aspects of the documents to preclude a penalty being imposed for 'carelessness' under Schedule 24, Finance Act 2007, they do need to act in a commercial manner. Paragraph 18, Schedule 24, Finance Act 2007 specifically addresses the reasonableness of reliance on a third party agent whose act or omission causes an inaccuracy in a return. It is directed towards professional advisers who assist taxpayers in completing their tax returns. In Hanson v HMRC [2012] UKFTT 314 (TC), the FTT said in relation to this paragraph: "the focus of whether a taxpayer has taken reasonable care will be whether he was reasonably entitled to rely upon his adviser, and what steps the taxpayer himself might reasonably be expected to take given that he has instructed a professional adviser." In our view, it is reasonable for taxpayers to treat tax structure documents in a similar way to that in which they would review like documents in other business contexts. Attempting to rely entirely, and without question, on professional advisers in relation to packaged tax avoidance structures may not always be sufficient.
Facts
In 2004/5, the Appellants participated in a capital redemption policy ("CRP") structure, marketed by the Montpelier group, in an attempt to reduce the capital gains tax liability arising on the disposal of a business. A fundamental aspect of the structure was the provision of an interest free loan to enable the purchase of the CRPs by the Appellants. Following the decision of the Court of Appeal in Drummond v HMRC [2009] EWCA Civ 608, the Appellants accepted that the structure was ineffective and in July 2009 they paid the tax and interest. In 2012, penalty determinations (for negligently delivering incorrect returns under s.95, Taxes Management Act 1970) were issued by HMRC and appealed by the Appellants to the FTT.
The issue before the FTT was whether or not the Appellants had been negligent.
The Appellants argued that they had done "what a reasonable taxpayer exercising reasonable diligence in the completion and submission of the return would have done" (Anderson (deceased) v HMRC [2009] UKFTT 206). They had included all information that was considered relevant to the claim capital losses, on the basis of advice from Montpelier and their accountants, Barnes Roffe, with such information including a DOTAS number; and they had properly relied on professional advice. That that advice was incorrect could not lead to a conclusion that the Appellants had been negligent.
HMRC argued that the transaction was a sham; and that the Appellants should have been aware that: "the scheme documentation was flawed, contained glaring omissions and did not demonstrate that the transactions portrayed were actually carried out, or not in the way described in the documents."
The FTT's decision
The FTT said that:
"The critical question … is how much enquiry should a sophisticated taxpayer be expected to make in respect of a packaged scheme in which advice has been provided by professional advisers and all documents have been drafted by them. We have concluded that the level of due diligence required of a taxpayer in respect of the technical and legal aspects of such a scheme is low, when professional advisers are involved and the relevant areas of law are technical, as is the case here."
That which particularly concerned the FTT was that there was no evidence that the loans had in fact been advanced:
"We have concluded that the Taxpayers were negligent in signing their tax returns reflecting transactions which relied on significant levels of financing which they had no evidence had ever been advanced or re paid. We do not think that any statements or advice from their professional advisers can or should remove the obligation on a taxpayer to consider whether the proposed transactions stand up to some basic level of commercial scrutiny. To decide otherwise would be to suggest that it is reasonable for a taxpayer to enter into a transaction believing that it can obtain £400,000 of tax losses for doing nothing other than signing a number of documents provided by their advisers and paying a fee."
The FTT concluded that it was not reasonable for the Appellants not to have done even basic due diligence to ensure that the transaction was not a sham and upheld the penalty determinations (but increased the penalty reductions primarily by reason of the Appellants' co-operation).
Commentary
In our view, the decision of the FTT, broadly, is right. However, it is, to an extent, infelicitously expressed. That is unfortunate, given the public importance of it being determined when a taxpayer may rely on the advice of professional advisers in relation to a packaged avoidance structure in the context of filing a tax return. Section 95, Taxes Management Act 1970 has been repealed and replaced by paragraphs 1 to 3, Schedule 24, Finance Act 2007. "Negligence" has been replaced by "carelessness". But, as it is accepted that the two terms are, effectively, synonymous, the FTT's decision has relevance to an interpretation of Schedule 24.
A sham is a fraud. The classic test is that enunciated by Diplock LJ in Snook v London & West Riding Investments Ltd [1967] 2 QB 786 at 802D: the words used, the documents employed or the acts done appear to create legal rights and obligations that are different from the actual legal rights and obligations that the parties intended to create. That is a fundamentally different concept to that of recharacterisation of a transaction, by applying the Ramsay or Westmoreland approach. The fact that a transaction is solely for the purposes of tax avoidance, its relevant steps are preordained and it has no commercial motive or effect other than the incurring of fees and commissions does not make the transaction a sham. That fact does not seem to have been appreciated properly by the FTT. In broad terms, the essence of the CRP structure that the Appellants were seeking to rely on was a perceived anomaly in s.37(1), Taxation of Chargeable Gains Tax Act 1992 that would create the magic of £400,000 tax losses being conjured from the signing of a number of documents provided to them by their advisers. That the interpretation of s.37(1) required for CRP structures to be effective has not been adopted by the courts (either for individuals or for companies (see Drummond and AbbeyLand Ltd v HMRC [2013] UKFTT 287 (TC) respectively)) does not have the consequence that CRP structures are sham. To be sham, there must be an intention to deceive.
Signing up to a CRP structure does not per se mean that the resulting return has been negligently delivered, even if it is decided subsequently that the structure is ineffective. In our view, the fundamental issue to be determined in order to answer the question whether there had been negligence by the Appellants was whether or not they failed to appreciate that the documents were so badly drafted that, even if the structure 'worked', the intended tax consequences would not occur, because the transaction had not been implemented properly (or perhaps even at all). In that regard, we agree with the FTT's statement that: "the level of due diligence required of a taxpayer in respect of the technical and legal aspects of such a scheme is low, when professional advisers are involved and the relevant areas of law are technical"
We consider that the decision raises two matters that taxpayers should be aware of.
1. It is not clear from the decision as to what happened during the 3+ years between the Appellants concluding that the structure did not work and paying the tax and interest due (Summer 2009) and HMRC raising penalty determinations (31 August and 17 October 2012). However, we would recommend that any settlement discussions with HMRC pertain not only to tax (and interest), but encompass also whether or not HMRC consider that penalties are exigible. Ensuring that a contract settlement addresses all three elements should prevent future uncertainty (and sleepless nights).
2. Whilst taxpayers entering into tax avoidance structures are not required to understand all the legal and tax aspects of the documents to preclude a penalty being imposed for 'carelessness' under Schedule 24, Finance Act 2007, they do need to act in a commercial manner. Paragraph 18, Schedule 24, Finance Act 2007 specifically addresses the reasonableness of reliance on a third party agent whose act or omission causes an inaccuracy in a return. It is directed towards professional advisers who assist taxpayers in completing their tax returns. In Hanson v HMRC [2012] UKFTT 314 (TC), the FTT said in relation to this paragraph: "the focus of whether a taxpayer has taken reasonable care will be whether he was reasonably entitled to rely upon his adviser, and what steps the taxpayer himself might reasonably be expected to take given that he has instructed a professional adviser." In our view, it is reasonable for taxpayers to treat tax structure documents in a similar way to that in which they would review like documents in other business contexts. Attempting to rely entirely, and without question, on professional advisers in relation to packaged tax avoidance structures may not always be sufficient.