Contentious tax: quarterly review
HMRC is increasingly targeting multinationals, in particular by questioning their transfer pricing arrangements and ensuring that they are not artificially diverting profits away from the UK. Additionally, HMRC has made a number of arrests and begun criminal investigations in relation to suspected fraud concerning the coronavirus job retention scheme.
This blog is based on an article first published in Tax Journal on 3 December 2020.
A taxing time for multinationals
HMRC estimates that the 2,000 largest businesses with operations in the UK may owe an additional £34.8bn in tax relating to the 2019/20 financial year — up from £29.9bn in 2018/19. A recent letter sent by HMRC to multinationals asks companies how confident they are that their transfer pricing is ‘appropriate’. HMRC has directed companies to submit information about their transfer pricing arrangements to its profit diversion compliance facility within 90 days, or face further investigation. The letter states, amongst other things:
‘In investigations we have carried out to date we are often finding that the UK profits do not reflect the value created in the UK ... We are also finding indications of careless or deliberate behaviour requiring penalties to be considered ... It will be too late to make an unprompted disclosure once we open an investigation and penalties will be higher.’
Challenging profit diversion by large corporates is a priority for HMRC. Given the recent increase in government expenditure as a consequence of the covid-19 pandemic, such challenges are likely to increase. Those businesses who have been written to by HMRC, and do not submit the necessary information to its profit diversion compliance facility within the 90 day time period, can expect an HMRC investigation which may be both time consuming and divert management focus away from the business. Companies should not ignore these letters and should proactively engage in a dialogue with HMRC.
We are finding that multinationals are increasingly being targeted by HMRC. Its ability to challenge companies was strengthened by the introduction of the diverted profits tax in 2015, which is designed to provide corporates with an incentive for good behaviour. HMRC is likely to continue to scrutinise multinational businesses to make sure they are not artificially diverting profits away from the UK.
Unallowable purpose
Earlier this month, the First-tier Tribunal’s decision in Blackrock Holdco 5 LLC v HMRC [2020] UKFTT 443 (TC) was published, a case which concerned transfer pricing and the ‘unallowable purpose’ rules. HMRC disallowed the deductibility of interest on $4bn worth of intra-group loans on the basis of the unallowable purpose rule in CTA 2009 s 441 (which disallows debits in respect of a loan relationship where they are, on a just and reasonable apportionment, attributable to the unallowable purpose). HMRC also argued that transfer pricing rules applied as the loans would not have been made at all between independent enterprises and therefore the deduction should not be allowed.
The facts of the case are complex, but put shortly, loan notes were issued as part of an acquisition funding structure for the Blackrock group. The structure comprised a chain of three Delaware LLCs (4, 5 and 6). LLC 4 and LLC 6 were tax resident in the US, whereas LLC 5, which sat in the middle, was UK tax resident. LLC 4 issued $4bn of loan notes to LLC 5 which subscribed for $4bn of preference shares in LLC 6. LLC 6 then made the acquisition of shares in the US part of the business of Barclays Global Investors from Barclays.
The parties’ expert witnesses on the transfer pricing issue stated that LLC 5 would have been able to borrow the same amount ($4bn) at similar interest rates from an independent lender, but that the lender would have required covenants to secure the cash flow, which were not present in the actual transaction. The FTT found that, although an independent lender may not have entered into the actual transaction, if it were lending to LLC 5, it would have lent the same amount and on the same terms as the parties to the actual transaction. Accordingly, HMRC’s transfer pricing challenge failed.
On the unallowable purpose issue, the FTT concluded that LLC 5 had both a commercial purpose and a tax purpose. In concluding that there was a tax purpose, the FTT considered both the conscious motives of the directors of LLC 5 (as evidenced in board minutes and witness evidence) and the ‘inevitable and inextricable consequence’ of entering into the loan, which was to secure a tax advantage.
Although there were two main purposes, as the securing of the tax advantage had not changed the amount of the loan relationship debits incurred, the FTT concluded that all of the debits in question could be allocated to the commercial purpose, rather than the tax advantage main purpose, and the taxpayer’s appeal was allowed.
Although the taxpayer will be pleased with the overall outcome of the decision, there is an oddity in the FTT’s reasoning. It appeared to be common ground that the interest deductions were a tax advantage as a ‘relief from tax’. But the FTT concluded that it is necessary to look beyond the ‘conscious motives’ of the taxpayer and find that, because securing a tax advantage was an ‘inevitable and inextricable consequence’ of the loans, it is a purpose and, because it cannot be described as merely incidental, it is a main purpose.
Taken to its logical conclusion, this would mean that any corporate borrower with an interest bearing loan inevitably has an unallowable purpose, irrespective of its actual ‘conscious motives’, since it will have obtained a tax advantage (the interest deduction) as an inevitable and inextricable consequence of the borrowing. It is difficult to see how that can be correct, or indeed why in this case the interest deduction was not an automatic incident of the loan and therefore not a ‘main purpose’ for entering into the relevant loan transaction.
Given the importance of this area of the law, we expect HMRC to seek to appeal the decision, and it is to be hoped that an appellate court will not only provide some much needed clarity on the unallowable purpose rules, but also establish that merely obtaining an interest deduction is not, of itself, a tax advantage.
HMRC has acknowledged the inevitability of some employers inadvertently falling foul of the CJRS rules but that, as the CJRS is dependent on its users’ honesty, there is also ample opportunity for abuse. Indeed, on 7 September 2020, Jim Harra, HMRC’s chief executive, said that HMRC believes that 5%–10% of CJRS claims have been paid out incorrectly (at the time of his statement the amount paid out under the CJRS was approximately £35.4bn).
On 8 July 2020, HMRC made its first CJRS related arrest as part of its investigation into a suspected £495,000 CJRS fraud and on 10 September 2020, a company director and an accountant were arrested on suspicion of CJRS fraud. Following the expiry, on 20 October 2020, of the first phase of the ‘amnesty’ period set out in FA 2020, HMRC has reportedly begun enquiries into 27,000 high risk claims where fraud or abuse of the CJRS is suspected and further arrests can therefore be expected.
In addition, following the closure of the government funded ‘eat out to help out’ (EOTHO) scheme (which ran from 3 to 31 August 2020, and paid out approximately £522m), HMRC has issued 4,000 letters to participants of that scheme where its records suggest that there may have been an incorrect claim. The letter requests that participants confirm the correctness of their EOTHO claims and refers to the voluntary disclosure facility established by HMRC to assist with the voluntary repayment of incorrect or overpaid EOTHO payments. EOTHO participants are being given a 60 day amnesty period in which to voluntarily repay any incorrect or overpaid EOTHO payments. On 3 November 2020, HMRC arrested three men on suspicion of cheating the public revenue and fraud by false representation, in connection with fraud allegations relating to the EOTHO scheme.
On 7 October 2020, the National Audit Office (NAO) published its report into the bounce back loan scheme (BBLS). The BBLS provides registered and unregistered businesses with loans of up to £50,000, or a maximum of 25% of annual turnover, to maintain their financial health during the covid-19 pandemic. The loans are provided by commercial lenders (such as banks) directly to businesses, who are expected to repay the debt in full. The government provides lenders with a 100% guarantee against the loans (in relation to both capital and interest). HM Treasury data shows that as of 6 September 2020, the BBLS delivered more than 1.2m loans to businesses, totalling £36.9bn. The NAO considers that up to 60% of loans (some £22.1bn) made available under the BBLS may not be repaid due to fraud or other default.
As we have previously noted, taxpayers can face significant obstacles when seeking to exercise their public law rights in challenging a decision of HMRC.
This issue arose again in the recent case of RT Rate Ltd v HMRC [2020] UKFTT 392 (TC). The facts can be stated shortly. In 2003, the appellants had made claims for repayment of overpaid output tax on supplies of demonstrator vehicles under VATA 1994 s 80. Those claims were based on the ‘Italian tables’ which were compiled by HMRC to help traders determine the output tax wrongly accounted for on sales of demonstrators for each year going back to the introduction of VAT in 1973. The claims were paid by HMRC.
The appellants later alleged that the Italian tables contained an error arising from incorrect assumptions in relation to car tax, which was abolished in November 1992. In 2016, they sought to make amended claims seeking further repayments of overpaid output tax between 1973 and November 1992. HMRC refused the claims on the basis that the original claims were closed and they in any event were new claims which were outside the April 2009 time limit, implemented by FA 2008 s 121.
The appellants argued that:
- they had a legitimate expectation under EU law that their claims would not be treated as closed on a materially incorrect basis; and
- in 2018, HMRC had settled claims by another motor trader which were the same as their claims, and the EU law principle of equal treatment required HMRC and the FTT to afford the same treatment to the appellants.
The FTT considered the relevant authorities (including Noor [2013] UKUT 71 (TCC) and Metropolitan International Schools [2019] EWCA Civ 156) and decided that the UK’s domestic VAT legislation did not give it jurisdiction to consider and give effect to the EU law principle of legitimate expectation and the appellants’ remedy for any breach of that principle had to be pursued by way of judicial review.
However, as we discussed in our previous article, in cases such as R (oao Boulting & Anor) v HMRC [2020] EWHC 2207 (Admin), the High Court has concluded that as the taxpayer has an alternative remedy before the FTT, permission to bring a judicial review claim should be refused.
The ability to apply for judicial review of a decision taken by HMRC is an important remedy available to taxpayers. It is the main way the courts supervise bodies exercising public functions to ensure that they have acted lawfully. This recurring jurisdiction issue needs to be resolved sooner rather than later, so that taxpayers are not caught in a jurisdiction trap which prevents them from pursuing important public law arguments. If the High Court continues to decline to apply its supervisory jurisdiction and taxpayers are unable to seek public law remedies from the FTT, the quality of HMRC’s decision making is likely to decline