Contentious tax: quarterly review
In this quarterly review, Adam Craggs and Michelle Sloane consider HMRC’s increasing propensity to seek the production of documents from accountants and other professional advisers, HMRC’s new policy of challenging taxpayers’ loan relationships, and the increase in the number of domicile enquiries launched by HMRC.
(Article originally published by Tax Journal)
In recent months, we have seen an increase in HMRC seeking to use production orders to obtain information and full client files from accountants who have advised clients in relation to HMRC criminal investigations, including under Code of Practice 9. HMRC is also seeking to extend the application of the ‘unallowable purpose’ provisions in order to challenge loan arrangements entered into by corporates to fund various commercial acquisitions. HMRC is, in effect, contending that any borrowing used to finance a commercial acquisition involves a main purpose of securing tax relief on the financing cost if the taxpayer intended to obtain the relief. We have also noted an increase in the number of HMRC enquiries relating to domicile, and there have been two recent tribunal decisions (Embiricos and Levy) on this issue, which suggests that taxpayers are facing greater scrutiny from HMRC in this area.
It is well known that HMRC is under pressure from the government to increase the number of criminal prosecutions for tax evasion. In 2010, the government provided HMRC with £900m to tackle non-compliance in the tax system. The number of convictions from HMRC prosecutions subsequently increased by 93%, growing from 336 in 2010/11 to 648 in 2018/19. This increase in HMRC criminal prosecutions has led to a significant increase in the number of production orders (POs) sought by HMRC, which issued 1,414 POs in the year ending 31 March 2018.
Under the Police and Criminal Evidence Act 1984 Sch 1 and TMA 1970 s 20BA, HMRC is able to apply to the Crown Court for a PO against third parties in a criminal investigation, such as accountants, tax advisers and banks, requesting potentially incriminating material regarding their clients’ affairs.
Once obtained from the court, a PO will be served on the third party concerned, which is required to produce to HMRC the material requested in the PO within a specified timeframe. Failure to comply with a PO can lead to a custodial sentence and/or a substantial fine. HMRC often insists that the documents are provided within a relatively short timeframe, which can be extremely disruptive to the recipient’s business, especially for smaller organisations.
POs can also raise difficult and complex compliance issues. Deciding what is and what is not covered by a PO is not always easy and the potential cost of making a mistake and getting it wrong can be high. We have seen a number of cases recently where third parties have made errors in complying with POs. In one case, a tax advisor provided HMRC with too much information and then faced action from their client for breach of confidentiality. In another case, certain information that was covered by the PO was withheld from HMRC, which led to HMRC seeking sanctions against the accountancy firm concerned.
In recent months, we have also seen an increase in HMRC seeking to use POs to obtain information and full client files from accountants who have advised clients in relation to HMRC criminal investigations, including under Code of Practice 9. It was confirmed by the Supreme Court in R (on the application of Prudential plc and another) v Special Commissioner of Income and Tax and another  UKSC 1 that common law legal professional privilege does not apply to any professional other than a qualified lawyer. Accountants and tax advisors can therefore be compelled to disclose information to HMRC, as their advice is not covered by legal professional privilege. Accordingly, all communications between clients and non-lawyer professional advisers assisting their clients with criminal investigations are potentially disclosable. In order to avoid HMRC obtaining access to such information, taxpayers and their professional advisors should consider, at an early stage in any criminal investigation, whether it is appropriate to engage a suitably experienced lawyer to advise and assist in the criminal investigation.
On 26 June 2019, HMRC added paras CFM39500–CFM39590 to its Corporate Finance Manual, which contain guidance on the loan relationships and derivatives regime anti-avoidance rules (RAARs). The guidance notes that the question of ‘purposes’ is one of fact, based on all available evidence. According to the guidance, the purposes are those of the arrangements and not the parties, and a tax purpose of one party may bring the arrangements within the RAARs for all the parties.
The guidance is released at a time when HMRC is seeking to extend the way in which the ‘unallowable purpose’ provisions (in CTA 2009 ss 441 and 442) operate.
We are aware that, in some cases, HMRC is refusing to allow the tax deduction sought for interest charged on loans used to finance bona fide arm’s length commercial acquisitions. HMRC is, in effect, contending that any borrowing used to finance a commercial acquisition involves a main purpose of securing tax relief on the financing cost, if the taxpayer intended to obtain the relief.
This is a surprising position for HMRC to adopt. Tax reliefs exist in order to incentivise taxpayers to behave in ways which Parliament wishes to encourage. It would be surprising, therefore, if by simply seeking to obtain relief for the cost of borrowing (where there are no ‘contrived’ or ‘artificial’ arrangements in place), a taxpayer should be denied relief.
As quoted in CFM38170, the minister, on introducing the aforementioned provisions in 1996, said:
‘It has been suggested that structuring a company’s legitimate activities to attract a tax relief could bring financing within this paragraph – some have gone so far as to suggest that the paragraph might deny any tax deduction for borrowing costs. These suggestions are clearly a nonsense. A large part of what the new rules are about is ensuring that companies get tax relief for the cost of their borrowing …
Provided that companies are funding commercial activities or investments in a commercial way, they should have nothing to fear. If they opt for artificial, tax-driven arrangements, they may find themselves caught.’
Notwithstanding these comments, HMRC has targeted a number of multinational corporates and is challenging certain loan arrangements they entered into to fund various commercial acquisitions. A number of these disputes are progressing on appeal before the tribunal.
In the recent case of Oxford Instruments UK 2013 Ltd v HMRC  UKFTT 254, the tribunal found that the issue of a promissory note by a UK subsidiary to its US parent had an unallowable purpose. HMRC had issued a closure notice to the effect that Oxford Instruments UK was not entitled to any relief for the interest which had accrued in respect of a promissory note with a principal amount of $140m which it had issued to its US resident parent company. This was on the basis that the company had an ‘unallowable purpose’ in entering into, and remaining party to, the $140m promissory note, because the US objectives of the arrangement would have been achieved if it had not implemented the final step in the debt restricting exercise, which gave rise to the tax advantage (referred to as a ‘tower structure’).
However, in that case there was no commercial or arm’s length acquisition. The ‘tower structure’ was an internal recapitalisation project which sought to increase tax efficiency within the group. HMRC had given clearance in relation to the arbitrage regime but had not highlighted the potential unallowable purpose, as its view of this type of transaction had changed since giving the clearance. We are aware that even in cases where HMRC has approved borrowing from a thin-capitalisation perspective, it is of the view that the unallowable purpose rules apply.
It would appear from its recently published guidance that HMRC considers ‘main purpose’ to be synonymous with ‘significant objective’. This, however, does not comport with the relevant statutory language. Incidental benefits are not main purposes but HMRC appears to be of the view that any benefit that is more than incidental is likely to constitute a main purpose. A tax reduction is not necessarily a main purpose simply because it features in the structuring decision making process. Choosing a tax efficient structure, from several available options, to achieve a commercial objective is permissible. In HMRC’s view, subsidiarity of tax value to commercial benefit does not preclude ‘main purpose’ status. The crucial question, so far as HMRC is concerned, appears to be whether a tax benefit is more than merely incidental. The question that should be asked is whether there is a commercial acquisition where the cost of borrowing is an automatic incident to the funding of that acquisition (where there are no contrived tax avoidance arrangements in place, as in Travel Document Service & Ladbroke Group International v HMRC  EWCA Civ 549). If the answer to this question is yes, the unallowable purpose provisions should not apply.
It is anticipated that the tribunal will publish several decisions during the course of the next 12 to 18 months, which will throw further light on this important area and confirm whether HMRC’s view on the operation of these provisions is correct.
We have also noted an increase in the number of HMRC enquiries relating to domicile. Two recently published decisions of the tribunal – Embiricos v HMRC  UKFTT 236 (TC) and The Executors of Mrs R W Levy v HMRC  UKFTT 418 (TC) – suggest that taxpayers are indeed facing greater scrutiny from HMRC in this area.
Individuals who are UK resident/ordinarily resident but also retain a foreign domicile can enjoy preferential tax treatment in a number of respects. Given that being non-UK domiciled may enable the utilisation of certain forms of tax planning, it is perhaps not surprising that HMRC is focusing on this area. HMRC appears to be particularly interested in the following:
- long-term UK residents who claim not to have acquired a UK domicile of choice;
- individuals with a UK domicile of origin who return to the UK but maintain they have not abandoned a domicile of choice acquired in another jurisdiction; and
- children who claim foreign domicile by reference to the domicile of a parent or grandparent despite never having resided outside the UK.
Domicile enquiries are often protracted and time consuming, with HMRC making numerous requests for large amounts of historic information. In the past, many taxpayers obtained rulings from HMRC in relation to their domicile status, particularly during the 1990s and early 2000s. However, HMRC is increasingly relying on Gulliver v HMRC  UKFTT 222, in which the tribunal confirmed that HMRC can enquire into the domicile status of a taxpayer even though it had accepted in an earlier tax year that the taxpayer was no longer UK domiciled, to commence domicile enquiries. It should be noted that being a decision of the tribunal, Gulliver is not binding. In any event, taxpayers are generally entitled to rely on decisions of HMRC and where HMRC seeks to resile from a clear decision in relation to an individual’s domicile, taxpayers should consider whether they have grounds for commencing judicial review proceedings on the basis that their legitimate expectations have been breached.