Dr Stephen Daly

The non-dom rule, a relic of the British Empire, appears all but set to go. In brief, the rule provides that non-domiciled individuals pay tax only on income earned in the UK and to pay on a remittance basis for that money brought into the UK. It also carries many other tax advantages relating to CGT and Stamp Duty. These details need not be teased out on this forum and indeed others have explained in far greater detail the general idiosyncrasies of the non-dom rule.

I wish here to touch upon one particularly strange and awkward feature, and it relates to me. It should first be recalled that domicile of origin is generally determined by that of a child’s father, if legitimate, or mother, if the child is illegitimate. This domicile of origin remains unless one acquires a new domicile by choice or dependence. The former arises where a person intends to make the country of residence their sole or principal permanent home and continues to reside there indefinitely. The latter concerns children under the age of 16 and persons suffering from mental ailments who will be considered to have the domicile of either their father, if legitimate, or mother, if illegitimate.

Now, returning to me, I was born and raised in the Republic of Ireland to two Irish born parents. My domicile of origin accordingly is the Republic of Ireland. Since 2012, I have lived in the UK, and will in reality probably live here for the rest of my life, but have the intention of returning to Ireland. Thus, I maintain my domicile of origin.

If I were to marry a British person and have a child with them, the curiosity of the non-dom rule is that this British born child could live in the UK for their entire life also and yet still be considered non-dom! However one might feel more generally about the non-dom scheme, this feature surely should appear to all to be uncomfortably benevolent (and socially regressive, one might note).

With both the main political parties now scrutinizing the rule (here and here) however, the writing looks like it is on the wall for both this historical anachronism and my hypothetical British born child. The quote above from CS Lewis appears particularly apt in this regard for whilst we may be able to reveal the origin of the idiosyncratic feature explained herein, we are found wanting for justification in this day and age.

Introduction

Having commented last week on the case of Ingenious Media, it is appropriate now to briefly revisit this case, given that the Court of Appeal on Wednesday unanimously dismissed the appeal by the taxpayers. There is one particular aspect of this judgment which ought to make public lawyers squeamish, and that is the level of deference which the court accorded to HMRC to decide upon issues of privacy and confidentiality.

Ingenious Media at the Court of Appeal

The facts of this case are important in respect of this deference issue. David Hartnett, then Permanent Secretary of HMRC, engaged with two journalists from The Times on an ‘off the record’ basis. The substance of the conversation was of tax avoidance schemes, which were taking advantage of the ‘Film Partnership’ legislative provisions. Over the course of the meeting, Hartnett referred specifically to the appellants, Ingenious Media and Patrick McKenna, as marketers of such avoidance schemes; expanded that these schemes had deprived the public purse of circa £5bn; that McKenna had personally used such schemes and pronounced such schemes as ‘scams for scumbags’. These comments were later quoted, albeit with anonymity attached, in an article published by the journalists on the 21st June 2012. The appellants sought judicial review of the decision of Dave Hartnett to disclose such information to the Times journalists.

What standard of review accordingly should be imposed upon HMRC’s decision to engage with the Times journalists and divulge such information? Hugh Tomlinson QC, renowned Human Rights silk, on behalf of the appellants submitted that in the case of disclosures by HMRC, the correct test to be applied was that of intensive judicial scrutiny. On questions of, inter alia, the effect on reputation of the appellants and their property rights, the court was in as good a position to assess the position as HMRC itself. The Court rejected this proposition:

To me that sounded like an invitation to the court – including the Court of Appeal – to review all the facts de novo as though it were the primary decision maker. I do not accept that. The Court is not a tax-gatherer. It simply is not in a position to evaluate the likely effect of a disclosure on an HMRC function in the same way as an official concerned with the day to day operation of the system [para 46]

The issue of deference

There is no question that HMRC is the rightful ‘tax gatherer’ as empowered with such a duty unequivocally by the Commissioners for Revenue and Customs Act 2005, s. 5. The argument of HMRC in this case is that such disclosures to the press are carried out in conjunction with this duty. Engaging with the press accordingly is in legitimate operation of this duty. (This is well explained by Sales J in the High Court judgment, with whom Sir Robin Jacob agreed at para 30)

That the press should be engaged by HMRC as a means of efficiently operating the tax system is uncontroversial. However, there is a need to distinguish between maintaining good relations with the press and divulging private information. It does not follow that the latter is necessary for the former.

This distinction is important because it goes to the heart of the purpose of judicial review-that the court should not intrude unnecessarily upon the expert decisions which a public authority has taken, but rather to provide a space wherein the court may intervene to substitute its judgment on issues which the court is better placed to make. The determination of legal questions, the protection of human rights, and ensuring a public body does not exceed the boundaries of its power accordingly are issues which the court, rather than the public authority, is better placed to make. For this reason, the Court of Appeal is right to assess that they should not generally substitute their decisions as to the collection of tax for those taken by the body statutorily empowered to make such decisions. However, it does not go so far as to provide that the court should defer to those decisions of the public authority which are made in light of the desire to efficiently collect tax, but which at the same time encroach upon rights to privacy and the duty of confidence.

By broadly conflating deference to public authorities and justiciable issues together, the Court has missed an important distinction, one which goes to the core of judicial review and the separation of powers between the executive and the judiciary.

In recent days, I’ve been reading back over my Jurisprudence notes in order to understand the place of law in achieving administrative justice-does the answer lie in structuring rules, or in providing discretion, or finding a balance between law, rules and discretion, or deciphering principles and so on. All of these propositions, when stripped, retreat to the same central question: what is law?

At which point, one is reminded of Hart’s famous metaphor that law has both a core and a penumbra. At the core, the fact scenarios which come within the scope of the law are clear. As one moves towards the penumbra however, the answer as to whether a fact pattern will fall within its scope becomes unclear. Famously, Hart used the example of a law which prescribed that there be ‘no vehicles in the park’ to explain this phenomenon. Undoubtedly, this would mean that a fully functional car would not be permitted in the park. However, would it cover the case of a skateboard? A defunct, stationary military exhibition tank? The idea is that fact scenarios, which the legislature will not have foreseen, will inevitably arise at the penumbra.

Tax law accordingly should be no different. Whilst the taxing provision should be clear at its core, it inevitably becomes unclear at its penumbra. The problem with tax law and tax avoidance however is that this inevitability of ambiguity has a cost, and more importantly, provides an active monetary incentive for those who wish to reduce their tax bill. Fact scenarios, rather than benevolently or inevitably arising in the penumbra, are manufactured so as to achieve an advantage which the legislature will not have foreseen.

This is one of the central legal difficulties of tax avoidance-not that ambiguity will exist in the law, but that individuals or companies are incentivized to place themselves in the penumbra.

HMRC is certainly taking a hammering these days. Those in the twittersphere have questioned their modus operandi and the press has hounded the public authority for failing to prosecute more Swiss bank account holders. Both the Treasury Select Committee and Public Accounts Committee have likewise interrogated HMRC’s top officials. Public confidence in the administration of the tax system is undoubtedly at a dangerously low ebb.

Curious things happen when such a crisis of confidence arises. For instance, most commentators will have (no doubt with bemusement) witnessed moral aversion of Greg Wise and Emma Thompson to paying tax as justified on the basis of her opposition to the current operations of HMRC. A more pressing issue however is how deterioration in public confidence generally can impact upon the human rights of individual taxpayers.

For this, we need only look as far as the case of Ingenious Media and McKenna from 2013. David Hartnett, then Permanent Secretary of HMRC, engaged with two journalists from The Times on an ‘off the record’ basis. The substance of the conversation was of tax avoidance schemes which were taking advantage of the ‘Film Partnership’ legislative provisions. Over the course of the meeting, Hartnett referred specifically to the claimants, Ingenious Media and Patrick McKenna, as marketers of such avoidance schemes; expanded that ‘Film Schemes’ had deprived the public purse of circa £5bn and pronounced such schemes as ‘scams for scumbags’. These comments were later quoted, albeit with anonymity attached, in an article published by the journalists on the 21st June 2012. The claimants sought judicial review of the decision of Dave Hartnett to engage with the journalists on the basis that the discussion, inter alia, breached the duty of confidentiality enshrined in s.18 CRCA 2005. For Sales J in the High Court, the question was whether the decision of Hartnett was justified on the basis that the release of such information was necessary for the performance of HMRC’s functions. Hartnett believed that the dialogue was important at that particular point in time given the public perception of ‘cosiness’ with large taxpayers. Moreover, the journalists intimated that they would pass onto HMRC a large body of information which they had accumulated in relation to tax avoidance. Sales J agreed and issued a high level of deference to HMRC’s decision

In my view, the court’s role in assessing whether Mr Hartnett stayed within the bounds of the law is not to “second guess” his decisions taken in the twists and turns of a conversation in which the court did not participate, and against a background of policy and handling relations with the press with which the court is not deeply familiar and in relation to which Mr Hartnett and those advising him within HMRC are experts. It is not appropriate for the court to approach the matter as if it were the primary decision-maker [Para 40]

Sales J was convinced by many factors such that the disclosure by Hartnett was justified (para 44). For instance, it would serve to foster a relationship of co-operation with the press. To fail to facilitate this would compound perceptions of bias and jeopardise efficient tax-collection. The specific information which the journalists held in relation to tax avoidance also provided further justification.

Phillipa Whipple QC of One Crown Office Row has criticized this judgment in respect of the fact that Dave Hartnett gave specific details in relation to the Claimants. There is some force in this argument. Sales J’s judgment is correct in its assessment of the need for confidence in the tax system and a co-operative relationship with the Press. However, it does not follow that it was necessary for Hartnett to reveal the taxpayers names and indeed his willingness to provide such information is contrary to what appears to be the settled Revenue practice of simply refusing to comment upon individual cases (see for instance Privacy International).

What is clear form this case is that public confidence in the administration of the tax system can impact upon the duty of confidentiality which is owed by HMRC and upon the right to privacy of individuals. When HMRC is increasingly pressured into vindicating its operations, it is justified in turn in encroaching upon their duty of confidence and the human rights of taxpayers.

The case has been appealed to the Court of Appeal, where judgment has been reserved. One can only wonder whether the recent events and pressure upon HMRC will serve to further vindicate the original decision in the High Court.

A INTRODUCTION

Global headlines have been caught by the release of data detailing the facilitation of tax dodging, likely evasion,[1] by the Swiss branch of HSBC. There is in reality nothing new about the revelations-the ‘Lagarde List’ has been blowing around the tax authorities’ desks for several years at this stage. Indeed, HMRC have been in the process of extracting tax from Swiss bank account holders for the last two years, by virtue of the Swiss/UK Tax Cooperation Agreement. The endeavour however has been quite unsuccessful.

This blogpost seeks to illuminate upon the substance of the Swiss/UK Tax Cooperation Agreement before detailing the inevitable pitfalls to which it has succumb.

B SUBSTANCE OF THE SWISS/UK TAX COOPERATION AGREEMENT

The Swiss/UK Tax Cooperation Agreement[2], which “effectively decriminalizes tax evasion”[3], was signed on 6 October 2011 and came into force on 1 January 2013[4]. The agreement provides for UK resident taxpayers with bank accounts in Switzerland:

• to be subject to a one-off payment on 31 May 2013 to clear past unpaid tax liabilities[5] and/or to be subject to a withholding tax on income and gains for the future from 1 January 2013 (between 27% and 48% annually); or
• to authorise the Swiss bank or paying agent of the taxpayer to provide details of the Swiss assets to HMRC. This option does not provide relief from past or future tax liabilities.[6]

Whichever route is chosen by the taxpayer, there are two essential elements: the first being a cleansing of past liabilities and the second being future compliance. In addition to the fact that it was evasion that these UK resident Swiss Account Holders had historically been pursuing, the agreement bears more than a mere passing resemblance to the “amnesty” agreement in the Fleet Street Casuals case. For this reason, it is not clear there was a need for legislative force behind the agreement but the answer probably lies in the fact that the agreement was complicated by the cross-border element. Per Philip Baker, Section 218 of and Schedule 36 to FA 2012 are necessary because the usual provisions for giving effect to double taxation conventions[7] and tax co-operation arrangements[8] do not provide for giving effect to an agreement such as the Rubik Agreement.[9] Unlike the Fleet Street compromise, the Swiss Account holders could remain anonymous if the first of the above two routes was chosen. Effectively, this results in a subrogation of HMRC’s duty of collection to the Swiss Authorities, as it is in practice impossible for HMRC to collect tax from persons, the details of who are unknown. Moreover, it is not possible in the UK to make an anonymous tax return. Against the cross-border element, this anonymity more forcefully illustrates why legislative effect was required.

A further comment is required on the level of co-operation from the Swiss authorities required to effectuate the agreement. The first of the above routes is more favourable to the taxpayer who has been aggressively evading tax and whose true tax bill is much greater than the figure to be derived under the arrangement. Implicit is an acceptance that certain categories of people have been aggressively evading HMRC. Taking this background against the 18month run-up time to the implementation of the agreement, it is obvious what issue could potentially arise, namely, that the aggressive taxpayer will simply continue evading by shifting funds to another tax haven. As a safeguard, the Swiss authorities “pledged that they [would] not be complicit in helping people to take money out of the scope of this [agreement]”[10]. In addition to the collecting of the tax and the prevention of further evasion, support was required from the Swiss authorities in deciphering the beneficial owners of various structures. As noted by Dave Hartnett, then Permanent Secretary for Taxation, on 12 September 2011 before the Treasury sub-committee:

“Where we have gone with the structures and trusts is that Swiss banks will require disclosure to them of beneficial ownership, and if that shows a connection to the United Kingdom, there will be withholding against those investments, and the Swiss tax authority will audit this in relation to the Swiss banks. It has a pretty fearsome reputation for the way in which it audits Swiss banks.”[11]

C THE UNAVOIDABLE PROBLEMS WITH THE AGREEMENT

The agreement has proved to be a press-disaster from the perspective of the HMRC, Treasury and Government. Much the same as the argument forwarded by the Small Businesses and Self-Employed in relation the Fleet Street Casuals agreement, there was a stark and palpable disconnect between the treatment of the ordinary taxpayer and the wealthy taxpayer. As surmised by Ian Swales[12]:

“I think what bothers members of the public is the vigour with which the authorities pursue people who defraud a few thousand in benefit compared with the vigour with which we pursue people who evade thousands and thousands in tax. That is what the public do not like. I think that they expect to see some equity, because we are talking about the public pound in both cases”

Secondly and relatedly, the agreement proved to yield substantially less for the exchequer than was initially forecasted. The Tax Justice Network outlined a number of “fundamental flaws” in the arrangement; whereby 10 inherent escape routes dilute the effect of the agreement for those looking to continue evading tax liabilities[13], most notably, through the carve-out for discretionary trusts[14]. Unfortunately, such limitations came to bear. HMRC forecasted that a total of £4.4 billion[15] would be received over the next three years in respect of past tax liabilities (2013, 2014, 2015)[16]. The initial headline grabbing £3.12bil collected in May 2013 turned out to be just that-headline grabbing. Such a sum was not collected in May 2013 and the misconception is derived from the rules for the budget. Estimated figures must be included in the budget as at May 2013 and as such, the figure is a mere estimation of the yield which the Revenue expected to get in that year. From January to October 2013, the Revenue had received £440mil, a far cry from the “Alice in Wonderland”[17] £3.12bil figure factored into the budget[18]. Going forward, for the year ended 2014, the revised figure from the OBR was £1.9bil[19] down from the previous estimate of £2.9bil[20]:

“The lower-than-expected yield is likely to reflect both a smaller initial tax base and a larger behavioural response than was estimated. The smaller tax base is likely to reflect some combination of: fewer assets held by UK individuals in Swiss banks; more of the assets belonging to non-domiciles or people who are already compliant; and the failure of Swiss banks to identify UK individuals holding assets; or circumvention of the deal. The SBA announcement suggested a high number of individuals with non-domicile status. The extent of capital flight to other offshore centres is likely to have been greater than expected…There are indications that a higher proportion of individuals have decided to disclose via [the LDF or to HMRC directly]. However, evidence from LDF and HMRC cases so far suggests that the average yield per case is lower than expected. As a result, the yield expected from these two routes has been reduced to less than half the original costing. The smaller-than-expected tax base means that the yield from the future withholding tax has also been revised down.”

D BRIEF COMMENT AND CONCLUSION

Given the level of Swiss co-operation required, quite grave pitfalls, limited exchequer return and the surprising willingness to appease tax evaders, one is pressed for the logic behind the agreement. Philip Baker, in response, explains that the reasons for entering into the arrangement “are complex but a partial explanation may be that budgetary deficits can lead governments to do strange things.”[21]

________________________

[1] For instance, the ‘‘French authorities concluded in 2013 that 99.8% of their citizens on the list were probably evading tax.’’ See: http://www.bbc.co.uk/news/business-31248913

[2] For an interesting overview of the first tax treaty entered into between Switzerland and the UK, see: Sunita Jogarajan, “The conclusion and termination of the “first” double tax treaty” (2012) 3 BTR 283

[3] Richard Brooks, ‘The Great Tax Robbery’ () 203

[4] Finance Act 2012, Schedule 36 and s. 218

[5] It is difficult to state in general terms this figure as a precise numerical percentage of capital. Suffice it to say that it is “calculated in accordance with a mind-bogglingly complex formula” (Baker, 490)

[6] See generally, the HMRC webpage on the UK/Swiss agreement: <http://www.hmrc.gov.uk/taxtreaties/ukswiss.htm> accessed 1 April 2014

[7] Taxation (International and Other Provisions) Act 2010, s. 2

[8] Finance Act 2006, s. 173. These provisions give power to Parliament to enter into tax agreements. Of importance to the case at hand is FA 173(2) which specifies that International tax enforcement arrangements relate to “a) the exchange of information foreseeably relevant to the administration, enforcement or recovery of any UK tax or foreign tax; b) the recovery of debts relating to any UK tax or foreign tax…”

[9] Philip Baker, “Finance Act notes: section 218 and Schedule 36: The UK-Switzerland Rubik Agreement” (2012) 4 BTR 489, 489

[10] Dave Hartnett, http://www.publications.parliament.uk/pa/cm201012/cmselect/cmtreasy/uc1371-iii/uc137101.htm in response to Q669

[11] Administration and Effectiveness of HMRC: Closing the Tax Gap http://www.publications.parliament.uk/pa/cm201012/cmselect/cmtreasy/uc1371-iii/uc137101.htm

[12] Committee of Public Accounts, Report by the Comptroller and Auditor General (Monday 28 October 2013)

[13] http://www.taxjustice.net/cms/upload/pdf/TJN_1110_UK-Swiss_master.pdf

[14] The agreement only relates to bank accounts held in trust so far as the beneficiaries are fixed. In the case of discretionary trusts, the beneficiaries only have a right to the assets when the trustee has exercised their discretion so as to entitle the beneficiaries. Discretionary trust beneficiaries, in other words, are differentiated from fixed trust beneficiaries in that the latter has a right to the assets or income from the assets, whereas the former has a right merely to be considered.

[15] Previously, the estimate by the Exchequer Committee was between £4-7bil. See Hansard, Public Bill Committee, Finance (No.4) Bill, Eighteenth Sitting, col 638 (June 26, 2012).

[16] http://www.nao.org.uk/wp-content/uploads/2013/07/10174-001_HMRC_Standard-report.pdf

[17] Margaret Hodge p. 16 http://www.parliament.uk/documents/commons-committees/public-accounts/PAC%2028.10.13.pdf

[18] p. 13 http://www.parliament.uk/documents/commons-committees/public-accounts/PAC%2028.10.13.pdf

[19] p. 115 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/276529/8748.pdf

[20] p. 1 http://budgetresponsibility.independent.gov.uk/wordpress/docs/June-2013.pdf

[21] Philip Baker (n 9), 490

Yesterday at the OUCBT conference on Diverted Profits tax (‘DPT’), the ‘respondents’ on behalf of the government (Philip Baker QC and Mike Williams of the Treasury) were quick to point out that the DPT was aimed at contrived, artificial arrangements. If this were the case, I asked Mike Williams, then would the GAAR apply to such arrangements already, and if it does not, then why not amend the GAAR? He responded that the two instruments have separate intended uses (fine, although I’m really not sure that they do) and secondly that he wasn’t sure that the GAAR would be able to catch such arrangements in any case. This latter response is crucial. The Treasury is not sure that the GAAR would apply to the contrived arrangements at which the DPT is directed. Should it not find out?

This underlines the real motivation behind the DPT-if the Treasury and HMRC were really concerned with countering contrived arrangements, then surely they would try out the GAAR first, which appears as yet unused 1 and a half years after its introduction. The real motivation must lie elsewhere and I posit that the DPT is driven by politics.

Last year, Labour introduced the idea of a ‘Mansion Tax’ which drew serious traction with focus groups. Such a tax would ensure that the wealthiest ‘pay their fair share’. Eager not to be tarred with the ‘party of the rich’ brush, the Conservatives were in need of a tax reform aimed at the wealthiest which would ensure that they also ‘pay their fair share’. Due to obvious constraints, the Tories could not direct such a reform at housing, and chose large multinational companies instead as the target. Hence, the Conservatives scrambled for the DPT. In other words, the DPT is a reaction against Labour’s wealth tax. The rush to introduce the tax in the next Finance Bill further supports this, as this change could surely wait until after BEPS, but this would be long after the General Election.

What this episode tells us about politics more generally is quite worrying. It appears more and more today that politicians are saying simply what we want to hear. But as history has surely taught us, danger lies in reactionary legislating, as directed by focus groups and dictated by populism.

Some commentators have been apocalyptic about the introduction of Advanced Payment Notices (‘APNs’). The APN regime broadly requires that taxpayers pay disputed tax upfront, before being able to challenge HMRC’s assessment through the normal channels. It is certainly ‘game changing’ and frankly unprecedented in UK Law generally. But is this new regime unconstitutional?

Of course, the new regime is challengeable through recourse to Human Rights, but that is an argument for another day. A separate challenge, however, could lie in taxpayers taking a judicial review case on the basis of how the legislation ought to be interpreted.

I believe that there is an argument to be made that the legislation ought to be interpreted so as to apply prospectively only, in other words, that APNs should only apply to avoidance schemes which were entered into after George Osborne announced his intention to introduce APNs in March 2013.

This argument finds its grounding in the fact that the stated policy aims of APNs are to shift the economics of tax avoidance and to change the behaviour of taxpayers in relation to avoidance. As the law previously stood, there was an economic incentive for taxpayers to enter into avoidance schemes regardless of whether the scheme would ultimately fail or not. The resolution of the case would take years and in this interim, the taxpayer would have the advantage of utilizing the disputed monies (which would otherwise have been taken by HMRC). APNs rebalance the scales by forewarning taxpayers that entering into a scheme which is likely to fail will have the same effect as paying taxes in the normal course. In other words, they negate the economic incentive to enter into schemes.

It becomes clear then why the policy aims are not effectuated when the APN is applied retrospectively. Incentives and disincentives can only affect future behaviour. Surely the legislation ought to have no application for persons who previously entered into avoidance schemes? A biblical equivalent would be banishing Adam and Eve from the Garden of Eden without having forewarned either of such an effect if they were to eat an apple.

The courts traditionally view draconian powers of the State with a fair degree of skepticism and reduce the scope of otherwise plainly worded Parliamentary statutes so as to limit, as far as practicable, the encroachment upon civil liberties. As APNs fall into such a draconian category, when applied retrospectively to schemes which were entered into before APNs were even on the horizon, then there is ample opportunity for the Court to intervene and narrow the scope of the legislation. Although the thesis here that the legislation should only apply prospectively is clearly very bare, it is nevertheless an interesting proposition that has captured my mind for the day.

There is likely to be much written on the blogosphere and in newspapers over the next few days dissecting George Osborne’s 50 minute-long Autumn Statement. Rather than attempting to extensively cover it, I just seek here to tease out a few of my own notes about the Chancellor’s speech.

First and foremost, there were a couple decent cracks at Labour and Miliband, in particular the reference to the exploration of Mars wherein he compared Labour to the Red planet where there is yet to be any finding of intelligent life, or indeed life at all.

Secondly, and moving onto more substantial matters, the statement was kitted out with plenty of numbers (mostly forecasts). But in one area, they were conspicuously missing, namely, in relation to the endeavour to continue with moratoriums on tax credits/benefits. If this is so necessary, explain why George!

Third, this statement gives further credence to the idea that the Government does not take death taxes seriously, much like the Budget last year. Between tax free pension transfers and exemptions for those who die combating the Ebola virus in West Africa, death taxes have become a useful tool for Government to grab headlines, with very little lost to the Exchequer.

Finally, what an interesting idea that the Government will introduce a levy of 25% on those companies who artificially divert taxes away from the UK. If you would like more details, I cannot provide them, because George didn’t actually elaborate on this point. Watch this space!

1. Introduction

This piece was originally posted on Joylon Maugham’s blog (waitingfortax.com) on 13 November 2014. It is reproduced here with permission.

The recent debate on tax in the UK has strayed into the murky area of questioning the relevance of morality. Chair of the Public Accounts Committee Margaret Hodge has stated that exploiting the complexity of tax law to reduce tax liability is “morally reprehensible”. David Cameron meanwhile recently voiced the opinion that there is a “moral duty” to cut taxes in order to allow people to spend more money on their families. What has perhaps been overlooked in relation to these assertions is that philosophers and jurisprudes for centuries have struggled to understand not only what influence morality has on the law, but also what influence it ought to have. As such, it appears unlikely that there will be a speedy resolution to the debate about tax law and morality.

Leaving aside the issue of what part morality ought to play vis-à-vis reducing tax bills; it is interesting to note that in certain circumstances there is no rigid figure as to the tax which must be collected by HMRC. Taxpayers may find their tax bills to be less than that which is strictly owed under the law, without resorting to the use of ‘gimmicks’ or abuse of reliefs. Accordingly, the tax which is raised from taxpayers is relative in the sense that it may legitimately be less than the amount Parliament has stipulated and this generally arises in two instances: first, where the law is fuzzy and second, where the law cannot practically be applied. The thesis of this post is that this relativeness is likely to play a more substantial role in the collection of tax than morality.

2. Theory of relativeness

To explain this relativeness, it is worth recalling that HMRC’s primary duty is to collect and manage taxes and credits (Commissioners for Revenue and Customs Act 2005, s. 5). Within this duty, however, there is a wide managerial discretion:

“In the exercise of these functions the board have a wide managerial discretion as to the best means of obtaining for the national exchequer from the taxes committed to their charge, the highest net return that is practicable having regard to the staff available to them and the cost of collection” (R v IRC, ex parte National Federation of Self-Employed and Small Businesses [1982] AC 617 (HL), at p. 637 (Lord Diplock))

This discretion however is limited to an extent:

“It does not justify construing the power so widely as to enable the commissioners to concede… an allowance which Parliament could have granted but did not grant” (R v HMRC, ex parte Wilkinson [2005] UKHL 30, para. 21 (Lord Hoffmann))

Taken to its logical conclusion, so long as the Revenue does not contradict the intention of Parliament, this discretion permits the use of cost-benefit analysis:

“In particular the [R]evenue is entitled to apply a cost-benefit analysis to its duty of management and in particular, against the return thereby likely to be foregone, to weigh the costs which it would be likely to save as a result of a concession which cuts away an area of complexity or likely dispute” (R (Davies and another) v Revenue and Customs Comrs; R (Gaines-Cooper) v Same [2011] UKSC 47, para 26 (Lord Wilson))

As a result of this discretion and legitimated use of cost-benefit analysis, HMRC is entitled to collect less tax than might be strictly due under the law. Thus, in the case of complex or fuzzy law where it is unclear as to the true amount of tax which is due, HMRC are empowered to arrive at a working interpretation which objectively satisfies the will of Parliament and in their opinion would raise the greatest amount of money in relation to that tax, over the course of all taxpayers. This same principle applies where the law itself is clear but would be impractical or unworkable in a certain set of circumstances. Where this arises, the Courts have found time and time again that it is proper for HMRC to forego the full collection of tax, so long as it is done with a view to raising the greatest amount of money for the exchequer overall. By focusing on morality in the tax system then, we ignore the other factors that in practice have a greater impact on how HMRC collect tax and how much tax they collect.

3. Application of relativeness

As this discretion is contained within the fundamental duty of HMRC, it pervades much of what they do. Three instances of the corresponding relative nature of tax appear especially pertinent to the differentiation between tax collection in practice and the normative collection of tax. The amount raised from settlements need not be the true figure which is prescribed as due under the law. Likewise, the decision to take or not take test cases rests solely with HMRC. This decision pivots on analysis of the benefit and likelihood of success rather than the desire to clarify law where it is unclear. HMRC may similarly spread their resources for the everyday collection of tax in a manner which would not collect all that is strictly payable. In each of these cases, what ought to happen is at conflict with what actually happens.

A) Settlements

One of the most controversial elements of tax collection in recent years has been the negotiation of settlements with large businesses. Sir Andrew Park, former High Court Judge and perhaps the most widely respected Tax Silk of his day, was commissioned to investigate HMRC’s conduct in relation to large settlements. Ultimately, the report concluded that the 5 settlements examined were ‘reasonable’ in terms of fair value for the Exchequer and public interest. As to the parameters of ‘reasonableness’, the report further provided as follows:

“[Reasonableness] included considering whether the settlement was as good as or better than the outcome that might be expected from litigation, considering the risks, uncertainties, costs and timescale of litigation” (Park Report, p. 5)

These cases concerned a complex smorgasbord of issues and must be held against the backdrop of resource constraints. It is for this reason that the question of reasonableness was resolved, not on the basis of what is due under the law, but on the basis of what might be gained from litigation. This is strictly what the exercise of managerial discretion requires (although the revised ‘Litigation and Settlement Strategy’ somewhat circumscribes HMRC’s power).

More generally, this report provides an insight as to the way HMRC may go about settling cases and litigation. Where the law is unclear and the litigation of the case would not be cost-beneficial, HMRC may arrive at a settlement for tax, below that which might be strictly due. The cost-benefit analysis is further engaged by the fact that, on their table, HMRC have a backlog of cases to get through. In other words, HMRC must look at the entire catalogue of disputed cases, given that the resources must be stretched across all, and will be entitled therein to settle for less than the true amount in any individual case, provided this is done so as to obtain what in their view is the highest net practicable return. Further depletion of resources or further increase in complexity will necessitate prudent decisions on HMRC’s part which will be strictly at odds with what the particular legislative provisions will require.

What HMRC have done in practice however, with the revised ‘Litigation and Settlement Strategy’ (‘LSS’), is further constrained this authority. The binary framework of the LSS, which facially proceeds on an all or nothing basis, delimits HMRC’s discretion and overlooks the relativeness of the tax due. As this was a managerial decision to put the LSS system in place, it would be interesting to see empirically whether or not it in fact raises a greater amount of tax than would occur in its absence.

B) Test Cases

As regards test cases, the managerial discretion ensures that much deference is given to HMRC as to what cases they choose or do not choose to pursue. Put another way, the decision to take test cases rests solely with HMRC. To this end, accusations that HMRC have ‘picked’ on certain taxpayers have fallen on deaf ears.

As with the jurisdiction in relation to settlements, HMRC is entitled when deciding which cases to pursue to take account of the legal advice as to the chance of success, which in turn is balanced against any likely return. The more unclear the law is, the greater the return must be from a successful outing in order to justify taking a test case forward. Further, test cases do not arise in a vacuum and HMRC must decide which ones to contest, given the lack of resources to take every case. Where they do not pursue taxpayers for amounts which might in fact be due under the law, liabilities to the law remain but are unenforced. This is a far cry from the normative world in which all tax liability is collected.

C) Collection

It is perhaps in the everyday collection of tax where managerial discretion is most engaged. HMRC must make decisions as to the allocation of scarce resources. To this end, the use of risk assessment is legitimated. Through this process, HMRC analyses various sources of information in order to obtain a view as to the risk of non-compliance. Less time and fewer resources are dedicated to low-risk taxpayers whilst more time and a greater amount of resources are expended on high-risk taxpayers. This categorisation diverges from the law in that it does not indicate whether any taxpayer has actually conflicted with the law but rather focuses on the statistical likelihood of non-compliance.

HMRC is also justified in putting systems in place to ensure future compliance with the law, which might result in less tax than due being collected. A notable example of this is the Fleet Street Casuals case, wherein the Revenue legally refrained from collecting all tax that was historically due (which was estimated to be in the range of £1mil per annum over a number of years) in return for the assurance of future compliance. What prevented the Revenue from opening investigations into the historical evasion was the combination of the unknown return to be obtained from expending resources and the threat of industrial action. The latter in particular would have compromised the possibility of future compliance. This case serves to highlight that HMRC are entitled to compromise on what the law might require so long as mechanisms are put in place to ensure future compliance. Bespoke sector specific agreements, such as Flat Rate Expense Allowances relating to Airline pilots, are justified on this basis.

Ultimately, HMRC is entitled to make decisions, which are pragmatic in their opinion, as to how to go about the everyday collection of taxes. The fact that many resources would be expended in seeking to ascertain and collect the full amount of tax due under the law in fact justifies compromising on the law:

“There will often have been… some “horse-trading” that has led, for good and practical reasons, to some departure from the strict requirements of the taxing statutes” (R (Bamber) v HMRC [2005] EWHC 3221, para. 48 (Lindsay J))

4. Conclusion

Whilst morality will continue to cause debate as to its proper relevance in relation to tax, the relative nature of tax itself provides an interesting problem which is often overlooked. We often ignore the factors that in practice are more likely to influence how HMRC operate. Settlements, everyday collection strategies and the (non) pursuit of test cases are but some of the pertinent ramifications of this relativeness. With the continuing reduction in resources and the increasing layering of complexity in tax law, this issue is set only to become more important. Should we not then be as, if not more, concerned with reality than morality?

Discourse is essential to fostering change. But discourse is not groups of people talking past each other; nor is it commentators using the same language, but according words differing interpretations to suit their argument. For discourse to foster change, it is essential that the language used in the debate is aligned and conceptually correct. The debate surrounding tax avoidance is certainly in need of alignment in this regard.

Terms such as ‘avoidance’ and ‘evasion’ are extracted from legal judgments and stripped of their context. This short piece will seek to give some clarity to this debate.

The easiest term to deal with is ‘evasion’. This is an illegal act and accords to a situation where the taxpayer is guilty of failing to disclose or concealing information.[1] If a shopkeeper deliberately lies about how much stock she has sold in order to hold onto customer’s VAT, this is evasion. It occurs, then, when a taxpayer has failed to engage with the law.

Avoidance, on the other hand, is trickier. The distinction between avoidance and evasion is often explained on the basis that avoidance is legal whilst evasion is illegal. But this is myopic and misconceived. Avoidance involves the use of the law in a manner which may not have been strictly intended. Sometimes this will be held to be legal, and in other times it will not. The feature distinguishing avoidance from evasion is that of engagement with the law. Whilst evasion arises where there is disregard for the law, avoidance arises where in fact the taxpayer has sought to comply with the law.

A brief example will help to illustrate this point. Let’s say that the law says that ‘Cycling through a red light is illegal’. Evasion then is cycling through a red light at a junction. Avoidance is approaching a red light at a junction, getting off one’s bike, walking with the bike across the junction and carrying on cycling at the other side of the junction. Whilst the former is illegal, the latter uses the rules in a way which is not intended. A policewoman watching the latter may or may not decide to book the cyclist, as it is not entirely clear whether the act is legal or illegal.

Avoidance and evasion are just two of the terms used in this debate whose definitions are in constant flux. It is imperative that everyone is reading, not from the same script, but from the same dictionary if any kind of meaningful change is to be procured. Discussions at cross-purposes rarely produce prudent, normative solutions.

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[1] Michael Devereux, Judith Freedman and John Vella, ‘Tax Avoidance’ (Oxford University Centre for Business Taxation, 2012), available at: http://www.sbs.ox.ac.uk/sites/default/files/Business_Taxation/Docs/Publications/Reports/TA_3_12_12.pdf