Follower Notices – and a Government that Listens

Even the most lazily complacent amongst us; even he who has happily waved through the GAAR and Direct Recovery of Tax Debts and Accelerated Payment Notices; even, well, me, has baulked at Follower Notices. I’ve never understood the intellectual case for them; I’ve always regarded them as unfairly loading the dice in favour of HMRC, and in a way likely to breach the Human Rights Act right to a fair trial.

Albeit belatedly, so, it would seem, does Government. In proposed changes to the Follower Notice provisions announced today, the Government has announced one sensible clarification of the Follower Notices regime and one equally sensible, but rather more fundamental, change to it.

The sensible clarification is this. As I have written elsewhere, the Follower Notices regime contains provision for an appeal to be made against a penalty under a Follower Notice albeit that, rather unsatisfactorily, that appeal will likely be decided at a point in time too late to provide the taxpayer with the clarity he needs. It was (in particular) that feature of the regime that I have focused on as a very real substantive defect. However, there was also a technical defect. Clause 207 Finance Bill 2014-15 (which specifies the appeals jurisdiction) did not state what jurisdiction the Tribunal hearing the appeal against the imposition of a penalty exercised. Did it exercise a supervisory regime? An appellate regime? Did it, in effect, make the decision to issue the Follower Notice anew?

That question has now been answered by new sub-clause 207(2A)(b). The test for the Tribunal is whether “the judicial ruling which is specified in the notice is… one which is relevant to the chosen arrangements.” This looks to me like an appellate regime: the Tribunal will have to ask and answer the question discussed in this blog post. That is a helpful, welcome and unsurprisingly clarification.

The fundamental change comes in new sub-clause 207(2A)(d). You may appeal against a decision that a penalty is payable under a Follower Notice on the grounds that “it was reasonable in all the circumstances” for you, when confronted with a Follower Notice, to decide to fight on. If it was reasonable the Tribunal must cancel the penalty. 

The main constituent elements of the reasonableness test are, it seems to me, two in number. First, do you have reasonable grounds for thinking that if you continue with your substantive appeal you could win? Second, do you have reasonable grounds for thinking that either (a) there is no relevant Judicial ruling or (b) if there is such a ruling, that it will not be decisive of your substantive appeal?

None but the most sophisticated of taxpayers is likely to be able to assess these factors for herself. Indeed, even the most sophisticated taxpayer is likely to want to be able to rely (a polite way of saying ‘transfer responsibility’) on the assessment of her professional advisers. However, where that assessment is carried out, and the conclusion is that it is reasonable to continue with the substantive appeal, the taxpayer should have good ground for resisting a penalty even if she then goes on to lose the substantive appeal.

There is a narrow sense in which this is a positive development. It provides a powerful safeguard against HMRC’s otherwise untrammelled power to put pressure on taxpayers to settle. I do not think it is an exaggeration to say that it restricts the likely ambit of Follower Notices to all but a narrow class of cases. As I put the matter in my blog post of several days ago:

That (narrow) class of case is, in my opinion, that class of tax avoidance scheme where one taxpayer has fought and lost. In those circumstances, others entering into that scheme, if they fail to fold, face the likelihood of FNs, and of courts upholding them.

However, approached from a technocratic perspective, this is bad legislation. It drives taxpayers into the arms of their professional advisers (good for me, less so for them) whilst still leaving them with a degree of doubt about whether they face a penalty. It would, in my view at least, have been better for Government simply to have tightened up and clarified the unsatisfactorily vague definition of “relevant” Judicial rulings.

The title of this blog post is ‘Follower Notices – and a Government that Listens.’ These changes will be welcomed by those facing the prospect of Follower Notices. But is it them to whom Government has listened? No, and nor the technocrats (like me) who will see this as poor legislation. Those to whom Government has listened are its legal advisers. They will have expressed to Government a genuine concern that this regime might not survive judicial review challenge. This change reads to me like an attempt to shore up the defences in anticipation of such a challenge. But shore them up enough? Now there’s a question.

The Narrow Scope of Follower Notices

I have written about Accelerated Payment Notices (“APNs”) elsewhere. Here, I propose to examine a feature common to both APNs and Follower Notices (“FNs”) – that of relevant Judicial rulings (“RJRs”) – but with a particular emphasis on the latter. However, I need to begin by setting out how the (complex) Follower Notices regime operates.

The FN regime seeks to put pressure on prospective appellants in tax cases to ditch their appeals by exposing them to the threat of a 50% tax geared penalty (i.e. on top of the tax that is due) should they (a) choose to pursue their appeal in circumstances where (b) there is a final RJR. If you receive a FN, you have 90 days to object and if you don’t object (or you do, and your objections are dismissed) you become liable to that penalty. That penalty disappears if you win your appeal but if you lose your liability may be increased by up to 50%.

Now, it has been said that you have no right of appeal against a FN. This is wrong, you do (see clause 207 of the Finance Bill). But that right of appeal looks deliberately constructed so as not to interfere with the critical pressure that FNs are designed to  place upon the litigant: the pressure to throw the towel in even in cases where you consider yourself to have decent prospects of succeeding.

Let’s assume HMRC issue you with a FN. Your advisers tell you that you have decent prospects. But you’re obviously concerned at the thought you might have to pay 150% of your present bill should the courts or tribunals disagree. And assume, also, that you disagree that a FN should have been issued perhaps because you consider there is no RJR.

To make the right decision in these circumstances you need to know whether the FN was correctly issued. If it was, you can then form an assessment of whether your prospects of winning are so good that you’ll take the chance of suffering a penalty of an extra 50% should you lose. If it wasn’t, you are in the familiar regime of merely suffering (at least if they are yours to bear) the professional costs of pursuing the appeal. But the statutory appeal provided by clause 207 against the issuance of the penalty is extremely unlikely to take place until after you have fought and won (or lost) the appeal in respect of which the penalty is due. So the certainty you need – as to whether you are at risk of a 50% penalty – comes too late to be useful.

Broadly I want to make two observations. First, it seems to me (for reasons set out following) that the circumstances in which courts or tribunals are likely to uphold the issuance by HMRC of FNs are likely to be very narrow indeed. Second (a point that will have to be explored elsewhere), it may well be the case that the sensible judicial review challenge is not a tanks-on-the-lawn challenge to the FN regime as a whole, but is a rather quieter one.

When will courts or tribunals find there is an RJR?

The concept of an RJR was hitherto unknown to English law. It is defined in clause 198(2) and (3) of the Bill as follows:

(2) “Judicial ruling” means a ruling of a court or tribunal on one or more issues.

(3) A “judicial ruling” is relevant to the chosen arrangements if… (b) the principles laid down or reasoning given, in the ruling would, if applied to the chosen arrangements deny [the tax advantage].

What follows is two short points about the concept of an RJR, one observation about how courts and tribunals are likely to approach RJRs and three golden rules the breach of any of which by HMRC would, in my view at least, leave them exposed to judicial challenge.

My two points about the concept of an RJR. First, a RJR is not the same thing as a binding ruling (or, as lawyers would put it, a ratio decidendi). Any judicial observation – even if merely passing and/or unnecessary – if found in a “final ruling” (a relatively straightforward concept which can be found in clause 198(4)) is capable of constituting an RJR. There is no explicit qualitative test. Second, a judicial ruling is only relevant – is only an RJR – if it would “if applied to the chosen arrangements… deny” the tax advantage. So, although the judicial ruling does not need to be of high quality it does need to be bang on point.

My observation about how courts and tribunals are likely to approach them. Follower Notices clearly raise Human Rights Act questions about the interference with the right to a fair trial . In such circumstances, to state the obvious, courts and tribunals are obliged to read legislation in such a way as to ensure it complies with Convention Rights. This is, in my view, likely to have practical consequences.

My three golden rules.

The best reasoning rule. There is nothing in the definition of RJR explicitly obliging HMRC to choose the better of competing “principles” or pieces of “reasoning”. I consider there is scope for the courts to read one in.

The qualitative control. Notwithstanding that a tribunal – whose decisions do not bind anyone else – is as a matter of law capable of delivering a final RJR (see clause 198(4)(b)) I consider that a court or tribunal will apply a qualitative control. In other words, the less compelling the judicial reasoning sought to be relied upon by HMRC, the greater the likelihood a court or tribunal will hold there is no RJR. Again, I consider there is scope for the courts to do this.

The scrutiny principle. The reality of litigating tax avoidance transactions is that there is very rarely a piece of reasoning or a principle which is decisive of the outcome. I consider courts and tribunals are likely closely to scrutinise the contention to the contrary.

It follows from the above that, in my view, the circumstances in which a court or tribunal will uphold a decision by HMRC to issue and not withdraw a FN are likely to be confined, in practice, and with only rare exceptions, to one class of case.

That (narrow) class of case is, in my opinion, that class of tax avoidance scheme where one taxpayer has fought and lost. In those circumstances, others entering into that scheme, if they fail to fold, face the likelihood of FNs, and of courts upholding them.

It is instructive to stand back and remind ourselves of how HMRC originally badged the provisions now known as the Follower Notice provisions. They were originally described as “Penalties for Other Users of Failed Schemes.” That original description accords with the likely legislative effect of the provisions as interpreted by the courts and tribunals at least as I understanding it. It is a point worth remembering.


Give Peace a Chance

Let’s begin by eating our greens.

Shortly after the launch of the Fair Tax Mark earlier this year, Mike Truman, Editor of Taxation, published an article [£] assessing the Mark’s award criteria. The pass mark was 65% with up to 20% awarded by reference to the relationship between an applicant’s average tax rate (“ATR”) and the then headline rate of corporation tax. The ATR was calculated by reference to the tax rate paid over the previous four years. In his article, Mike Truman expressed a preference for a weighted average (such that the rate paid in years where profits were higher counted more heavily than the rate paid in years where profits were lower) rather than the unweighted ATR adopted by the Mark. Mike Truman also reported the view of the Technical Director of the Fair Tax Mark, Richard Murphy, that in 95% of cases it would make no difference. It was not suggested that there was any bias inherent in the adoption of an unweighted rather than a weighted ATR.

If you were toying with your broccoli, now to the beef. The criticism was merely this: a technically less purist measure, making (it was claimed) no difference in 95% of cases, had been used in relation to but 20% of the weighting for the Mark.

Yet from such an unpromising beachhead, and without other serious technical criticism, was launched attack after attack on the technical soundness of the Mark. And, in a manner equally unattractive, its defenders accused the attackers of base motive. That, in other words, they were actuated purely by a desire to preserve their turf; to enrich themselves, and their wealthy clients, and to preserve their monopoly over public debate on this most critical public policy arena.

That was, on any view, a profoundly one-dimensional anecdote. You will expect me, in due course, to seek to justify its telling. But first a diversion.

There are those – let me call them the Moralists – who seek to bring about broad social change and who recognise the tax system as an important tool to achieve that change. Their champions, in the UK at least, are such figures as Alex Andreou, Polly Toynbee, the Chair of the Public Accounts Committee Margaret Hodge, and the grandfather of them all, the aforementioned Richard Murphy.

The Moralists have, of course, political detractors who disagree either with the Moralists’ objectives or with their assessment of how to use tax policy to achieve them. These political detractors are, in a sense, Moralists too. UKIP, until very recently, advocated a flat rate of tax as a means to “make all taxpayers better off.” However, this rather energetic logic has never featured heavily on their policy platform and so they are, disappointingly, less visible members of the Moralist class.

The Moralists have a further group of detractors. They are tax academics, practitioners, and even the odd member of the Bar. They occupy a smaller stage, those merry few. They are guardians of the craft of taxation and invisible to a public with but the barest interest in such matters.The thrillingly uninhibited Christie Malry – a witty pseudonym referencing the eponymous subject of BS Johnson’s novel – who tweets as @fcablog is perhaps as good an exemplar as any. I shall call them the Technocrats.

Such justification as I can offer – I didn’t say I would, only that I would try – of the anecdote set out above is as synecdoche. It aptly illustrates the unproductive nature of debate between the Moralists and the Technocrats. Neither recognises the role played by the other. Too often the Moralists boldly go where no well informed advocate for social change would. Too often the Technocrats look at questions of social reform through the wrong end of the telescope.

But each needs the other. Tax is a legitimate tool to achieve social change and the Technocrat must recognise that lest he be shorn of moral purpose. The Moralist, too, must recognise that, as I have put it (in an otherwise nugatory article) elsewhere, by moral fury alone she will not get the job done.

This is my plea to give peace a chance.

Thanks to @alexcobham who got me started on this.

Holding on to the fruits of tax avoidance

It’s difficult to think of a measure that has attracted such universal hostility as the proposals announced in the Queen’s Speech for so-called Accelerated Payments. Badged by the Telegraph as treating taxpayers as “guilty until proven innocent” and by Pinsent Masons as “unconstitutional” and “having the effect of making HMRC judge and jury” they have nevertheless found their way into the Con/Lib Government’s final Queen’s Speech.

These are heavy charges. But are they justified? Do the Accelerated Payments provisions effect some step change to the present system for collecting tax? And if they did, would they be wrong to do so? The answer, in both cases, is an all but unqualified no.

Let’s remind ourselves what the provisions do. Where your tax behaviour looks like ‘bad’ behaviour – defined in ways I shall come on to – HMRC can compel you to hand over the fruits of avoidance pending a final judicial determination. And, err, that’s it. Standing back, the policy rationale is, where your behaviour looks like it’s bad, you hand over the cash now. But should the courts later define your behaviour to be, in effect, ‘good’, you’ll get the money back plus interest.

So the provisions are only about the question ‘who should hold the cash?’ in the meantime.

To, then, the first of the two questions I posed. Do they effect some step change?

Answer, clearly not.

The provisions bite only where you are holding on to the tax fruits of your avoidance behaviour in the meantime. But the question whether you are – or whether HMRC already have the cash – is not a function of some broad constitutional principle that you should enjoy the money until a court compels you to hand it over. It’s a function, instead, largely of fortuity: whether you’re employed or self-employed.

The effect of successful personal income tax planning is typically to remove an obligation to pay income tax on otherwise taxable income. This intended effect is achieved either through the taxpayer generating ‘losses’ which she can set against her other taxable income thus reducing her net taxable income. Or by triggering her entitlement to a tax credit which, again, she can set against her liability to pay income tax.

Now, where you are self-employed, or have other income not subject to deduction of tax at source, you claim the benefit of these losses or this tax credit by saying on your tax return, in effect, I have a liability to pay you 100 but I have losses of 80 so I will only pay you nine (45% of the remaining 20), and then handing over that nine. However, where your income is subject to deduction of tax at source (because, for example, your employer deducts it under PAYE) you claim the benefit by saying, in your tax return, you HMRC have deducted tax on 100 but you should only have deducted tax on 20, so please repay the 36 (45% of 80). Sometimes HMRC do, even where they think your claim to 80 of losses may not be secure, but increasingly they don’t. So if you’re self-employed, typically you’l have the cash. But if you’re employed, generally HMRC will already hold it.

The effect of all of this is that the question ‘who should hold the cash?’ is one which, even under the legislation as it stands, is apt to produce different answers for different types of taxpayer. Or, in a nutshell, no step change to see here, move along.*

My second question was, even if the provisions effected a step change, would they be wrong to do so?

Plainly this is a question in relation to which different people can reasonably hold different views. My starting point is that HMRC is a department of Government, obliged as a matter of proper public administration to act reasonably in collecting tax, and that, where it says tax is due, it is generally likely (I put it no higher than that) to be right. The data in tax avoidance cases supports this proposition: HMRC claims to win over 80% of disputes. Now, one might reasonably ask, in those circumstances, why should HMRC not have the cash pending a determination.

And there are additional safeguards. In order for the accelerated payments provisions to apply, there must be more than a mere statistical probability that  HMRC will likely end up with the cash anyway, to justify them getting it now. For HMRC to issue an accelerated payment notice, they must be able to pass through one of three gates. The first gate is that an independent advisory panel has indicated that the transaction is likely to be “abusive”. The second gate is that the transaction has already been disclosed under the Disclosure of Tax Avoidance Scheme regulations. The third gate is that HMRC must be of the view there is a judicial ruling which, if applied to the case, would deny the asserted advantage.

Now, none of these gates is perfect.** They are all proxies for the (technically challenging) question the subject of the taxpayer’s appeal, what is ‘good’ and what is ‘bad’ tax avoidance. But they are, on any view real safeguards. And they have broadly the effect that only measures which are likely to be ‘bad’ avoidance cases should trigger the provision of an accelerated payment notice. Again, nothing to see here.

Summarising, the accelerated payments provisions are – or so it seems to me – well targeted provisions which seek to reduce tax avoidance behaviour by targeting one of the cash-flow benefits of that behaviour. In that objective, and generally in their execution, they are to be applauded.

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