I have alluded elsewhere on this blog to the challenges that taxpayers face in assessing tax risk. BigXCo may feel comfortable – assuming its audit committee trusts its professional advisers – that it can make a fully informed decision as to the level of tax risk it wishes to take. But MediumYCo or IndividualZ will generally not possess that capacity. And, lacking it, they can unwittingly become participants in – and sometimes victims of – tax arrangements with a higher risk profile than they might choose.
I am not alone in being interested in the consequences of this state of affairs. The consensus view is that, if taxpayers knew what they were getting into, they wouldn’t get into it. And, collectively, we would suffer less the consequences of tax avoidance. But even if that consensus were wrong, a higher degree of certainty on the part of HMRC that taxpayers knew what they were doing would open up other avenues for addressing avoidance. For example, those who chose to participate in high risk transactions could be penalised if they went wrong.
With these policy wins in mind, a number of proposals have been advanced to help taxpayers assess tax risk: kite-marked tax advisors, higher quality explanatory notes, Revenue pre-clearance procedures, and the badging of certain promoters as “monitored”.
This is not the place for me to analyse the strengths and weaknesses of those proposals. Each presents challenges, each has limitations and each has strengths. What, instead, I would like to do is propose a further, and I hope realistic, proposal. A set of diagnostic criteria against which a taxpayer might self-assess the risk of the transaction proposed to him.
The objective of these criteria – or badges as one might call them – is a modest but important one. It is to enable the interested taxpayer to position the contemplated transaction on a risk spectrum that might start with pension contributions and finish near to evasion. He should, with the benefit of that positioning, be able to decide whether or not to transact.
What follows is my first pass at something that might be publicised to taxpayers. I’ve thought about how these criteria might apply to various transactions I have litigated. But please do likewise – and suggest, criticise and redraft.
Badges of tax risk
External criteria. There are a number of externally verifiable signals of tax risk. You should ask the following questions of the person putting the proposal to you (your “Adviser”).
1. Is there a DOTAS number that I will have to put on my tax return? DOTAS stands for Disclosure of Tax Avoidance Schemes and if there is a number that is a strong indicator of high tax risk.
2. Is there a promoter reference number for your transaction? Transactions with promoter reference numbers will have been devised by those identified by HMRC as more likely to be engaged in high risk behaviour.
3. Is there a page on HMRC’s website that deals with this transaction? HMRC publishes on its website very detailed Manuals for its Inspectors which set out the tax treatment of most transactions.If the Adviser cannot direct you to where the transaction is addressed in the Manuals it may indicate the transaction is higher tax risk.
4. What fee are you being asked to pay? If you are asked to pay a fee calculated by reference to tax saved, that is a strong indicator of high tax risk. If your fee is calculated by reference to your adviser’s reasonable hourly rate, that is an indicator of low tax risk.
5. Are you asked to keep the details of the transaction confidential, or sign a Non-Disclosure Agreement? The confidentiality in your tax affairs is generally yours to keep – or waive – and not your Advisor’s. If your Advisor asks you to keep details of the transaction confidential that may well indicate that the transaction is being sold to others and is a strong indicator of high tax risk.
The transaction itself. Why are you transacting – and why are you transacting in this way?
6. Does your transaction advance a non-tax (i.e. either a commercial or a personal) objective? If your only purpose in transacting is to achieve a tax benefit, this is a strong indicator of high tax risk.
7. Is the attractiveness of the transaction a consequence of the tax benefits it delivers? If you would transact without the tax benefits, that is a strong indicator of low tax risk.
8. If your transaction has a non-tax objective, is the manner in which you are transacting a natural way to achieve that objective? Most transactions structured in a normal way will attract the tax treatment Parliament intends. It is a common feature of higher tax risk transactions that they deliver your objective by an artificial route.
9. Does the shape of the transaction give you a better tax result than another economically equivalent transaction? What are the tax consequences of achieving your objective through a different route? A transaction that is not tax maximising has some tax risk but a transaction that is tax maximising has none.
10. Does the shape of the transaction advance your pre-tax objectives? If both the transaction and its shape are dictated by your non-tax objectives that is a strong signal of low tax risk.
The tax effects of transacting. In tax, as with other things, there is rarely such a thing as a free lunch. The difference between tax efficient transactions and tax avoidance transactions is very often whether Parliament intended the tax result your transaction delivers. So, you should ask yourself:
11. Is it likely that Parliament intended this tax result? It is useful to ask this question alongside 3. above: if Parliament did intend it, it is very likely HMRC’s website will say so.
12. Are you being taxed on the economic or ‘real’ transaction that you entered into – or do the tax consequences attach to some other transaction? If you are being taxed on a transaction that differs from the ‘real’ transaction that is a strong signal of high tax risk.
Follow me on twitter at @jolyonmaugham