I am very pleased to have been invited to give tonight’s Hardman Lecture. I hope you’ll find it interesting and engaging. More engaging than what I said last time I was here. That was the Wyman Debate where I attempted to defend the Direct Recovery of Debts. If it prompts your memory, the evening finished with me being pelted with bread rolls. Engaging compared to that – that’s my baseline hope for this evening’s lecture.
What I’m going to set out tonight is some thoughts on where we go now with tackling marketed tax avoidance.
Were you Chancellor, you might well think about the business of keeping your departments fed as being a bit like watering your garden with a colander. Human nature being what it is, tax revenues are prone to a kind of gravitational effect. They want not to be collected; they want to fall out of the bottom. So, good gardener that you are, you plug up the holes in the bottom. But then you notice that all the holes further up the sides, from which the water previously only trickled, now it gushes.
You can’t approach the question of whether it’s game over for tax avoidance without thinking about what holes have been plugged by successive Treasury Ministers. And if you look at the big plugging exercises; the first is undoubtedly the DOTAS regime. Then we had the GAAR. Then we had Accelerated Payment Notices. Follower Notices too will do a little work – but less than previously expected. Now we have High Risk Promoters… and no doubt there will be some surprises in the Autumn Statement.
But can I start with a feature of the landscape that is, it seems, sometimes overlooked. There is not one solution because there is not one problem.
A good example of this is the reaction of promoters to APNs. Accelerated Payment Notices fundamentally alter the dynamics of tax avoidance. In the salad days of tax avoidance, you would, on the 5th of April, dip into your overdraft for 20, borrow 80 in a funding loop, put 100 into the scheme du jour, claim 100 of loss relief, set that against your income of 100, enjoy a reduction in your tax liability of 40, spend 21 of that 40 repaying your overdraft and have 19 left over to spend on Bordeaux futures.
That’s a gross oversimplification, of course, but the attractiveness of the arrangements really did depend on them being no worse than cash-flow neutral. In other words, you had at least to be able to repay your 20 overdraft. Accelerated Payment Notices (for DOTASed schemes) remove that cash-flow advantage. So promoters have responded by searching high and low for schemes that don’t need to be disclosed under DOTAS. Or for people who will say that schemes don’t need to be disclosed under DOTAS. But I’ll come back to that.
As I said, the plugging of a hole slows down the leakage. But the gravitational effect survives. The tax still wants to escape the colander. (As Samuel Butler put it in Erewhon – “Even a potato in a dark cellar has a certain low cunning about him which serves him in excellent stead. He knows perfectly well what he wants and how to get it. He sees the light coming from the cellar window and sends his shoots crawling straight thereto.”) Tax has that same low cunning: it will look for the other holes in the colander, even if higher up, where the effect isn’t so strong.
And I think that’s where we are now. As I put it on my blog some months ago – when I wasn’t burdened with the need to sustain a metaphor – it seems to me the heavy lifting on personal tax avoidance is now done. That’s not to say we can or should relax. But it is to say that the losses should be smaller from now on. Albeit that the holes that are left might be tricky to plug.
What I’d like to do is look at the remaining problems through the eyes of the various participants in the tax market. I think it’s only in that way that we can think about their solution.
Let me start with taxpayers.
Of course, at the moment, taxpayers generally are put off tax planning by a hostile environment. But older heads than mine – there are so many people in this room whose eye I don’t want to catch at this point – will remember that we’ve had this before.
In the late 70s and early 80s there was a similar mood to today’s. That was also a time of low or negative economic growth – and enormous public concern about tax avoidance. But when the economy recovered so did the planning market. Judges who had been activist in giving voice to society’s concerns about avoidance became, once again, merely lawyers applying the law.
I don’t think there’s anyone at Treasury who is kidding themselves that the same won’t happen again as the economic recovery gathers pace. Indeed, what I hear quite clearly is a recognition that this is the golden moment when the stars are perfectly aligned for the introduction of measures to tackle avoidance.
It’s clear that there are a number of people around who find themselves involved, quite unwittingly, in transactions with a higher risk profile than they would choose. I was speaking to a senior Inspector only a couple of days ago who said that he gets phone calls all the time from people who say, plaintively, ‘what else could I have done’? Often you think that what you’re buying is Vanilla ice-cream, and it’s only later you discover that you’ve bought, well, Rocky Road.
That’s a problem for all of us. It’s something our inner headmaster who wants to throw a blackboard duster at tax avoiders needs to confront. It’s a problem for the general body of taxpayers – represented by the Exchequer – that bears the costs associated with tax avoidance behaviour. And it’s certainly a problem for taxpayers who can be pushed into quite awful financial circumstances.
When you look to solve the problem you need to start by recognising that everyone likes a little honey poured into their ear. Or as Paul Simon put it – I know my audience – “a man hears what he wants to hear and disregards the rest”. We need to give people very good reason to have regard to the rest.
I’ll come back to this later on. But I do think that, even within the bounds of the law as it stands, there is room for HMRC to be more activist in encouraging people to engage with reality.
So, having flagged that point, my view is that we need to give taxpayers the tools to assess whether what they are being offered is an ‘investment opportunity’ or is really a piece of ‘counter-purposive tax planning.’ And not just with the benefit of hindsight.
Many members of the tax community have chipped in to a collective project called ‘Badges of Tax Risk’ which proposes a series of questions that a taxpayer might ask herself to distinguish good from bad tax planning. It’s, I think, a really valuable project and the signs are that one of the Big Four is going to throw its considerable weight behind the project. That would be a very welcome development. I don’t want to talk too much about it – you can read all about it here and here – but the broader the input the better the output. So I would encourage everyone in this room to have a look and comment.
Of course, once you give taxpayers the tools with which to assess their tax risk, you begin to feel a bit more comfortable about the idea that they can be required to exercise judgment about what they do.
Take a step back.
Typically a marketed avoidance scheme is put together by a House. It then sells that scheme to taxpayers via those taxpayers’ advisers. Those advisers may be IFAs, they may be accountants, banks, tax advisers, solicitors. The scheme is sold on the strength of an Opinion from, typically, leading Counsel who has said that it – or something similar to it – delivers a tax advantage of 100.
But who has Counsel said that to? The answer, almost invariably, is to the House. The House tells the adviser that it has Counsel’s advice that the scheme delivers an advantage of 100. The adviser tells the taxpayer that the House has been told that it delivers an advantage of 100. But no one tells the taxpayer that it delivers a tax advantage of 100. Indeed, typically the House is explicit that it is not giving tax advice to the taxpayer. And that the taxpayer cannot rely on what the House has been told.
Now, assume you’re the taxpayer in that situation and you self-assess on the basis that you have a tax advantage of 100. How careful have you been? I ask that question because, if you haven’t been careful, if you’ve been careless, you’re liable, on the law as it stands to a tax geared penalty.
The question whether any particular taxpayer is “careless” will depend on the facts – and I don’t want to get side-tracked into a lengthy discussion of this issue – but if you assume X has claimed £1m of sideways loss relief in his tax return without anyone actually telling him he’s entitled to then… well, he’s either brave or foolish.
So, it seems to me that there is already a very good mechanism through which taxpayers can be encouraged not to “disregard the rest”. The mechanism might be improved with a small tinker. But even today, it works. And it’s the consequences of HMRC availing itself of this mechanism that I think are really interesting.
Taxpayers are going to have very real skin in the game. At the moment there’s a perception that they don’t. You jeopardise your upfront cash – which might be 20 – but really that’s all the skin you have. If you’re going to get a penalty calculated by reference to that 100, that’s a whole different ball game. (If anyone’s playing mixed metaphor bingo, that was number two).
They only way in which they can avoid that risk is by being ‘careful’. So they will need someone to tell them that they get 100 of relief before they claim it on their tax return.
What are the consequences of the taxpayer needing that advice? Well, it will make it much less attractive to participate in the scheme: you’ll have to factor in the costs of getting advice. And this will be an upfront cost – you won’t know whether you’ll get a saving until you’ve spent the money. And as it’s a serious thing to tell someone liable to transact that a scheme works – dangerous and risky – so those costs will be high.
What will the House do?
Its response will be to arrange for the barrister who gave the initial advice to repeat it to potential clients. The barrister’s done the work so he just has to press ‘print’ and deliver his opinion. The costs can be kept manageable. But if the barrister gives that advice he will owe the client a meaningful duty. He will need to be careful – he will need to be careful – to ensure that that advice is correct.
And the Bar?
Now, it won’t have escaped your attention that the course I’m suggesting improves the accountability of the Bar by the mechanic of giving it more work. I want to acknowledge that. But it will improve accountability. If you are asked to sign off a ‘scheme’ you will anticipate that saying ‘yes’ will involve you giving that advice directly to prospective punters.
I don’t want to spend a disproportionate time on the Bar – but some of you will know that I have bemoaned the poor mechanisms for transmitting risk to the Bar – and so I did just want to touch upon the alternatives.
As to negligence proceedings, unless the barrister owes a duty of care to the taxpayer these are difficult. The House will sometimes have but a modest interest in whether the scheme works. But the taxpayer will be very interested. So you need to enable the taxpayer to bring proceedings against the barrister. The ‘solution’ I am recommending lies in the hands of HMRC. And it closes the circle.
You may well feel that if a barrister does misbehave, that’s a matter for the regulator. If Doctors can be struck off for incompetence, then why should Barristers not be? I agree – and I can tell you that so does the regulator. But the regulator has two difficulties. First, establishing that the barrister’s conduct falls below the regulatory standard. And, second, getting evidence of the barristers’ conduct at all.
As to the first, the tax bar is small – there might be 50 serious players. An adequate understanding of the technical material will be even more closely held. And not all of those practitioners would be prepared to prosecute, defend or hear regulatory matters.
The second problem is how the regulator gets hold of evidence of a breach of regulatory standards. I can’t just give the Bar Standards Board stuff that crosses my desk because I owe a duty of confidentiality to my client. Can I ask my client to waive that duty? I see this stuff because I have a litigation practice. I might be able to persuade them to give it to the BSB when the tax litigation is settled. But while it’s ongoing I can’t ask my client to say (in effect) this planning is so obviously wrong that the barrister’s conduct falls below a regulatory standard.
My sense is that the Bar Standards Board has got a real appetite for this fight. But it’s important not to underestimate the difficulties.
I said that I thought we needed to look at the problem of tax avoidance through the eyes of the various protagonists. So, the House.
Many have shut up shop. That’s, in part, testimony to the work that has been done in introducing the Disclosure of Tax Avoidance Scheme provisions, the General Anti Abuse Rule, Accelerated Payment Notices, Follower Notices and so on. And I can exclusively reveal to you this evening that I claim some personal credit too. The best reason for not avoiding your taxes is the realisation that you have failed to avoid your taxes. And the First-tier Tribunal has been a little unkind kind to me of late.
Now I didn’t say that for the punchline – I didn’t say that just for the punchline. We have to recognise that the creature we are now dealing with is not the creature we were once dealing with. If the main-stream players have already left the market, it’s those we have left that we must legislate for.
And we do have legislation: the High Risk Promoters regime. But I am concerned that it might be too gentle a piece of legislation. You have to be a promoter, you have to be a ‘problem’ promoter, the threshold for being a ‘problem’ promoter is quite high, you have to be given conditions with which you should comply, you have to fail to comply with those conditions and you have to be issued with a monitoring notice. You then become a monitored promoter – and then various quite tough consequences attach.
I’m encouraged that Treasury is thinking about these issues in the right way. It knows that tax wants not to be collected. It knows that, like Samuel Butler’s potato, tax has a low cunning. It recognises that you have to block all the holes in the colander – and that if you block up one, you catch a little more tax, but you also create overflows elsewhere. It’s not just being tougher on tax avoidance – it’s being tougher on the causes of tax avoidance.
But I am concerned that the High Risk Promoter’s regime requires multiple failures – and time – before you can become a monitored promoter. Before the regime bites, you have to have a monitored promoter. If you set up an SPV for each scheme will these provisions bite in practice?
They are capable of biting. If we focus on the controlling mind of the House. If we know at the start that we are going to identify the individual or individuals at the heart of arrangements and concentrate our fire at them. If we don’t allow our point of attack to be diffused between different individuals and different corporate entities then, eventually, these measures can bite.
But, and this is no more than instinct, I think history will show this to be a somewhat gentlemanly solution for rogue operators. I think it will need to be toughened up.
The ICAEW has kindly offered me a platform to talk about measures to tackle tax avoidance. And I don’t want to abuse its hospitality to talk about anything else but I do want to open the conversation up a little wider. I want to make some observations on three associated points.
First, the GAAR.
Has it gone away? Well, it was introduced on 17 July 2013. Transactions prior to that date were grandfathered. So think about the self-assessment cycle. When would you expect a transaction post 17 July 2013 to be reported? How long would you expect HMRC to take to enquire into that transaction? How long would you expect HMRC to take before they launched their first ever test case for this brave new world?
So, it’s just much too early to call it a damp squib.
And it’s also too early, I think, to be asking the question whether the GAAR should be extended. At a conceptual level the debate is this: the advantage of a GAAR is that it might offer a broad spectrum antibiotic against tax avoidance. The disadvantage is that it erodes the legal certainty that people need to transact and invest. If you look through the GAAR provisions in detail – and I have had cause to do that – you can see time and again the draftsman choosing to prefer legal certainty over breadth of coverage. The GAAR is narrowly – and to my mind rather precisely – drawn.
I think that’s the right balance to strike: you take careful and measured steps if you wish not to scare off investment. If investors take fright it will be very difficult to tempt them back.
And I think you need clarity about what it is that you’ve already done before you do any more.
That having been said, I do think there is a good case for a GAAR specific penalties regime. Having fenced off a relatively small part of fiscal territory, I do think there is an argument for electrifying the fence by imposing a penalty on those who stray into that territory. Very often, the most artificial of transactions have very limited economic costs associated with them. Sometimes no more than professional fees. If you believe, as I do, that the GAAR territory is tolerably closely drawn, then you can easily get yourself comfortable with the idea of giving people reason to stay outside it.
The second point I wanted to touch on is the public discourse in the avoidance sphere.
I am pleased that we have, collectively, found a voice. I am pleased that Margaret Hodge has acted as the mouthpiece for that voice: she is a very effective one. And I find the notion that there is a moral element in taxation to be free of difficulty.
However, that moral voice must not be confused with the legal voice.
Heaven help us if first tier tax tribunal judges – I think there’s one or two in the audience and if you had bread rolls to hand I’d point them out – become arbiters of morality. Take it from me – they lack the qualifications. Indeed, some of us tax lawyers barely possess the life skills necessary to be let be out alone after dark. That’s why I’ve brought my wife – she’s here to take me home once I’ve finished lecturing you lot on tax law.
More seriously – but no less alarmingly – is the notion that the moral voice should become an arbiter of tax consequences. And there is a lot of that happening.
There are some Inspectors at HMRC who are refusing to do deals with taxpayers that they absolutely should do. And they are refusing to do those deals because they are afraid of those deals being hauled over the coals by the Public Accounts Committee. And I know this because they’ve told me. Explicitly.
And that’s not good at all. It’s bad for the administration of the tax system. It’s bad for investment. It blunts the effectiveness of tax reliefs as a tool for encouraging investment. And it’s critically bad for the country. I’d like to see greater leadership being shown on this issue by the senior people at HMRC.
I want to finish with the most important point I’ll make this evening.
We have collectively, all of us taxpayers in the room and all of those taxpayers out there, some £14bn of exposure to marketed artificial avoidance schemes. That’s a HM Treasury figure. It’s a huge number. It’s almost half the tax gap.
A huge chunk of it represents exposure to two issues: what is a “trade” and what does the phrase “incurred on” mean? The two leading cases on these issues are plodding their way through the appellate system. So far HMRC has won. But so far the cases have only come before the lower tribunals. And I think it’s far from certain HMRC will win on appeal.
That’s only my view. So let’s assume I’m wrong.
The quoted figure for HMRC succeeding in avoidance cases is 80%. And Treasury extrapolates all sorts of stuff from that 80% figure, including HMRC’s prospects of success going forward. But that’s a figure from a four year period (April 2010-March 2014) that has been a prolonged golden moment for winning avoidance cases. It’s like looking at the performance of the London property market over the last couple of years and concluding therefrom that the London property market will always rise by 20% per annum.
Moreover, there is a heavy bias in that period to cases before the junior tribunals. And it’s punchy to assume that superior courts will follow their lead – there are many examples where they haven’t. The obvious example is a case called Conde Nast where the taxpayer lost in every tribunal except the House of Lords (where I appeared for the first time – I do win occasionally). The Exchequer’s exposure to that case ran into many billions.
So if you dig into the evidence, you can see that there are very real reasons to think we might be seriously understating the risk that HMRC will lose one or even both of those issues on appeal. And, although I don’t have the breadth of perspective that HM Treasury does, from what I’ve seen I think it’s reasonable to assume a loss on one of those issues might represent a loss of £5bn of tax.
Now, the other element in the equation is this: at what price will the taxpayer settle? Here, too, we have a golden moment. Taxpayers today are desperate to settle. They are dispirited by a run of losses at first instance and in the Upper Tribunal. They will settle for less than – looked at dispassionately – they should.
So, if you’re Treasury, limited downside (low cost of settling) and big upside (no contingency risk).
A courageous Government would recognise these facts. It would act in the public interest and settle these cases at knock down prices. It would relinquish that contingent £14bn in return for a certain £11bn. It would be criticised for doing so – but it would be right.