“I had a dream about you. I invented and sold shoes that left no footprints, and you were thinking about committing a murder in a muddy area. I said that committing a murder was a bad idea, and that you should commit several murders, but I was just trying to sell more shoes. ”
― Jarod Kintz, We Had A #Dream About You
The ratio of the decision of the Second Division of the Court of Session may be summarised as follows:
Emoluments are payments in respect to services and they are regarded as paid when they are paid to the employee or to any third person with either his agreement or acquiescence.
The court takes the view that, when determining tax liability, one is, in such cases, entitled to go beyond the position in law and, in particular, the legal entitlement of the taxpayer. In the case before it, the court then held that the payments to the Employee Remuneration Trust were in themselves payments of emoluments to employees, At paragraph , the court holds:
The first submission made by HMRC was that the scheme involving payments to the various trusts and the application of the monies so paid amounted to a mere redirection of earnings which did not remove the liability of employees to income tax. In our opinion this submission is correct, and accordingly the appeal must be allowed on this ground.
It followed that a liability to income tax arose to employees concerned at the point of contribution to the trust and that the terms of the trusts or loans were not in themselves material.
 The fundamental principle that emerges from these cases appears to us to be clear: if income is derived from an employee’s services qua employee, it is an emolument or earnings, and is thus assessable to income tax, even if the employee requests or agrees that it be redirected to a third party. That accords with common sense. If the law were otherwise, an employee could readily avoid tax by redirecting income to members of his family to meet outgoings that he would normally pay: for example to a trust for his wife, as in Hadlee, or to trustees to pay for his children’s education or the outgoings on the family home. It follows that, if the principle applies, it is irrelevant that the redirection is through the medium of trust arrangements. It is equally irrelevant that the trustees who receive the payment, at whatever remove, exercise a genuine discretion as to what happens to the funds. The funds are ultimately derived as consideration for the employee’s services, and on that basis they are properly to be considered emoluments or earnings.
The three cases relied upon by the court in arriving at its ratio do not go towards the point in contention in this case. Brumby v Milner is a case which relates to what emoluments are for (i.e. whether they arise from the employment) and not so much about what emoluments are in the first place or when they can be said to have been received. Admittedly, Brumby is only relied upon on the basis that the House of Lords and the Court of Appeal in that case adopted a realistic approach to the facts – and this is then put forward by the court as encouragement for the broad-brush approach it then seeks to develop here. The irony is that in doing so they have perturbed the clear matrix which the House of Lords in Brumby espoused – which is that emoluments are received when they are placed at the unreserved disposal of the employee (in Brumby, the tax arose on distributions from the trust). A second irony is that in refusing to give weight to the terms of the sub-trust or the legal entitlement of the employee (in respect to the amounts which were contributed to the trust), the court has focused on a very narrow aspect of the realities of the arrangements in place there.
Setting aside the strict legal position, it is clear that the court was driven primarily by policy considerations. The court is right in idetifying the potential mischief here:
 The fundamental principle that emerges from these cases appears to us to be clear: if income is derived from an employee’s services qua employee, it is an emolument or earnings, and is thus assessable to income tax, even if the employee requests or agrees that it be redirected to a third party. That accords with common sense. If the law were otherwise, an employee could readily avoid tax by redirecting income to members of his family to meet outgoings that he would normally pay: for example to a trust for his wife, as in Hadlee, or to trustees to pay for his children’s education or the outgoings on the family home.
The objective of countering this mischief is one with which all would naturally have great sympathy with. However, the court appears to proceed on the assumption that this would be the first time such a notion would ever have occurred to any person. And that the tax field is somehow a barren landscape where the legislator or the courts have never given thought to the problem. There is no regard made in the decision of the host of anti-tax avoidance rules which already cater for this problem. The settlements code is not considered – in which context the courts have previously had to adopt a restrictive approach in light of the anomalies which would otherwise arise. This line of cases proceeds on the assumption that there is no problem with income arising to another person provided that this is done on a commercial footing. The agencies or PSC legislation is also not considered, a set of rules under which the legislator fully assumes that the fruits of one’s personal exertions may accrue to another person (such as the company of the person concerned). Most problematically, Part 7A of ITEPA is not considered. So, we now face the prospect of a charge on a contribution in to a trust and then one out of the trust too. Taking into account Part 7A, we have gone to having two sets of Draconian avoidance inventions to the same (non)problem, which together create a new (real) one.
The courts should not take on the role of legislator. In particular, when it comes to the attribution of A to B – among other things, it is only the legislator who, once he has made the re-attribution, can award B the right under general law to have recourse to A.
There are a great deal many other objections to be made here and these I expound on in my opinions. For the time being and setting aside the legal and policy-based problems with the decision, it would be in the interests of caution to meet it on its own terms. Though depending on the facts, this ought to be capable of being done with relative ease.
And, downward, it flows on; and when that ditch,
ill-fated and accursed, grows wider, it
finds, more and more, the dogs becoming wolves.
– Purgatorio, Canto XIV
“Hey, hey, hey, baby I got your money, don’t you worry…..”
– Got Your Money, Pop Song, 1999
1. Accelerated Payment and Follower Notices: Part 4 of the Finance Act 2014
These were introduced following a consultation in 2013. However, the draft did not appear till the Finance Bill itself.
Follower notices and APN are related but not quite the same thing. A Follower Notice in effect allows for a penalty (i.e. an additional amount) where, in the course of an ongoing enquiry, the taxpayer does not capitulate in light of a ruling which in HMRC’s opinion is determinative of the issue concerned.
An APN seeks to bring the payment of the disputed tax itself forward. The use of the word ‘accelerated’ is misleading here. You can only accelerate something which is headed in your direction in the first place. (You could import a cow from the grazing fields of Montana and let it lose on me but I feel that it would be an exaggeration to call that an acceleration…) Anyway, the regime is better described as an assumption of the tax treatment being in HMRC’s favour. The APN regime comes with its own penalties for non-payment. The issue of a Follower Notice constitutes one of the three gateways into the APN regime.
Chapter 2: Follower Notices
2. When can a Follower Notice be given?
204 Circumstances in which a follower notice may be given
(1) HMRC may give a notice (a “follower notice”) to a person (“P”) if Conditions A to D are met.
(2) Condition A is that— (a) a tax enquiry is in progress into a return or claim made by P in relation to a relevant tax, or (b) P has made a tax appeal (by notifying HMRC or otherwise) in relation to a relevant tax, but that appeal has not yet been— (i) determined by the tribunal or court to which it is addressed, or (ii) abandoned or otherwise disposed of.
(3) Condition B is that the return or claim or, as the case may be, appeal is made on the basis that a particular tax advantage (“the asserted advantage”) results from particular tax arrangements (“the chosen arrangements”).
(4) Condition C is that HMRC is of the opinion that there is a judicial ruling which is relevant to the chosen arrangements.
(5) Condition D is that no previous follower notice has been given to the same person (and not withdrawn) by reference to the same tax advantage, tax arrangements, judicial ruling and tax period.
(6) A follower notice may not be given after the end of the period of 12 months beginning with the later of—
(a) the day on which the judicial ruling mentioned in Condition C is made, and (b) the day the return or claim to which subsection (2)(a) refers was received by HMRC or (as the case may be) the day the tax appeal to which subsection (2)(b) refers was made.
3. Judicial Ruling:
205“Judicial ruling” and circumstances in which a ruling is “relevant”
(1) This section applies for the purposes of this Chapter.
(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— (a) it relates to tax arrangements, (b) the principles laid down, or reasoning given, in the ruling would, if applied to the chosen arrangements, deny the asserted advantage or a part of that advantage, and (c) it is a final ruling.
(4) A judicial ruling is a “final ruling” if it is— (a) a ruling of the Supreme Court, or (b) a ruling of any other court or tribunal in circumstances where— (i) no appeal may be made against the ruling, (ii) if an appeal may be made against the ruling with permission, the time limit for applications has expired and either no application has been made or permission has been refused, (iii) if such permission to appeal against the ruling has been granted or is not required, no appeal has been made within the time limit for appeals, or (iv) if an appeal was made, it was abandoned or otherwise disposed of before it was determined by the court or tribunal to which it was addressed.
(5) Where a judicial ruling is final by virtue of sub-paragraph (ii), (iii) or (iv) of subsection (4)(b), the ruling is treated as made at the time when the sub-paragraph in question is first satisfied.
The ruling needs to have been final (Supreme Court) or else not appealed for whatever reason or capable of being appealed. There’s something strange about this. If someone else’s appeal is ongoing, we’ll wait for it. But in the case of our own appeal we may not and are required to pay up now.
The question arises as to when a ruling would be ‘relevant’ for the purposes of subsection (3). The following points arise. First, as a matter of English common law, there is, of course, no compunction on a judge or tribunal to give reasons. The judge may apply reasoning but where this is not expressed, the position is unclear. Second, the ruling would only be relevant to the extent that it was a ‘holding’ rather than a pure ‘finding’ of particular facts: this follows from the use of the word ‘principle’ and the general tenor of the section. Likewise, the ruling would only be relevant to the extent that the facts were the same (or materially similar) in both cases. For instance, in Philip Boyle, the purported making of loans were treated as outright payments whereas in cases such as Sempra, Dextra and Murray Holdings, the purported loans were recognised as just that – loans. The difference lay in the facts – or rather the findings of fact, which in turn hinged on the delicate weighing up in court of matters such as the credibility of the witnesses and their understanding of the arrangements. Third, problems will arise when a judge accepts a proposition expounded by one party without any reason – this does happen (and sometimes with the mistaken consent of the other party). Fourth, the interpretation given to a word or phrase in a decision may be context specific. An examination of Stroud’s dictionary indicates that it is more often than not futile to attempt to transplant the meaning or connotation conferred on a particular word as found in one provision to the same word when found in another (I find that dictionary definitions often simply provide a useful starting point for judges but one they are happy to stray away from at the behest of the context). Applications of the GAAR (or, say, discussions on the old common law test of residence or the present test of domicile or particularly widely worded provisions such as TiS or section 75A FA 03) will be resistant to giving up nuggets to be catapulted at other taxpayers. Fifth, the correct arguments may not have been raised – for an obvious instance, the question of the engagement of EU Treaty Freedoms was not raised in TAA cases until 2014. Sixth, the position where there is an out-of-court settlement (in particular, on appeal by the taxpayer but before that appeal is heard by the higher tier court or tribunal) does not appear to be taken into account. In certain cases, there may now be some incentive for appeals to be made by taxpayers – especially connected taxpayers – where they would not before (or for HMRC to settle so as to crystallise a decision which favours them). Seventh, the prospect that a court may expressly reverse an earlier decision is not factored in (for an instance of this occurring in tax, see my article on Congreve in TAA and the Overkill Defence). Eight, the question of the ‘relevance’ of a decision does not take into account the inherent pluralism of the decision-making process and in particular the fact that a decision will often consist of the pronouncements of multiple judges. There are decisions where, say, three judges give three different reasons for arriving at a decision, the fourth abstains and the fifth appears to agree with all the others.
This is just a list of potential problems which occur to the writer at present – in practice, there may be any number of reasons as to why one reliance on one ruling may not be appropriate in another case. One could write a book on it and it might be said that Bennion has already done so.
4. Review by HMRC
207 Representations about a follower notice
(1) Where a follower notice is given under section 204, P has 90 days beginning with the day that notice is given to send written representations to HMRC objecting to the notice on the grounds that— (a) Condition A, B or D in section 204 was not met, (b) the judicial ruling specified in the notice is not one which is relevant to the chosen arrangements, or (c) the notice was not given within the period specified in subsection (6) of that section.
(2) HMRC must consider any representations made in accordance with subsection (1).
(3) Having considered the representations, HMRC must determine whether to— (a) confirm the follower notice (with or without amendment), or (b) withdraw the follower notice, and notify P accordingly.
The right representations may result in the notice being withdrawn. There is a 90 day period within which to seek review. This review is desirable because, apart from the time allowance, it is questionable whether a judicial review can really be sought where another recourse is available.
208 Penalty if corrective action not taken in response to follower notice
(1) This section applies where a follower notice is given to P (and not withdrawn).
(2) P is liable to pay a penalty if the necessary corrective action is not taken in respect of the denied advantage (if any) before the specified time.
(3) In this Chapter “the denied advantage” means so much of the asserted advantage (see section 204(3)) as is denied by the application of the principles laid down, or reasoning given, in the judicial ruling identified in the follower notice under section 206(a).
(4) The necessary corrective action is taken in respect of the denied advantage if (and only if) P takes the steps set out in subsections (5) and (6).
(5) The first step is that— (a) in the case of a follower notice given by virtue of section 204(2)(a), P amends a return or claim to counteract the denied advantage; (b) in the case of a follower notice given by virtue of section 204(2)(b), P takes all necessary action to enter into an agreement with HMRC (in writing) for the purpose of relinquishing the denied advantage.
(6) The second step is that P notifies HMRC— (a) that P has taken the first step, and (b) of the denied advantage and (where different) the additional amount which has or will become due and payable in respect of tax by reason of the first step being taken.
(7) In determining the additional amount which has or will become due and payable in respect of tax for the purposes of subsection (6)(b), it is to be assumed that, where P takes the necessary action as mentioned in subsection (5)(b), the agreement is then entered into.
(8) In this Chapter— • “the specified time” means— (a) if no representations objecting to the follower notice were made by P in accordance with subsection (1) of section 207, the end of the 90 day post-notice period; (b) if such representations were made and the notice is confirmed under that section (with or without amendment), the later of— (i) the end of the 90 day post-notice period, and (ii) the end of the 30 day post-representations period; • “the 90 day post-notice period” means the period of 90 days beginning with the day on which the follower notice is given; • “the 30 day post-representations period” means the period of 30 days beginning with the day on which P is notified of HMRC’s determination under section 207.
(9) No enactment limiting the time during which amendments may be made to returns or claims operates to prevent P taking the first step mentioned in subsection (5)(a) before the tax enquiry is closed (whether or not before the specified time).
(10) No appeal may be brought, by virtue of a provision mentioned in subsection (11), against an amendment made by a closure notice in respect of a tax enquiry to the extent that the amendment takes into account an amendment made by P to a return or claim in taking the first step mentioned in subsection (5)(a) (whether or not that amendment was made before the specified time).
(11) The provisions are— (a) section 31(1)(b) or (c) of TMA 1970, (b) paragraph 9 of Schedule 1A to TMA 1970, (c) paragraph 34(3) of Schedule 18 to FA 1998, (d) paragraph 35(1)(b) of Schedule 10 to FA 2003, and (e) paragraph 35(1)(b) of Schedule 33 to FA 2013.
The taxpayer has a month after the HMRC’s review to take corrective action. Corrective action means adjusting the assessment or settling with HMRC. The concept of ‘denied advantage’ may be a bone of contention in itself – as an acceptance of governing principles may not determine the entire issue.
6. Amount of penalty
209 Amount of a section 208 penalty
(1) The penalty under section 208 is 50% of the value of the denied advantage.
(2) Schedule 30 contains provision about how the denied advantage is valued for the purposes of calculating penalties under this section.
(3) Where P before the specified time— (a) amends a return or claim to counteract part of the denied advantage only, or (b) takes all necessary action to enter into an agreement with HMRC (in writing) for the purposes of relinquishing part of the denied advantage only, in subsections (1) and (2) the references to the denied advantage are to be read as references to the remainder of the denied advantage.
As noted, the ‘denied advantage’ may in itself be in dispute. There may be a reduction for co-operation:
210 Reduction of a section 208 penalty for co-operation
(1) Where— (a) P is liable to pay a penalty under section 208 of the amount specified in section 209(1), (b) the penalty has not yet been assessed, and (c) P has co-operated with HMRC, HMRC may reduce the amount of that penalty to reflect the quality of that co-operation.
(2) In relation to co-operation, “quality” includes timing, nature and extent.
(3) P has co-operated with HMRC only if P has done one or more of the following— (a) provided reasonable assistance to HMRC in quantifying the tax advantage; (b) counteracted the denied advantage; (c) provided HMRC with information enabling corrective action to be taken by HMRC; (d) provided HMRC with information enabling HMRC to enter an agreement with P for the purpose of counteracting the denied advantage; (e) allowed HMRC to access tax records for the purpose of ensuring that the denied advantage is fully counteracted.
(4) But nothing in this section permits HMRC to reduce a penalty to less than 10% of the value of the denied advantage.
The payment must be in a month of notification of the penalty: (3) A penalty under section 208 must be paid before the end of the period of 30 days beginning with the day on which the person is notified of the penalty under subsection (2).
7. Repayment of penalty:
213 Alteration of assessment of a section 208 penalty
(1) After notification of an assessment has been given to a person under section 211(2), the assessment may not be altered except in accordance with this section or on appeal.
(2) A supplementary assessment may be made in respect of a penalty if an earlier assessment operated by reference to an underestimate of the value of the denied advantage.
(3) An assessment or supplementary assessment may be revised as necessary if it operated by reference to an overestimate of the denied advantage; and, where more than the resulting assessed penalty has already been paid by the person to HMRC, the excess must be repaid.
So, once again the ‘denied advantage’ is key. Who decides if there’s been an over-estimate or an under-estimate?
8. Appeal of penalty:
214 Appeal against a section 208 penalty
(1) P may appeal against a decision of HMRC that a penalty is payable by P under section 208.
(2) P may appeal against a decision of HMRC as to the amount of a penalty payable by P under section 208.
(3) The grounds on which an appeal under subsection (1) may be made include in particular— (a) that Condition A, B or D in section 204 was not met in relation to the follower notice,
(b) that the judicial ruling specified in the notice is not one which is relevant to the chosen arrangements,
(c) that the notice was not given within the period specified in subsection (6) of that section, or…
These grounds are to be expected – as they pertain to the applicability of the Follower Notice regime. However, in addition, there’s a reasonable excuse defence too:
(d) that it was reasonable in all the circumstances for P not to have taken the necessary corrective action (see section 208(4)) in respect of the denied advantage.
The inclusion of (d) here is a revelation. At first glance, it is strange that one might be in a position where he is unable to rely on sub-paragraphs (a) to (c) (in other words, all the conditions pertaining to the applicability of the Follower Notice regime are indeed met) but where he is nonetheless excused from a penalty under the regime. ‘Reasonable’ is generally not exhaustively conceptualised for the purposes of tax legislation. However, it appears to me that the legislator is leaving open the prospect of there being an exemption from the regime even where there is otherwise a relevant judicial ruling. It strikes me that the most likely instance of such a case is where there is a reasonable argument that the relevant ruling was inadequately argued or the decision (or its application to the present case) otherwise questionable. Two other points: ‘reasonableness’ is a spectrum – so as long as there was a reason (i.e. for not having taken the corrective action) which would have appealed to the man on the Clapham Common omnibus, then the appeal would succeed notwithstanding that the tribunal would not have adopted that approach themselves. Second, reliance on counsel’s advice on complex matters is normally and quite rightly recognised as constituting a reasonable excuse.
The appeal must be made within a month of the penalty notification being given:
(4) An appeal under this section must be made within the period of 30 days beginning with the day on which notification of the penalty is given under section 211.
(5) An appeal under this section is to be treated in the same way as an appeal against an assessment to the tax concerned (including by the application of any provision about bringing the appeal by notice to HMRC, about HMRC’s review of the decision or about determination of the appeal by the First-tier Tribunal or Upper Tribunal).
Payment is deferred until after the appeal is determined.
Chapter 3: Accelerated Payment Notices
9. When can an APN be given?
219 Circumstances in which an accelerated payment notice may be given
(1) HMRC may give a notice (an “accelerated payment notice”) to a person (“P”) if Conditions A to C are met.
(2) Condition A is that— (a) a tax enquiry is in progress into a return or claim made by P in relation to a relevant tax, or (b) P has made a tax appeal (by notifying HMRC or otherwise) in relation to a relevant tax but that appeal has not yet been— (i) determined by the tribunal or court to which it is addressed, or (ii) abandoned or otherwise disposed of. This seems rather unfair – it isn’t the case that payments pending appeal are brought forward. The tax enquiry itself can trigger off acceleration. Of course, the other conditions need to be met too but this one has relevance to timing:
(3) Condition B is that the return or claim or, as the case may be, appeal is made on the basis that a particular tax advantage (“the asserted advantage”) results from particular arrangements (“the chosen arrangements”).
(4) Condition C is that one or more of the following requirements are met— (a) HMRC has given (or, at the same time as giving the accelerated payment notice, gives) P a follower notice under Chapter 2— (i) in relation to the same return or claim or, as the case may be, appeal, and (ii) by reason of the same tax advantage and the chosen arrangements; (b) the chosen arrangements are DOTAS arrangements; (c) a GAAR counteraction notice has been given in relation to the asserted advantage or part of it and the chosen arrangements (or is so given at the same time as the accelerated payment notice) in a case where the stated opinion of at least two of the members of the sub-panel of the GAAR Advisory Panel which considered the matter under paragraph 10 of Schedule 43 to FA 2013 was as set out in paragraph 11(3)(b) of that Schedule (entering into tax arrangements not reasonable course of action etc).
(5) “DOTAS arrangements” means— (a) notifiable arrangements to which HMRC has allocated a reference number under section 311 of FA 2004, (b) notifiable arrangements implementing a notifiable proposal where HMRC has allocated a reference number under that section to the proposed notifiable arrangements, or (c) arrangements in respect of which the promoter must provide prescribed information under section 312(2) of that Act by reason of the arrangements being substantially the same as notifiable arrangements within paragraph (a) or (b).
(6) But the notifiable arrangements within subsection (5) do not include arrangements in relation to which HMRC has given notice under section 312(6) of FA 2004 (notice that promoters not under duty imposed to notify client of reference number).
(7) “GAAR counteraction notice” means a notice under paragraph 12 of Schedule 43 to FA 2013 (notice of final decision to counteract under the general anti-abuse rule).
10. Effect of the APN
223 Effect of notice given while tax enquiry is in progress
(1) This section applies where an accelerated payment notice is given by virtue of section 219(2)(a) (notice given while a tax enquiry is in progress) (and not withdrawn).
(2) P must make a payment (“the accelerated payment”) to HMRC of the amount specified in the notice in accordance with section 220(2)(b).
(3) The accelerated payment is to be treated as a payment on account of the understated tax (see section 220).
(4) The accelerated payment must be made before the end of the payment period.
(5) “The payment period” means— (a) if P made no representations under section 222, the period of 90 days beginning with the day on which the accelerated payment notice is given, and (b) if P made such representations, whichever of the following periods ends later— (i) the 90 day period mentioned in paragraph (a); (ii) the period of 30 days beginning with the day on which P is notified under section 222 of HMRC’s determination. Payment must be made in 3 months from the date of the APN or one month from the determination by HMRC of its review.
11. How much is to be paid?
(4) “The understated tax” means the additional amount that would be due and payable in respect of tax if— (a) in the case of a notice given by virtue of section 219(4)(a) (cases where a follower notice is given)— (i) it were assumed that the explanation given in the follower notice in question under section 206(b) is correct, and (ii) the necessary corrective action were taken under section 208 in respect of what the designated HMRC officer determines, to the best of that officer’s information and belief, as the denied advantage; (b) in the case of a notice given by virtue of section 219(4)(b) (cases where the DOTAS requirements are met), such adjustments were made as are required to counteract what the designated HMRC officer determines, to the best of that officer’s information and belief, as the denied advantage; (c) in the case of a notice given by virtue of section 219(4)(c) (cases involving counteraction under the general anti-abuse rule), such of the adjustments set out in the GAAR counteraction notice as have effect to counteract the denied advantage were made.
(5) “The denied advantage”— (a) in the case of a notice given by virtue of section 219(4)(a), has the meaning given by section 208(3), (b) in the case of a notice given by virtue of section 219(4)(b), means so much of the asserted advantage as is not a tax advantage which results from the chosen arrangements or otherwise, and (c) in the case of a notice given by virtue of section 219(4)(c), means so much of the asserted advantage as would be counteracted by making the adjustments set out in the GAAR counteraction notice.
Section 208 provides:
(3) In this Chapter “the denied advantage” means so much of the asserted advantage (see section 204(3)) as is denied by the application of the principles laid down, or reasoning given, in the judicial ruling identified in the follower notice under section 206(a).
12. Review of the APN
222 Representations about a notice
(1) This section applies where an accelerated payment notice has been given under section 219 (and not withdrawn).
(2) P has 90 days beginning with the day that notice is given to send written representations to HMRC— (a) objecting to the notice on the grounds that Condition A, B or C in section 219 was not met, or (b) objecting to the amount specified in the notice under section 220(2)(b) or section 221(2)(b).
(3) HMRC must consider any representations made in accordance with subsection (2).
(4) Having considered the representations, HMRC must— (a) if representations were made under subsection (2)(a), determine whether— (i) to confirm the accelerated payment notice (with or without amendment), or (ii) to withdraw the accelerated payment notice, and (b) if representations were made under subsection (2)(b) (and the notice is not withdrawn under paragraph (a)), determine whether a different amount ought to have been specified under section 220(2)(b) or section 221(2)(b), and then— (i) confirm the amount specified in the notice, or (ii) amend the notice to specify a different amount, and notify P accordingly.
The taxpayer has 90 days to seek a review. There do not appear to be any provisions for an appeal to a Tribunal. The reasoning must be that the pre-conditions do not involve a value judgment. However, it would be needed to the extent that one needed to decide if there were DOTAS arrangements (in respect to one of the limbs). A withdrawal of the follower notice would assist. The appeal procedure for that has been discussed above.
13. Penalty for non-payment under APN:
226 Penalty for failure to pay accelerated payment
(1) This section applies where an accelerated payment notice is given by virtue of section 219(2)(a) (notice given while tax enquiry is in progress) (and not withdrawn).
(2) If any amount of the accelerated payment is unpaid at the end of the payment period, P is liable to a penalty of 5% of that amount.
(3) If any amount of the accelerated payment is unpaid after the end of the period of 5 months beginning with the penalty day, P is liable to a penalty of 5% of that amount.
(4) If any amount of the accelerated payment is unpaid after the end of the period of 11 months beginning with the penalty day, P is liable to a penalty of 5% of that amount.
(5) “The penalty day” means the day immediately following the end of the payment period.
(6) Where section 223(6) (accelerated payment payable by instalments when it relates to inheritance tax payable by instalments) applies to require an amount of the accelerated payment to be paid before a later time than the end of the payment period, references in subsections (2) and (5) to the end of that period are to be read, in relation to that amount, as references to that later time.
(7) Paragraphs 9 to 18 (other than paragraph 11(5)) of Schedule 56 to FA 2009 (provisions which apply to penalties for failures to make payments of tax on time) apply, with any necessary modifications, to a penalty under this section in relation to a failure by P to pay an amount of the accelerated payment as they apply to a penalty under that Schedule in relation to a failure by a person to pay an amount of tax.
First things first: these rules do not change the substantive position – that is, they do not render an effective form of planning into an inefficacious one. Rather, they make a presumption about the (in)efficacy of an arrangement where certain conditions are met – and it, of course, remains open for taxpayers to make a substantive appeal under existing routes. Any penalty under the Follower Notice regime is tax-geared, so that if the substantive appeal is successful, the penalty is discharged. At first glance, the provisions therefore represent a sort of Purgatorio from which redemption is possible.
However, the presumption under the Follower Notice does not only affect the question as to who holds the funds in the interim. It may be that the taxpayer loses his appeal and, as a result of the Follower Notice, has therefore to pay an amount in addition to the taxes and costs. So, he has had to pay a (rather high 50%) price simply for fighting his case. A fairer design would have been one under which the taxpayer had the option to appeal the Follower Notice and, if he fails and then capitulates on the substantive issue, he then has the option of paying just the tax due. However, under the present rule, if he appeals the Follower Notice and fails, then the only way he can avoid the penalty is if he wins the substantive case. So, the risk to him of pursuing litigation is asymmetrically greater. And the provisions deliberately prey on his sense of uncertainty.
Should the prospect arise of HMRC issuing a Follower Notice, the likelihood of a successful appeal (i.e. of the Follower Notice) could be factored in. On appeal, the challenge for HMRC is going to be to demonstrate that there is a ruling which does affect the planning. However, I have highlighted numerous reasons as to why it might not be proper for one ruling to be relied upon determinatively in another case – for instance, where the facts can be distinguished. Second, there is, in the form of section 214(3)(d), a defence to a penalty under the Follower Notice regime – even in cases where there is a relevant judicial ruling. What I infer from this is that the legislator is leaving open the prospect of a let-out in cases where there is good reason – such as where the other ruling was poorly argued (even though it would otherwise be relevant). So, the real target of the Follower Notice regime, as it appears to me at least, are really those cases where the taxpayer simply has no leg to stand on but persists with his appeal simply with a view to securing for himself simply the cash flow advantages of a prolonged appeal. The securing of this objective is perhaps not as benighted an aspiration as might first have appeared. However, no matter how much I might highlight the various grounds under which an appeal might successfully be made (the application of the Human Rights Act and of EU principles have rightly been considered here too), the fact remains that the very act of holding one’s position against HMRC carries, as a matter of design, the prospect of an additional levy and this is ultimately objectionably coercive.
As far as APNs are concerned, the legislator’s moral position is even less straightforward here in my view. As seen, one gateway into this regime is the issue of a Follower Notice. In addition, another gateway here is where there are, in simple terms, DOTAS or GAAR arrangements. The fact that the mere falling of an arrangement within DOTAS (which really says nothing about the efficacy of that arrangement) should bring one within the remit of the APN is problematic and hard to reconcile with the more laudable policy objectives with which I have sought to underpin these new provisions here. A far fairer approach would have been for the interim position to be based on the likely prospects of success (with a summary hearing being held to decide this).
This article is based on a speech delivered for BeyondPB in October 2014
“You know, ‘Why? Why?’ and that was a very (again, in my way of seeing America) a very American finger-snapping question. I did something magnificent and mysterious and I got a practical ‘Why?’ And the beauty of it is that I didn’t have any ‘why’.”
– Philippe Petit, Man on Wire (2008)
There is a scene in the film A Bronx Tale (1993) – which Roger Ebert rightly awarded 4 stars to – where the frustrated young protagonist Calogero is chasing an elusive acquaintance who owes him twenty dollars. He is spotted by his mentor, Sonny, who waves him over. When explained the situation, Sonny laughs and advises Calogero to forget about the loan. The way Sonny sees things is that Calogero has paid a mere twenty dollars for the privilege of not ever having to see that person again – a bargain. It is a brief exchange in a classic film which has stayed with me. So much in life depends on how we see things and we each have a slightly different way of doing so. The viewing of a transaction, such as the release of the loan, will be through the prism of motivation and this is something which the Alexanders and Parmenions of the world may not agree on.
It is strange, given just how widely accepted it is that the tax should follow the economic substance of a transaction, how little formal thought is in fact given to economics by lawyers, judges and legislators. The presumption appears to be that once the facts are established, one is drawn irresistibly to the economic substance. But this is to gainsay the notion, commonly held among economists, that theirs is a field which especially lends itself to the accommodation of hugely divergent views. The old joke being that one can have six economists in a room and seven opinions. In Capital in the Twenty First Century (which I reference in another of my pieces), the author Thomas Piketty reiterates how economics is more an art than it is a science. He says:
To put it bluntly, the discipline of economics has yet to get over its childish passion for mathematics and for purely theoretical and often highly ideological speculation, at the expense of historical research and collaboration with the other social sciences….The truth is that economics should never have sought to divorce itself from the other social sciences and can advance only in conjunction with them….
Of course, one should be weary of being flattered by highly readable economists like Piketty – or Daniel Kahneman, whose book forms the subject of this piece – into thinking that one has acquired, from a reading of them, a license to comment on their fields with some Savonarola-like authority. For instance, Piketty himself is mostly diffident about his own predictions. The real lesson to be had from their writings is that the truth remains elusive to us all and empowerment, if any, comes from the realization that we are all equally in the Garden of Tantalus when it comes to certainty on economics.
In Citizens, which I happen to be reading at the time of writing, Simon Schama states:
Public bankruptcies are a state of mind. The exact point at which a government decides that is has exhausted resources so completely that it can no longer fulfill its most basic function, the protection of sovereignty, is quite arbitrary. For great powers never go into receivership. However dreadful a financial situation they may get into, there generally will be moneymen lurking in the wings prepared to set them on their feet – at a price….
That macro-economics is rife with uncertainty was something we had all known long before the recent crisis. However, it was not until I read Daniel Kahneman’s Thinking Fast, and Slow that I fully realized that there was another branch of economics – behavioral economics – which is far more pervasive. Not only does it pervade aspects of our lives well beyond our commercial operations but it does so without our even realizing it. Just as Capital in the Twenty First Century is likely to be the dominant influence when it comes to my arguments on policy, Kahneman’s book ought to be a steady beacon in the future when it comes to practice.
The tenor of the book is best illustrated through the following puzzle. There is a woman called Linda. She likes writing about women’s rights and she doesn’t like warfare. Which of the following careers is she most likely to be pursuing?
(c) Writing about women’s rights.
Choose an option before you continue. Now: Kahneman polled people along similar lines. A very significant proportion of individuals gravitated towards (c). They did not consider that the set of (c) formed a subset of (b) – so the likelihood of one falling within (b) was, a priori, greater than falling within (c). Had no background information been proffered at all, then it is likely that they would not have made that mistake. However, the pithy introduction to Linda ‘anchored’ their minds to wrong answer. The book gives several other instances of anchoring. If you ask someone whether Gandhi was 110 years old when he died and, having received a negative response, then ask them whether he was 80 or 90 when he died, you are more likely to get 90 as a reply.
Kahneman (who was awarded the Nobel Prize in 2002) and his colleague, Amos Tversky (who died before he could be awarded it) developed the cognitive basis for biases. Before their work, the often accepted position had been that people were rational unless they were overcome by emotions. However, as the examples above indicate, heuristics can be equally detrimental to clear thinking. In his book, Kahneman settles (at least for me) the perennial question as to whether we ought to be guided in our choices by our intuition. He states that intuition is nothing other than memory. When a new person (say X) walks through a door and reminds us of another, Y, for some reason or another, then we will make a decision about X on the basis of our experience of Y. We may attribute this to ‘intuition’ – but it is (really) our minds reaching through our memories to find a match with X so that we might then make a snapshot decision about him or her. A good decision-maker uses his intuition – but also trains it, so that he factors in only information about Y which might be useful in making a determination about X.
That people are impressionable or muddled in their motivations is not a revelation. However, the value of books such as Kahneman’s and Piketty’s lies in how they refocus the mind and bring their themes to the forefront of the consciousness. On reflection, the ways in which anchoring affects tax in practice are both many and diverse. I discuss only some examples here.
Consider the HMRC & other executive Manuals. A curious realization that emerges as one goes through the manuals is that these might be misleading even where the statement within is completely true. For instance, the Manual on GAAR states:
B4 What the GAAR is not targeted at
B4.4 Similarly, decisions to invest in an ISA in order to take advantage of the income tax relief which such investments carry, or to give away assets to a son or daughter without retaining a benefit in the gifted asset, with a view to reducing the amount of inheritance tax payable on the transferor’s death, clearly fall outside the target area of the GAAR. Using statutory incentives and reliefs to support business activity and investment in a straightforward way (for example business property relief, EIS, capital allowances, patent box) are also not caught by the GAAR. However, experience has shown that incentives and reliefs can be abused. Where taxpayers set out to exploit some loophole in the tax laws e.g. by entering into contrived arrangements to obtain a relief but incurring no equivalent economic risk then they will bring themselves into the target area of the GAAR.
When viewed in isolation, there is nothing wrong with the italicised paragraph. However, it is potentially misleading in the sense that it anchors the mind to the notion that the GAAR threshold is lower than it in fact is – the test under GAAR is, of course, reasonableness. An especially cautious taxpayer or his advisor might read this paragraph with trepidation and come to the view that a form of reasonable planning – such as, say, a non-domiciliary expatriating funds – is problematic.
The Guidance on the Mixed Partnership rules provides another instance which comes to mind. The purpose of these new rules, in brief, is to ensure that where a company and individual enter into a partnership, then the profits accruing to the company from the partnership are such as would be expected. This is achieved through the concept of ‘appropriate notional return’:
B Ltd has invested £10,000 in the ABC LLP. It receives no return on this other than its profit share.
ABC LLP is paying 2% on loans on the commercial market, reflecting its good credit rating. This represents a commercial rate, so B Ltd has an appropriate notional return on capital of £200.
HMRC appear to believe that the rate of return on an investment should hinge only on the creditworthiness of the borrower. According to them, the nature of the venture, the competitiveness of the market and the strength of the wider economy appear not to have any bearing – so that a return of anything more than £200 on £10,000 is completely inappropriate. Now, if one were inclined to attribute a greater measure of business acumen to HMRC than is perhaps evinced in this Guidance, it could be argued that the Guidance here is suggesting that the £200 falls within the concept of ‘appropriate notional return’ – but, also, that there may be more as well. However, if this were the case, then one would have expected the Guidance to state that the £200 constitutes B Ltd’s appropriate notional return rather than it saying that B Ltd has an appropriate notional return of £200, which suggests something rather different. That the power of suggestion is being consciously employed here is further corroborated by the choice of the hypothetical rate of interest at a low 2%.
Turning away from Manuals and Guidance, I consider the execution of tax law itself. When reference is made to the ‘economic substance’ of a transaction, this ought to encompass two separate limbs – first, what value is being transferred from one party to another and second, why this is being done. Without knowing the psychology that undergirds a transaction, then, in the absence of there being some deeming provision, there cannot, of course, be any remuneration, any consideration, any gift, any trading receipts, any trade, any expenditure wholly and exclusively for the purposes of the trade, any view to earmarking, any distribution, any associated operation and so on. But if inferring or establishing purpose is already contentious under the apparently extant presumption of rationality, then how much more uncertain are made things when one factors into the equation the fact that individuals may not even know why they are doing what they are doing.
This may seem academic at first glance. But that questions such as these arise in practice is made palpably clear from the cases themselves. In Mallelieu v Drummond (my least favoured decision of all time), the House of Lords had to decide whether the expenses were incurred wholly or inclusively for the purposes of trade. It was accepted that the test was subjective. So, in other words, their Lordships were acting on their understanding of psychology. The chequered route which the case took on its way through the courts suggests how uncertain the position was. The House of Lords came to the view that since the individual would have needed the clothes for some reason or another, it was not open to them to hold that the taxpayer’s purpose was wholly and exclusively for the purposes of her trade. The easy riposte to this reasoning is, as I have suggested elsewhere, to say that the taxpayer would have had other clothes, so the purpose for the expenditure in respect to these particular items was the trade carried out by her. However, the object of this piece is not to replicate points made elsewhere and the concern at present is psychology. Lord Brightman considered that the taxpayer would inevitably have had the additional benefits in mind – even though there was nothing in the taxpayer’s testimony to suggest that she had and her credibility was not in question in any way. Could it not be the case that the taxpayer may simply not have considered the additional benefits, no matter how obvious those benefits may have appeared to the judges? Is it right to attribute rationality when psychologists like Kahneman argue the opposite?
In Postlethwaite’s Executors v Revenue and Customs Commissioners  STC (SCD) 83, the question arose as to whether, in transferring funds from a close company to a retirement benefit scheme, there was an intention on the part of the participator of that company to confer a gratuitous benefit upon another person. The beneficiary of the retirement scheme included, apart from the participator himself, his wife. It was held that there was no intention to confer a gratuitous benefit – as the participator was only 49:
Paragraph 95: The normal life expectation of a man in England aged 50 given in Whitaker’s Almanack (1993) was over 25 years. It was clearly unlikely that Dr Postlethwaite would die before receiving benefits even taking account of the preservation of benefits under cl 5.6 and it follows that it was unlikely that any death benefits would become payable under cl 6. While we accept that Dr Postlethwaite clearly did wish to protect his widow in the event of his early death, it seems clear that his primary intention was to be able to provide for her during his life. We do not consider such intention to be an intention to confer a gratuitous benefit on her because primarily it was to provide for himself. The element of benefit intended to be directly conferred upon her was de minimis.
The section 10 IHTA test here requires exclusivity just as much as the test in Mallelieu. However, even though some intended benefit to the wife was found here, it was overlooked. In Mallelieu, though no subjective intention other than those related to trade was found, the test was failed. I submit that the Postlethwaite approach, with an emphasis on the conscious purpose, is to be preferred. Individuals are more often than not governed by what Kahneman and others refer to the limbic part of the brain and, moving away from neurology and the opportunities of comicality it presents in its introduction here, the point being made – put more simply – is that people do make snapshot decisions on the basis of a reduced understanding of the facts. In fact, they do it all the time.
Another question which arises all the time, as I say, is what the payment is for. Whilst not so obviously expressed, this also requires a consideration of what the purpose of the payments is. Not all payments from my employer to me will be in recognition of my past services. For instance, it may be to incentivize me in the future. It may a gift (i.e. a payment which the employer would have made to me had I never been employed by him in the first place – an aspect which is considered in the context of ‘tips’). It may be for consideration provided by me under a collateral contract or to wrinkle out a problem which has arisen in the past. According to Kahneman, it may, in an economic sense, be for nothing at all:
Some years ago I had an unusual opportunity to examine the illusion of financial skill up close. I had been invited to speak to a group of investment advisers in a firm that provided financial services and other services to very wealthy clients. I asked for some data to prepare my presentation and was granted a small treasure….It was a simple matter to rank the adviser by their performance in each year and to determine whether there were persistent differences in skill among them and whether the advisers consistently achieved better returns for their clients year after year…The results resembled what you would expect from a dice-rolling contest, not a game of skill.
There may be a silver-lining to this finding. The conceptual difference between a bet and a bonus is that the latter involves the counterparty influencing the outcome. But if there is not to be any influencing in actuality and the services provided by an employee are mostly mechanistic, then the employee is better off receiving a salary for those mechanistic services and then taking an independent bet as opposed to a bonus. The winnings would not have been ‘earned’ or produced by him in an economic sense. The legal position would be complex and may well depart from the economic substance – for instance, where the bet takes the form of employment related shares, then Part 7 ITEPA would apply. If the UK tax code were really committed to tracing the economic substance of a transaction, then there would not be posited in it so many unfair deeming provisions, which provide no opportunity for rebuttal on the basis of the facts. This appears not to make the blood boil.
It sometimes appears to me that tax law is one half art, one half science. And one half distortion.
On reflection, it cannot help but be so – as it involves the coming together and meshing of so many soft disciplines – language, economics and psychology. The dicta in Barclays Mercantile is that a purposive interpretation of the law must be married to a realistic interpretation of the facts. But a realistic interpretation of the purpose of the taxpayer (which tends to be one of the facts to be established) requires a more sympathetic take on the many fallibilities of human reasoning, as demonstrated in Thinking Fast, and Slow.
On the other hand, practitioners of tax should be aware of the role ‘which anchoring’ plays in HMRC Guidance – there and also in the use of titles such as ‘Disguised Remuneration’ and ‘False Self Employment’, which have the effect of unfairly stigmatizing what are often normal commercial transactions.
In this article, I have simply highlighted how these aspects may impact the administration of tax laws. The effect of anchoring is in fact far more widespread than that of course. In “Capital in the Twenty First Century, And Tax.” I consider why it is the case that discussion on inequality hinges so much on differences on income rather than overall wealth. A significant part of the blame must lie with the media. How often is it that one reads in the media that ‘Sam Smith, who earns £80k a year…’ has violated this rule or another? This has the effect of exaggerating the differences between those of us in the lower centiles. The wealth of the proprietors of these newspapers remains undisclosed.
Because something is happening here, but you don’t know what it is, do you, Mister Jones?
– Ballad of a Thin Man, Highway Revisited, 1965
Qui dit étude dit travail,
Qui dit taf te dit les thunes,
Qui dit argent dit dépenses,
Qui dit crédit dit créance,
Qui dit dette te dit huissier…
Alors on sort pour oublier tous les problèmes.
– Alors On Dance, 2010
The current dialogue on capital
A sign of the earnestness with which the issue of global concentration of wealth has now been recognized is the fact that the movement, which rose to headlines in the form of the Occupy protests in Zuccotti Park in 2011, has now culminated in a conference hosted and attended by the economic, political and business luminaries of the world. I am referring to the conference which was held in London in May 2014 by the Inclusive Capital Initiative, a non-profit organization. Keynote speakers included HRH Prince Charles, Christine Lagard and Bill Clinton. The ICI website states that Inclusive Capitalism is committed to fixing the ‘broken escalator’ in the economist Larry Katz’s metaphor. Larry Katz’s metaphor is as follows:
Think of the American economy as a large apartment block. A century ago – even 30 years ago – it was the object of envy. But in the last generation its character has changed. The penthouses at the top keep getting larger and larger. The apartments in the middle are feeling more and more squeezed and the basement has flooded. To round it off, the elevator is no longer working. That broken elevator is what gets people down the most.
The topic of the viability of capitalism has been on the agenda over the last few years. Waves in the publishing world were made recently and notably by the publication in English of the French economist, Thomas Piketty’s book, Capital in the Twenty First Century and its runaway success. Piketty researches the dynamics of capital and income, focusing mostly on historical data from Britain and France. Of particular interest to me were the chapters on the inefficacy of the tax codes in addressing this imbalance. Piketty’s theses resonated so much with me that they inspire this piece and undergird many of the points made here.
I write now with two audiences in mind and with the aspiration of bringing them together. First, I write with the view to bringing to the wider economic dialogue the perspective of someone who has practiced UK tax law for a period approaching 10 years. Journalists and economists – Piketty included – discuss tax primarily by reference to the headline grabbing rates and thresholds. The purpose of this article is to cast some sort of light upon the more impermeable recesses of the UK tax code and demonstrate how these contribute just as much to the phenomenon of Katz’s ‘broken elevator’ as do rates and thresholds. Second, as someone who in the course of his practice has often represented the interests of what is called ‘Middle England’, it appears to me that the ideas raised in Piketty’s book demand consideration by stakeholders in the tax field – the legislator of the UK tax code, tax practitioners and the wider public. The current debate on tax avoidance acquires an altogether different complexion when one takes into account the implications of the rising accumulation of capital in the hands of the top centile.
Any views expressed here are my own. Insofar as it might be relevant, I am only accidentally political, the accident being my vocation. Nor am I an economist. I am also aware of the detractors of Piketty’s book and other controversies. For instance, I note how Piketty himself has warned of the dangers to jobs of minimum wages being introduced in Seattle. Mervyn King objects to Piketty viewing the period from 1910 to 1970 as exceptional and not reflecting the evolution of wealth in a normal capitalist society. He also highlights that the share of the top one per cent is markedly lower than it was two hundred years ago (as Piketty accepts). Mervyn King notes how the risk premium, which constitutes a large part of the return on capital, reflects the uncertainty as to the recurrence of major shocks to which capital is vulnerable. By contrast, Piketty argues that the commonly used definition of growth rates do not account for capital depreciation and demographic factors such as increasing population. However, this ought not to detract from the book as much as it constitutes a snapshot of the current state of affairs. At the ICI conference, Christine Lagard gave the following statistic:
The 85 richest people in the world, who could fit into a single London double-decker, control as much wealth as the poorest half of the global population– that is 3.5 billion people.
Nor do they undermine my criticism of the particular central feature of our tax system which I highlight here.
Tax and capital: Imagine a Robin Hood who gives to the least well off – but only takes from the middle.
I only began to seriously think about the relationship between tax policy and capital a few months ago as I sat at the back of a taxi on the way home from dinner.
A member of a political party had that day made some comments in PMQs about the ‘Tories’ millionaires tax cuts’, referring to the reduction from the 50% to the 45% additional tax rate. I can’t remember how the driver and I jovially made the faux pas of getting on to this topic but I made comments to the effect that the tax reduction wasn’t a cut for millionaires. The driver didn’t agree – in his mind, the dichotomy was between people who earned in the tens of thousands and those who earned in the hundreds of thousands, with the latter category comprising ‘millionaires’. This came somewhat as a surprise to me, I had taken it for granted that everyone appreciated the difference between wealth and income. It appeared not to have occurred to my driver that to become a millionaire with earnings of £150,000 a year, one would have to work for more than 6 years, this assuming that one did not pay any taxes and saved the entirety of their income. To be fair, one cannot fault my cabbie – he was taking his cue from the political leadership.
I began to ponder over this matter and the more I did so, it seemed to me that tax – or at least, the tax system that we have here in the UK – has the effect of pitting earners in one income tax bracket against others, but very little consideration is given to capital at all. As Piketty states:
If the capital-labor split gives rise to so many conflicts, it is due first and foremost to the extreme concentration of capital. Inequality of wealth – and of the consequent income from capital – is in fact always much greater than inequality of income from labour.
He maintains that the real disparities in society arise from differences in capital. I understand this not to be contentious.
At the same time, many in society – my cabbie and the said political leader among others – appear preoccupied with inequalities in earnings. In the case of the politician, to be fair, he was clearly in his speech employing a populist, if rebarbative, manner of attacking the tax cuts.
Moving away from public perceptions, I began to ask myself whether the legislator of the UK tax code demonstrates some cognizance of this economic truth. When one gets round to asking the question, the answer is one which comes readily to all tax practitioners. Ours is a system which is fixated on income. Indeed, if there is any tax with which the legislator is particularly interested, it is employment income. The particular code which governs the taxation of employment income (known as the ‘Income Tax Earnings and Pensions Act 2003’ or ITEPA) is the longest and most prescriptive of all. The legislator is extremely concerned to ensure that should one earn remuneration through their employment, then there ought not to be any benefit accruing to him at all which remains untaxed. This seems a highly reasonable aspiration at first glance. Though when the stringent manner of execution is considered and when a comparison is then made with the treatment of capital, a very different picture emerges.
How we treat our workers…
Whilst rates grab headlines, the challenges which our tax system poses to our workers are often found in those rules which receive lesser or no coverage in the press. I only here mention a few examples.
A few months ago I was consulted by trainee GPs who had been denied deductions for the cost of GP examinations. The cost of these examinations was in the region of £2,000 (around the monthly wage of trainee GPs) and most trainees had to sit them a couple of times before they passed, very much in the manner of the driving license tests. The reason the costs of the examinations were not deductible was because the particular statute allows only a deduction of those expenses which are ‘necessarily incurred in the performance of the duties’. Since the examinations were viewed simply as a prerequisite to there being any duties in the first place, any sums expended towards them were not deductible.
Another instance which comes to mind is the case of Mallelieu v Drummond 57 TC 330, a case from 1983 which remains legally binding to this day. The case involved a lady barrister who expended sums towards acquiring black dresses, suits, tights and shoes, and white shirts or blouses in accordance with Bar requirements. (More accurately, the sums were expended towards maintaining and replacing such clothes, as the initial cost, being a capital cost would not have qualified for a deduction in any event). HMRC, or the Inland Revenue as it then was, disallowed the deductions on the basis that these had not been incurred wholly and exclusively for the purposes of her profession. On appeal, the Tribunal agreed. It held that her purpose in making that expenditure was not only to enable her to earn profits in her profession but also to enable her to be properly clothed during the time she was on her way to Chambers or to court – or, as counsel for HMRC put it, for her ‘warmth and decency’. The High Court allowed the taxpayer’s appeal and the Court of Appeal agreed. However, when the matter eventually came before the House of Lords, it decided against deductions. Lord Brightman stated:
But she needed clothes to travel to work and clothes to wear at work, and I think it is inescapable that one object, though not a conscious motive, was the provision of the clothing that she needed as a human being…
I regret that their Lordships were not able to find more purposive a construction of the statutory rule. Could they not have taken it for a given – given the particular socio-cultural context in which the expenses were borne – that the taxpayer would have worn clothes for the purposes of warmth and decency and then arrived at the conclusion that the expenses borne in respect to these particular items of clothing were for the purposes of her profession? In our northerly jurisdiction, very little is done which does not involve considerations of warmth.
One cannot help but feel that whilst, when it comes to tackling tax avoidance, the emphasis remains at all times on overlooking the form of the transaction to arrive at the economic substance of it, when it comes to quotidian payments incurred by everyday people and which would be accepted by most economists as business expenses, an altogether different rule applies. One begins here to acquire a greater appreciation of Larry Katz’s ‘squeezed middle’.
For a much lesser known instance, I cite the decision in Flanagan v HMRC TC02161. An employee of a bank took out a mortgage from his employer. The rates of interest were commercial, those at which the bank would have lent to the public at large. There is a rule in the said ITEPA which stipulates that when an employee receives a loan from his employer and interest is paid at less than the prescribed HMRC official rates (as was the case here), then he is deemed to receive a benefit equal to that difference. Employment income tax is then levied on that benefit. The tribunal therefore held that the employee taxpayer was liable to tax on this basis. This even though the tribunal readily accepted that the stipulated official rates may be higher than the rates at which loans may be commercially available to the public at large.
Flanagan leads me to the last of the points I would like to raise in the context of employment income planning, though it is a broad one. One might well understand how a government would wish to tax a benefit (such as a loan on beneficial terms) from an employer to an employee which constitutes remuneration to the employee for his services. However, in Flanagan, the taxpayer simply happened to be an employee of the bank, which provided loans to the public at large. The purported benefit was never intended to constitute remuneration to the employee for his services. The problem arose because ITEPA assumes that a loan made from an employer to an employee is always made in connection with the employment. The tax code is peppered with assumptions of causation such as this. These many legislative assumptions contained in ITEPA, made without any opportunity of rebuttal, bar the taxpayer from being able to demonstrate his facts and place reliance on them. So keen is the legislator to prevent any benefit from slipping through the tax net, that he appears not to care that the predicated facts on which the tax is charged bear little semblance to the truth.
One of the most egregious forms of legislative deeming at present occurs in the context of self-employed workers or contractors. ITEPA contains a raft of measures which deem contractors to be employees. The tax and National Insurance position of workers and of the persons who engage their services is beneficial where the worker is self-employed rather than employed. It follows therefore that the government is concerned to discourage parties from arranging their affairs so that there is no employment. What is neglected in the course of this deeming of contractors as employees, however, is that there is a fundamental difference – well recognised both as a matter of general law and economics – between employment and self-employment. A contractor is more akin to an entrepreneur, has a greater degree of freedom and, for instance, is often likely to have ownership of intellectual property developed by himself. On the other hand, he will have none of the security and concomitant rights (such as employment pension rights – an area which has seen major recent changes in favour of employees) that come with employment. What has been held to be especially objectionable about the law in this area is not only that it seeks to tax contractors as though they were employees, it refrains from going that one step further and deeming them to be employees for the purposes of general law and, in particular, employment law. So, a contractor is left both burdened with the detriments of employment as far as tax is concerned and exposed to the vagaries of self-employment in almost every other sense. This is unfair.
Equally objectionable is the fact that the law has been introduced in the name of ‘False Self-Employment’. This stigmatises self-employment and confuses the debate. As the test which has been set by the courts as to whether or not there is employment is comprehensive and substantive, there can be no such thing as ‘false employment’, a formal shift in the drafting of the contract itself does not preclude there from being employment.
And how we treat capital…
So far, I have solely discussed the tax treatment of earners. The position is aggravated when we stand back and consider the wider arena and, in particular, asking the question: what taxes are imposed by reference to the entirety of the capital of the taxpayer?
For most purposes – and, in particular, those of raising revenue – there is none.
The closest is IHT, which is sometimes described as a ‘voluntary’ tax. This view stems from the relatively low takings, which amount to only slightly over £3 billion. The truth is that the tax is better described as a manageable tax, which allows for planning under the auspices of the legislator, such as through lifetime giving. Piketty argues that lifetime giving is more commonplace than is thought. (During the period from 1820 to 1870, the total annual value of gifts was 30 to 40% of the annual value of inheritances – these gifts mostly taking the form of dowries and other gifts on marriage. In Britain lifetime gifts have remained stable at 10% of the inheritance since the 1970s whereas in France and Germany they have increased to 60% to 80% of the total. He concedes that there may be a statistical bias and for my part, I wonder whether forced heirship laws in certain countries have some effect here on the extent to which record-keeping extends to lifetime gifts in these countries). There are two points to be made here. First, the making of lifetime gifts is made easier the more capital one has. Second, the same is true for the obtaining of legal advice. Manageable taxes are especially resented by the wider public on account of their supposedly indirect regressive nature – as in the case of expense deductions, this too is something which is not discussed as much by economists. It is interesting to note that almost whenever participants in television and radio debates complain about tax avoidance, it is more to do with the fact that wealthier individuals have access to legal advisors. In other words, it is not so much the case that others are ‘avoiding’ tax, it is more the case that others are able to pursue a route which is not seen as open to them. In actuality, neither of these two hindrances ought to constitute a bar to effective tax planning. An advisor’s fees are unlikely to constitute more than a small fraction of the inheritance tax savings (even for the more average-sized estate). And the inheritance tax code contains various straightforward exemptions, such as the spouse exemption and the donor-donee cohabitation exemption, which ought to be as applicable to those who have only the one house in their estate as it is to the wealthier. Alongside this, one must also list the one factor which an economist is more likely to focus on – the ‘nil rate band’, the threshold which is protected from inheritance tax in all estate. Whilst this band has the effect of exempting most estates in the land, it provides little comfort to greater estates. In light of all this, it appears mysterious as to why the tax continues to be levied on smaller estates. It is more likely the case that people, as in the case of pensions, simply do not plan until too late. In any event, my purpose here is not so much to consider the effect of the taxes across different classes of estates but more to compare the taxation of capital with that of earned income. As between the classes, it appears to me that inheritance tax is equally manageable in practice.
SDLT and the new ATED are not latched to wealth – even as glimpsed through the ownership of one property. They do not even take into account the extent to which the particular purchase (or ownership) has been affected through financing. In other words, the fact that I buy a house with a 90% mortgage or with no mortgage at all has no bearing on the amount of SDLT payable. Rather mysteriously, there is no principal private property relief for buyers as there is in the context of capital gains tax. This seems strange when considered alongside the ‘help to buy scheme’ and the policy objectives which must have propelled its implementation.
Capital gains tax is levied on gains alone. The tax applies asset-by-asset and that too on disposals, the timing of which the taxpayer has control over. As with the other taxes, the rates are not affected by reference to the overall capital of the person making the disposal. Furthermore, to the extent that capital is tied in the principal private residence, a disposal of the asset escapes this tax. Perhaps some indication of the regressive nature of this tax can be gleaned from the way in which the private principal property relief is defined:
222 Relief on disposal of private residence
(1) This section applies to a gain accruing to an individual so far as attributable to the disposal of, or of an interest in—
(a) a dwelling-house or part of a dwelling-house which is, or has at any time in his period of ownership been, his only or main residence, or
(b) land which he has for his own occupation and enjoyment with that residence as its garden or grounds up to the permitted area.
(2) In this section “the permitted area” means, subject to subsections (3) and (4) below, an area (inclusive of the site of the dwelling-house) of 0.5 of a hectare.
(3) Where the area required for the reasonable enjoyment of the dwelling-house (or of the part in question) as a residence, having regard to the size and character of the dwelling-house, is larger than 0.5 of a hectare, that larger area shall be the permitted area.
The subsections above define the scope of the land which qualifies for relief. What I find telling is subsection (3). If one has a small house, then the surrounding land which is also eligible for relief is limited to 0.5 hectares. On the other hand, if one has a mansion, then the prescribed upper limit is explicitly occluded.
The combined effect of these taxes is that whilst benefits are conferred to those already in the ‘real estate’ club (in the form of capital gains tax exemptions), hurdles are posed to those outside (in the form of SDLT). Of course, in this piece I am only discussing how tax contributes to growing inequality. The stretching out of society is, of course, exacerbated by the poisoned chalice of rising house prices and even without tax considerations. Rising house prices in London have made all home-owners wealthier in absolute terms and their position, relative to each other, also remains the same. The problem, of course, is that the difference between those occupying the upper echelons and those at the middle rises in absolute terms, a difference so great that normal earnings alone are unlikely to compensate for it in the future. This is a vast topic and the tax strategy to adopt in light of it ought to make up for a separate piece.
As far as the taxation of capital income is concerned, the rate on savings and on dividends is generally lower. A very curious feature of the tax code is that the exact rates here hinge on the total amounts of income – so that if I work and have greater earned income, then I may end up paying more tax on my savings and dividends income. Surely, a fairer system would ring-fence earned income so that our workers were not penalised for their industry by bearing a greater burden on unconnected income (and capital gains, which is also top-sliced). Another anomaly is that the taxation of distributions does not discriminate between distributions which have in a sense been earned and those which arise from passive investments. Indeed, cases such as PA Holdings highlight that if we earn our dividends, then we are to be treated worse off than if they were simply passive investments. One would have thought that this is just the sort of dividend which we would wish to encourage.
All this forms part of the very same UK tax code which denies trainee GPs deductions for exam expenses. Cases like Mallelieu and Flanagan may seem petty to us, but that may be part of the problem. I suspect that their implications loom far larger in the minds of the many thousands of people whom they affect than they do in the minds of our luminaries, politicians and the media.
It appears to me that there are various counter-intuitive dynamics at play here. Primarily, the notion that the same income tax rates apply to all individuals (subject only to the various thresholds) appears fair at first glance. However, as seen, even the income tax rates actually favour Balzac’s ‘rentiers’ or Aldous Huxley’s Tantamounts.
And when one takes into account capital as well as income, then the counterintuitive truth which emerges is that a parity of rates actually results in a more disparate society. The greater the capital, the smaller a proportion the income bears to one’s overall wealth. The disconnect between capital and income is most significant in the case of earned income, where the income far more often than not constitutes a greater proportion of the individual’s wealth. A taxation of this income therefore constitutes a greater detriment to a worker’s wealth and especially so when one considers the proportion of this income which must be expended towards subsistence. On the other hand, a capitalist will normally expect a yield of 5% on his capital (this usual rate of return has apparently remained constant since 1700). So, even assuming a tax of 50% on his return, one is only taxing 2.5% of his original capital (and even less of his accumulated capital), ignoring any appreciation in the course of the year.
And what can be said of rates, can be said of the wider manner in which tax is implemented. Judges are often concerned that the principle espoused in one case might result in taxpayer abuses in others. This often restricts their responsiveness to the particulars of the case before them. (For instance, in Mackinlay v Arthur Young, the House of Lords disagreed with how the lower court had factored in the large size of the firm before allowing partnership expenses. Though, as I discuss in my TAA piece, the judges are not always concerned that principles espoused by them might result in abuses in other cases by HMRC). The idea that everything and everyone should be governed by a set of uniform principles of course represents the best of British values. But could it be that we might actually wish to treat some individuals more leniently than others? Can one imagine another jurisdiction (Spain, Italy, further afield?) where a judge posed with the problem in Mallelieu v Drummond would have said, ‘You are a young barrister, a worker and have taken certain risks to secure yourself a career which is itself fraught with uncertainties….I will allow you these expenses, though I cannot promise that the same approach would be taken if you were a company laying pipelines in the North Sea.’
Why is there no reverse-Ramsay? And where are the Lord Dennings?
A cynic might even conclude that the purpose of taxation, as it presently is, quite far from being redistributive, is actually the opposite – as it preserves capital accumulated by the ‘landed gentry’ and prevents accumulation by newcomers. That this verity is somehow intuited by the young people of the land can be seen from the rise of celebrity culture – the number of those who aim to become actors, singers, footballers and the like appears to far eclipse those who aspire to join the middle classes. Admittance to a class which does not promise even a footing on the housing ladder does not appeal. The motto of the day is very much ‘All or Nothing.’ I note that Mervyn King uses ‘Winner Takes All’ in his piece.
I have wondered why it is the case that things are this way and, also, why it is not discussed more among practitioners.
As to the former, it may simply be that there have been historical reasons for this – most of the European (rated) income tax codes were set up hastily in anticipation of war. In his book, Black Swan, Nassim Nicholas Taleb argues that so taken is the system by the statistically small likelihood of certain occurrences taking place (in this context, a massive accumulation of capital), that it fails to address the contingency of them actually occurring. There is also in our system, at first glance, a very proper reluctance to subject to taxation that which has already been taxed. In other words, once something has been processed through the system, the taxpayer ought to be left in peace to enjoy the remainder. The view might be taken that to tax capital which has already been subject to income or inheritance tax is unfair. However, it appears to me that under the present system, it already is the case that, when one looks across various taxes, the same property may be subject to multiple taxes to the detriment of the same individual. For instance, a middle class earner may pay up to 45% of income tax on his earnings and his estate might then suffer a 40% charge to inheritance tax on the remainder when he dies.
As to the silence of practitioners, my brethren in the tax industry may well be wondering why I am arguing in favour of the tax net being cast even wider. Over the course of my career, I have encountered a range of moral attitudes espoused by practitioners. On the right, there are those who have a principled objection to the state’s encroachment over private property. In general terms, when one appreciates how hard it is for most earners to earn a living, one certainly has some sympathy with this diametrical reaction to the nonchalance with which people in television debates say, ‘Tax this or that person’s income….’. However, so absolute a response will not succeed in the real world. Others choose to remain silent in the name of professionalism, the idea being that it is one’s job to comment on the law as it is, not as it is meant to be. The reasoning, however, is not without conceptual problems – because of the purposive nature of interpretation, the law is at least sometimes what it is meant to be. In any event, the problem with silence is that there is a danger that moderates and well-meaning individuals are mistaken for unprincipled easy-riders.
I began with Capital in the Twenty First Century and ought to end with it. The book makes a case for a small capital tax on net wealth. This because whilst net public wealth in the richer countries is pretty much nil, net private wealth is greater than it has been for centuries. But the book also acknowledges that the time is not yet right for the imposition of such a tax. This is primarily because of the amount of global co-ordination which would be needed if such a tax were to be effective. Failed instances of such a taxation being attempted in Spain, Italy and Cyprus are cited. I would agree with the administrative objections and also have concerns that such an infrastructure, once set up, might become an instrument for populist pillaging by governments of the future. I have other problems with the book. For instance, Piketty does not ask the question as to what end tax revenues ought to be devoted to (his arguments for taxation are primarily redistributive). Also, he does not really address the question as to what steps individuals might take to better their position relative to the rich. The book makes the point that mass education is not a solution as this has the effect of turning a diploma into the high school education and simply defers competition. I query whether this is true – or, rather, whether it has to be true – in a time of globalisation. However, it is hard to take exception to a book which is expressly written with the view to encouraging debate. And in light of the extreme amounts of concentration which are the real subject of his book, it is questionable whether there is anything which could be achieved other than through taxation or central banks (in the form of inflation).
The purpose of this piece is more to highlight the issue than to provide answers. In general, it appears to me that the exemptions, reliefs and thresholds (such as the CGT residence relief discussed above or even those that might be said to emasculate IHT in many respects) are in fact undergirded by sound policy considerations, at least when applied to the wider public. What is needed is a greater, albeit measuredly gentle, articulation of the rules towards the tail end of the Bell curve which represents the spread of capital in the UK. And, equally, a reciprocal relaxation of the rules in favour of workers.
Diplomacy is the art of letting someone else have your way.
– Sir David Frost
An onslaught of judicial review claims has been predicted in light of the introduction of ‘follower notices’ by the Finance Act 2014. My own view, however, is that the review option will not be needed in genuine cases of discrepancy. This is based on my experiences of negotiating with HMRC, which have been overwhelmingly positive to date.
Consider the following scenarios in circumstances where a dispute arises over tax liabilities:
(A) HMRC disagree with you and the courts agree with them;
(B) HMRC disagree with you but the courts agree with you.
Now consider this:
(C) Your advisor writes a letter to HMRC. HMRC agree with you and withdraw 100% of their claim.
We live in a world of false choices. The focus in practice is all too often on the route that leads us down to (A) or (B), not so much on (C). Promoters start off with a ‘fighting fund’ and the selection of a litigator as primary advisor. When a dispute first arises, consensus is often not considered viable enough an option in its own right, with the instruction of a barrister being deferred until after the appeal notice has been issued. And looking back from a successful resolution, it certainly is the case that a legal team which has procured a victory in litigation has a more glamorous prize to boast of than one which has obtained a settlement or a withdrawal by HMRC of its claim.
This is strange. May I submit that there is, quite simply, no better service one can render the lay client and his insurers than to achieve the same result sooner whilst at the same time protecting him or her altogether from the stress, the burden, the vagaries, the costs and the publicity of litigation? Once you get to (B), the question which you must then really ask yourself is why (C) was not obtained in the first place. Seen this way, (B) is a failure. When you have failed to settle it is not just so much that you have failed to convince HMRC of the merits of your case, it is more that you have failed to convince HMRC that you would not fail to persuade the courts of the merits of your case – this, as a matter of logic, is a lower threshold to satisfy, as the courts will naturally not always agree with HMRC.
There are various reasons as to why there is this proclivity towards litigation, especially in terms of perception. First, there is the publicity which attaches to a decision – there is a particular date, an outcome, a label, a name. The very attraction of a sub rosa negotiation is perhaps its greatest weakness here. In addition, there is some inbuilt bias towards litigation within the legal profession itself – given that a decision is not only the source of law but also the fossil of a previous dispute, it is not surprising that our minds are inclined to viewing its ratio primarily as a tool to be applied to a subsequent dispute. The silk system has traditionally been based on experience in advocacy, even though there has rightly been a shift in recent times with a greater emphasis now being placed on securing the best outcome for a client in a dispute. As far as the lay client is concerned, there may be a distrust of HMRC and a desire for the case to be heard by the judges. There is also a sense of machismo attached to litigation which, based on my readings of non-fiction around the banking crisis, might well appeal to many in the City, lawyers and non-lawyers alike. I suspect that the greatest factor may well be momentum – the biographies of most advisors recount their involvement in cases and, to a lesser extent, settlements – but less so the ‘six’ of facilitating a withdrawal by HMRC of its claim. It may simply be that practitioners have been unsure as to how to highlight this in their resumes, given the established format which they follow.
Smoothly does it…
And so the purpose of this piece is not so much to undermine our own hard-fought victories in litigation as it is to highlight, through an adumbration of my other experiences, the seminal part that negotiation can play in practice.
When I was first training to be a barrister, negotiation was taught to us as a separate discipline, taking it’s own distinct place alongside drafting and advocacy. It then disappeared from my sphere of operations, at least on a formal basis, as I joined the tax bar. Then, in 2006, I was involved with an income tax dispute. An agreement had been reached between the client and HMRC over a telephone conference. Subsequent claims by HMRC seemed to disregard this agreement. I restated the case for the client. HMRC withdrew 100% of their claim.
In 2008, I advised on the SDLT treatment of a particular transfer of land. The matter was disclosed to the HMRC. They made some enquiries. I told the client to convey X, Y and Z to HMRC. The client did so. HMRC did not raise any further questions.
In 2012, I was involved in a VAT dispute. The client had a charity fund-raising company and auctioned goods on behalf of charities at fund-raising events. HMRC argued that the client ought to have accounted for output tax on those auctions. I wrote a letter to HMRC and they withdrew 100% of their claim.
Soon afterwards, I was involved in a residence dispute. As is usual, there had already been some correspondence by the time my involvement commenced. I wrote a letter to HMRC and they withdrew 100% of their claim.
In a period approaching 10 years, HMRC have, in any direct dealings between ourselves, always agreed to my interpretation of tax provisions.
As to why this has been the case, it seems to me that there are various factors at play here. To some extent, we are, of course, entering here those realms of professional pursuit which are governed more in their outcomes by our personal characteristics than others. Some of it must come down to the style of the negotiator concerned.
But if there is one thing which I believe to be paramount to achieving a successful early settlement, it is a consistency in the theory of the case. The concept of ‘theory of the case’ is more commonly used in criminal law but has as much a place in tax. The idea being that the parties are able to explain from the outset as to what exactly has been done and to take a strong and clear stance on what they believe the general and tax ramifications of it being done are. For instance, in Philip Boyle, there was uncertainty as to whether the payments were loans. The use of a foreign currency was claimed but not evidenced. There is nothing to be achieved in claiming facts which cannot be evidenced or in evidencing facts which cannot avail in any event (this is my understanding of the use of foreign currency here).
There will inevitably be cases where the negotiator is brought in at a later stage. As an advisor being brought in, there is nothing to be gained from lamenting past actions. A QC in our chambers, when I once made such a complaint to him, told me a joke about a man who asked another man he had come across the way to a certain town. The other man thought about it for a moment and said, ‘If I were you, I wouldn’t start from here!’ Very true. The best thing here would be for the parties to seek legal advice as soon as possible with a view to characterizing the facts and the law in the best way possible. For what it’s worth, my interventions in some of the cases above were after-the-event interventions. Often, it is the mere act of having sought detached independent legal advice which in itself goes some way towards pacifying HMRC.
But a coherent theory of the case will really be best put together where the actions have all along been based on proper legal advice. In other words, there is no substitute for sound planning. When things are done by the book, one will be in a position to provide prompt answers to any HMRC questions and nip the thing in the bud. It is not just the answer but the meticulousness which will impress. In writing for professional clients, I am in a sense preaching to the converted. However, the point is not simply that comprehensive legal advice must be sought, rather it is that planning is best proceeded with under the auspices of an expert in the particular area rather than say a litigator who may well go from one area to the next. For instance, in Leeds Design, I understand that there was some difficulty in explaining why the interest was formed as a discount. In Kings Pollen, there was difficulty in explaining the policy objectives underlying the HMRC argument. No professional is likely to have as much ownership of the planning as the architect himself. As the saying goes in the film business, ‘You are more likely to make a good film with a good script, but with a bad script, the odds are against you.’
I am conscious that there is perhaps an air of self-congratulation in my recounting of my experiences. However the clandestine nature of negotiations renders it hard to discuss negotiations other than those experienced firsthand. Furthermore, the tenor of this piece is that the key, even more than the negotiator, is sound planning ab initio. I have also tried to challenge the commonly held perception of HMRC as difficult. My experience of negotiating with HMRC has shown them to be always helpful, open-minded and, as seen, even acquiescent.
The lessons learnt from negotiation can be brought to bear on disputes arising with HMRC in the context of ‘follower notices’. It seems to me that follower notices, rather than attempting to extend the scope of judicial precedents, are targeting more those instances where the parties wish to lean on the circuitousness of the appeal system to defer the payment of tax due. I have some sympathy for what is being attempted by the legislator.
The discipline ought to be given greater consideration to in general practice too. Counsel ought to be instructed with the specific objective of settling once a dispute first looms. And when it comes to planning, the litigation tail ought not to wag the dog. Where one’s budget allows for it, advice is really best obtained from a specialist in the particular area with a record of having consistently been agreed with by none less than HMRC itself.
Schedule 13 of the Finance Act 2014 will introduce a raft of rules pertaining to partnerships. The ‘salaried members’ and ‘mixed partnership’ rules are the most far-reaching of these (but by no means the only!). The salaried members rules are domestic in scope, whereas the mixed partnership rules can apply to offshore entities too.
My concern is that many parties appear to be reacting in knee-jerk style by unravelling existing mixed structures. There are two primary reasons why this ought not to be done without careful deliberation.
First, because the new rules are not as draconian as might first appear. Through Conditions X and Y, the legislator is essentially attempting to provide a barometer through which he assesses whether the profits accruing to the corporate member are such as one might expect in circumstances where the parties are acting at arm’s length terms. To the extent that these conditions are not satisfied, profits arising to the corporate member are relocated to individual members. Whilst Conditions X and Y appear to me to provide a sufficient measure of leeway to allow for real-world practices, the Examples provided by HMRC in the concomitant guidance indicate (in my opinion, misleadingly) that the rules are far stricter than they in fact are. (Examples in executive Guidance perhaps not surprisingly tend to present a stricter view of legislation and a ready example which comes to mind is the admission in the GAAR Part D Guidance that the use of ISAs would not be viewed as an unreasonable course of action!)
Second, because to unravel existing structures with a view to addressing the mixed partnership provisions would result in an irrevocable, complete and possibly negligent forfeiture of the valuable pre-commencement GAAR protection.
There are other points arising too – those pertaining to construction and others pertaining to facts which might very reasonably be taken to preclude an application of these rules. In light of all these, I would recommend a fine-tuning of the arrangements rather than a re-structuring where possible.
The most important thing in communication is to hear what isn’t being said.
– Peter Drucker
There is much to comment on the decision of the First-tier tribunal in the Leeds Design case. However, in this short piece, I intend only to content myself to the examination of a sole point. The wide plethora of arguments did not serve to advance the taxpayer’s case. These arguments have been processed by the tribunal, its reply to them are to be found in the packaged paragraphs of its decision. The case solved. And yet. And yet there remains the curious incident of the dog in the night-time.
What were the issues arising? Before we turn to answering that question, let us first ask as to what were the issues the tribunal concerned itself with. The tribunal considered whether an undertaking, given on the part of the borrower, to pay official rates of interest could in itself be regarded as the payment of the requisite interest, so as to preclude an employment-related loan from constituting a ‘taxable cheap loan’. The taxpayer’s argument was that this ought to be the case – even in circumstances where the interest was to be simply rolled up over the course of the term of the loan rather than paid year-in year-out. The facts were complicated by the fact that the lender’s fee was expressed not as interest but rather as a discount.
The tribunal came to the conclusion that the labeling of the lender’s fee as a discount ought not in itself preclude it from constituting interest. The computation of the lender’s fee under the agreement concerned indicated that it bore all the characteristics of interest, constituting, as it did, a fee for the use of money borne by reference to time. So far, so good – for the taxpayer. Interest had accrued. However, the problem arose when the tribunal refused to accept that the accrual of interest could be viewed as the payment of interest. The case of Fenton was discussed. (I have a lot of fondness for this case for completely unconnected reasons – as the judges there accepted that the policy objective underlying the provision in question there could not be inferred – which makes it a useful addition to the quiver in the fight with GAAR). The provision concerned in Fenton was removed from the ‘taxable cheap loan’ provisions – as to how far removed, one cannot really say, in light of the accepted amorphousness of the policy objectives it embodied. In any event, in that case, the judges held that the capitalization of interest did not constitute a payment of it and, also, that ‘payment’ was an expression which derived meaning from its context. In Leeds Design, the tribunal managed an obedience to both principles. It reiterated that the expression took its meaning from its context and then also held that it meant the same as it did in Fenton, at least in the sense that capitalization could not constitute payment. In the end, one cannot take exception with this.
My own objection arises not so much from the arguments which the tribunal did address (that is, whether the compounding of interest can be viewed as a payment of it) but rather to an altogether separate point. This point was either not made to the tribunal or, if so, was considered picayune enough to be dismissed without much ado. The question when it comes to considering whether one has a taxable cheap loan, as I see it, is not so much whether interest has been paid at official rates but rather whether, under the terms of the borrowing, interest at such rates is to be paid. Assuming that this is the correct test, then Fenton and the question as to whether rolling over interest constitutes payment – questions with which both the pre-existing HMRC guidance and the tribunal concerned themselves – really fall away like fireflies in the night.
The question next arises as to how this magical switch is affected, whereby the test is adjusted from by reference to the interest actually paid to the interest contractually due under the terms of the borrowing. This is an argument which I have developed and would be happy to elaborate upon where needed to do so, so that others may rely upon it. (I have not seen any other writer espouse these views of the ‘taxable cheap loan’ provisions in their publications at the time of writing – whether in wake of the Leeds Design case or otherwise). I do not guarantee that it would be accepted but there are, in my opinion, reasonable grounds on which it is based. For the avoidance of doubt, should the argument ever be rejected by a court or precedent-setting tribunal, then I intend to leave this article posted here, as an exercise in hermeneutics. However, as promised, the weapon of choice today is the rifle and shot needs to be clean.
Section 175 ITEPA provides:
175 Benefit of taxable cheap loan treated as earnings
(1) The cash equivalent of the benefit of an employment-related loan is to be treated as earnings from the employee’s employment for a tax year if the loan is a taxable cheap loan in relation to that year.
(2) For the purposes of this Chapter an employment-related loan is a “taxable cheap loan” in relation to a particular tax year if—
(a) there is a period consisting of the whole or part of that year during which the loan is outstanding and the employee holds the employment,
(b) no interest is paid on it for that year, or the amount of interest paid on it for that year is less than the interest that would have been payable at the official rate, and
(c) none of the exceptions in sections 176 to 179 apply.
Subsection (2) provides the definition of a ‘taxable cheap loan’, without which there cannot be a charge under subsection (1). The test at (2)(b) is clearly whether there is a divergence between the official rates of interest and the interest paid for the year. My suggestion is that a reference to ‘interest paid for a year’ is to interest paid for a year! Not to interest actually paid ‘in’ a year, as appears to be argued by HMRC. However, setting aside this deeply archaic, naïve and unimaginative proclivity to go simply by the words of the legislator, there is another, more telling clue to which recourse may be had. This is found at subsection (3). Subsection (3) provides the method for calculating the ‘cash equivalent’ of the benefit:
(3) The cash equivalent of the benefit of an employment-related loan for a tax year is the difference between—
(a) the amount of interest that would have been payable on the loan for that year at the official rate, and
(b) the amount of interest (if any) actually paid on the loan for that year.
So, assuming that there is a ‘taxable cheap loan’ under subsection (2), then the computation of the charge hinges on the difference between the official rate of interest and the rate of interest which has ‘actually’ been paid. Suppose that the official rate of interest is 5% and 2% is actually paid, then the charge is 3%.
What I find telling is that (3)(b) is predicated on the assumption that there is a class (‘the class of actual payments on the loan for that year’) which forms a subset of the larger set of the class described at (2)(b) (‘the class of payments of interest on the loan for that year’). If it doesn’t form a subset of the latter, the former is at the very least something different – as the legislator is at (3)(b) simply looking at the interest payments actually made for the year (and I would respectfully submit that the former does in fact form a subset of the latter). To say that the two classes at (2)(b) and (3)(b) are the same would be to regard as otiose the very deliberate inclusion by the legislator of the word ‘actually’ at (3)(b). But the legislator is never taken to have acted in vain. And in this particular case, it seems to me to require the overlooking of a very deliberate inclusion to hold that there is not somehow a change between the two classes in his mind as he goes from one subsection to the contiguous other, as in one he looks to payments of interest for the year and in the other he considers only actual payments of interest for the year.
Now, if the class at subsection (2)(b) is not coterminous with the class at (3)(b) (and we can agree that the class at (3)(b) is rather well defined and not even I, for all my love of Hobbes, would query the concept of actuality before the First-tier tribunal), then the question arises next as to what this class is? Once we find ourselves posed with this question, the rest seems to follow rather swimmingly. The class of interest payments at (2)(b) (‘interest paid for the year’ but not ‘interest actually paid for the year’) is a reference to the contractual rate of interest – it is to the interest to be paid. There is quite simply no other candidate – and if there is, I should very much like to be told what it is.
When the realization dawns on us that the matter was really to be adjudged by reference to the contractual rates of borrowing, then those discomfiting details which so niggled at our conscious seem instead to line up in harmony. The legislator’s use of the expression ‘interest paid for the tax year’. Or ‘taxable cheap loan’. Or ‘benefit’. Everything is illuminated. But not here, not in this article. The scheme of the legislation would need to be developed into a comprehensive matrix, various objections soothed and section 191 addressed. But you are now already more than half-way there. The lawyerly expedient of taking the legislator at his word appears to bring meaning and consistency to the law.
I want a house that has got over all it’s troubles…
– Jerome K Jerome They and I (1909)
superated: adjective (archaic) overcome, surmounted, surpassed
– Collins English Dictionary
This is article on a speech I delivered at the M5 Conference at Oxford in October 2013 titled A-Ten: Ten Strategies for ATED. This article will be completed here after the KeyHaven Conference in December 2013.
1. All summer long I observed with some unease the deluge of solutions which followed the introduction of ATED. It seemed to me that the knee-jerk reaction in many cases was to liquidate and for corporate ownership to be supplanted with packaged solutions. There were two reasons for this unease. First, because even though it is mostly with approbation that I regard some of the solutions which have now obtained common currency, it appears to me that there other solutions which are not being considered and which would be far more efficacious in many cases (and I discuss some – but not all – of these solutions below). Second – and this really is the gravamen here! – is that one fundamental question which is being overlooked is whether anything really needs to be done at all. Or rather, the question more properly put is: whether the advantages hoped for from the entering into arrangements can really be said to outweigh the loss of the IHT and SDLT advantages which, we can say with relative confidence, have already been secured. I have considered what factors must be found to exist in a certain case before we reach for liquidation and I find that in many cases these factors may simply not be present.
2. One of the features of ATED is that even though it is, for the most part, a thorn in the side, to properly address it, one needs to know everything about everything if one is to preserve the overall position. The tax itself is, in simple terms, a tax on owner-occupied high value residences. I discuss the provisions in detail (and we shall even dabble in some algebra when we turn to consider ATED-related gains – you have been warned!) but I mention two salient points: It is not a tax on wealth – in an economy in which things proceed on credit and in a culture in which home ownership is perhaps the most prized investment, there ought not to be any inference which can safely be made about a person from the value of the house he or she resides in – and if there is one, I would submit that it be more to do with his or her aspirations and tastes rather than his or her wealth. It is more an indirect charge on non-domiciliaries, something which they must now effectively bear to secure certain IHT advantages (akin to the remiitance basis charge which they must pay to secure income tax advantages).Second, if you are pragmatic enough to leave the property which is in the structure and rent out another property, you can escape the tax. If you are romantic and resolve to stay in the property, then you need to consider further options. ATED is really a tax on sentimentality.
3. For the avoidance of doubt, the opinions expressed below are just that – opinions expressed in the spirit of academia. The gist of this speech is that things need to be looked at closely in each case. We start with considering the ATED provisions in detail first. Beautifully packaged solutions in PDF documents, that comes later. Before beauty, first comes blood and sweat. From Malcolm Gladwell’s David and Goliath (2013) which I just finished:
“You know there’s something about solving a math problem that’s very satisfying,” Randolph said at one point, and an almost wistful look came over his face. “You start with a problem that you may not know how to solve, but you know there are certain rules you can follow and certain approaches you can take, and often during this process, the intermediate result is more complex than what you started with, and then the final result is simple.And there’s a certain joy in making that journey.”
First, we dissect this new creature before us!
4. Part 3 of the Finance Act 2013 introduces the ATED regime. The conditions governing applicability are found in section 94. This provides:
94 Charge to tax
(1) A tax (called “annual tax on enveloped dwellings”) is to be charged in accordance with this Part.
(2) Tax is charged in respect of a chargeable interest if on one or more days in a chargeable period—
(a) the interest is a single-dwelling interest and has a taxable value of more than £2 million, and
(b) a company, partnership or collective investment scheme meets the ownership condition with respect to the interest.
(3) The tax is charged for the chargeable period concerned.
(4) A company meets the ownership condition with respect to a single-dwelling interest on any day on which the company is entitled to the interest (otherwise than as a member of a partnership or for the purposes of a collective investment scheme).
(5) A partnership meets the ownership condition with respect to a single-dwelling interest on any day on which a member of the partnership that is a company is entitled to the interest (as a member of the partnership).
(6) A collective investment scheme meets the ownership condition with respect to a single-dwelling interest on any day on which the interest is held for the purposes of the scheme.
(7) If a company is jointly entitled to a chargeable interest (as a member of a partnership or otherwise), then regardless of whether the company is entitled as a joint tenant or tenant in common (or, in Scotland, as a joint owner or owner in common) the ownership condition is regarded as met in relation to the whole chargeable interest.
(8) The chargeable periods are—
(a) the period beginning with 1 April 2013 and ending with 31 March 2014, and
(b) each subsequent period of 12 months beginning with 1 April.
(9) See also section 95.
So, one looks at the time slot of 12 months beginning the 1st April. One then asks of a chargeable interest, whether on one or more days within that period:
(1) that interest is a single-dwelling interest;
(2) has a taxable value of more than £2 million; and
(3) a company, partnership or CIS meets the ownership condition in respect of that interest.
5. The definition of chargeable interests at section 104 is similar to that adopted for SDLT. The following are not chargeable interests:
(3) An exempt interest is not a chargeable interest for the purposes of this Part.
(4) The following are exempt interests—
(a) any security interest;
(b) a licence to use or occupy land;
(c) in England and Wales or Northern Ireland, a tenancy at will.
(5) In subsection (4) “security interest” means an interest or right (other than a rentcharge) held for the purpose of securing the payment of money or the performance of any other obligation.
6. ‘Entitlement’ is central to the ownership conditions and is defined at section 95:
95 Entitlement to interests
(1) In this Part “entitled” means beneficially entitled—
(a) whether solely or jointly with another person, and
(b) whether as a member of a partnership or otherwise.
This is subject to subsection (2).
(2) References in this Part to entitlement to a single-dwelling interest (or any other chargeable interest) do not include—
(a) entitlement in the capacity of a trustee or personal representative, or
(b) entitlement as a beneficiary under a settlement.
(3) Subsection (1)(b) does not apply where the contrary is specified.
(4) In this section “settlement” has the same meaning as in Part 4 of FA 2003 (see paragraph 1 of Schedule 16 to that Act).
7. It follows from sub-paragraph (2) that in the case of a company holding as trustee of a settlement of which another company (or that company) is a beneficiary, none meets the ownership condition. For instance, A Co holding as trustee of settlement in which B Co has an interest in possession should mean that the ownership condition is not met. ‘Settlement’ does not include bare trusts.
8. In the context of the partnership ownership condition at section 94(5), a company must be a member of the partnership and must be entitled to the interest as a member of the partnership. This particular condition will not be met where the company is not so entitled.
Entitlement to the income should not suffice either for the purposes of the partnership condition. Suppose A, an individual, and Co, are in partnership. Co is not entitled to the interest as a partner or otherwise, so that A holds the interest. The partnership condition is not met.
Single-dwelling Interest and Merging
9. A ‘single-dwelling interest’ is defined at section 108(2) as:
A chargeable interest that is exclusively in or over land consisting (on any day) of a single dwelling is a single-dwelling interest (on that day).
In circumstances where the chargeable interest is in two or more single dwellings, then the person is deemed to have a separate chargeable interest over each dwelling, with each constituting a single-dwelling interest. They are not merged: tax is quite really a tax on expensive residences.
In circumstances where the chargeable interest is in land consisting of dwellings and non-residential land, then the person is deemed to have a separate single-interest dwelling in each dwelling and a chargeable interest in the rest.
It follows from the wide definition that a single-dwelling can harbour multiple single-dwelling interests. Section 109 caters for this:
109 Different interests held in the same dwelling
(1) Subsection (2) applies if on one or more days in a chargeable period—
(a) a company is entitled to two or more single-dwelling interests in the same dwelling, or
(b) two or more single-dwelling interests in the same dwelling are held for the purposes of the same collective investment scheme.
(2) This Part has effect with respect to that chargeable period as if those separate interests constituted just one single-dwelling interest, the taxable value of which on any day is the sum of the taxable values of the separate interests.
(3) In calculating the taxable values of the separate interests for the purposes of subsection (2), the market value of each interest is determined, under the provisions of TCGA 1992 applied by section 98(8), on the assumption that the other interest or interests are placed on the open market with that interest (on the valuation date appropriate to that interest).
The section therefore provides for the merging of separate single-dwelling interests held by the same person in certain circumstances. Where a company is entitled to several single-interest dwellings in the same dwelling, they are treated as one. The same where they are held for the purposes of the same CIS. Two points to make:
(1) This does not apply for the purposes of a partnership. So, suppose a partnership has three single-dwelling interests in a dwelling. Each is separate.
(2) It is also worth noting that there is no merging for individuals (relevant to below).
Section 110 provides for the further merging of single-dwelling interests in cases where different but connected persons have single-dwelling interests in the same dwelling. In the case of a company and a connected person, the company is deemed to be entitled to both of their interests:
(a) Where the connected person is a company, then the same applies to that company.
(b) Where the connected person is a CIS, then the company’s interest is also deemed to include the scheme interest (and the scheme interest is also deemed to include the company interest).
(c) However, where the connected person is an individual, then there is no merging unless the company is entitled to a single-dwelling interest in the dwelling that is a freehold or leasehold interest with a taxable value of more than £500,000
In the case of two CISs, the single-dwelling interests are also merged both ways.
(1) One important point about merging here – it can work both ways, with seemingly punitive consequences. One would have thought that in such cases (once my interest has merged with that of another, it would no longer constitute my interest. The position is actually the opposite). However, this should not result in a double charge:
104 No double charge
Tax in respect of a given single-dwelling interest is charged only once for any chargeable day even if more than one person is “the chargeable person” with respect to the tax charged.
Though there will be joint liability – section 97 provides:
97 Liability of persons jointly entitled
(1) Subsection (2) applies if—
(a) a company is within the charge for a chargeable period with respect to a single-dwelling interest by virtue of section 96(2)(a), and
(b) one or more other persons are jointly entitled to the interest on the first day in that period on which the company is within the charge with respect to it.
(2) The company and the other person or persons are jointly and severally liable for the tax charged for that period with respect to the interest (whether or not those other persons are also within the charge with respect to the interest on the day in question).
(2) If A Co, A and B each have single-dwelling interests and A Co and A are connected and A and B are connected but not A Co and B, then only the interests of A are merged with those of A Co. This is relevant to valuation.
(3) There is no merging under these rules where the single-dwelling interests are in separate dwellings. One structure which therefore suggests itself is for unconnected parties to have shares in separate residences.
(4) In order for there to be merging of A and B’s interests, each must have single-dwelling interests in the same property. There is no suggestion that if A has an interest and B does not, then for the purposes of the ATED applicability conditions and, in particular, the ownership conditions, B will, by reason of connection to A, be deemed to have A’s interest (or any interest) where B does not otherwise have one. So, if A and A Co enter into a partnership and A Co has no entitlement to the property, then the ownership condition will not be met. Merging does not really affect the question of entitlement but more the computation of the tax. The object is really to avoid interest-splitting. However, it can affect applicability as it affects the taxable value of the interest.
10. The meaning of ‘dwelling’ is provided for at section 112:
112 Meaning of “dwelling”
(1) A building or part of a building counts as a dwelling at any time when—
(a) it is used or suitable for use as a single dwelling, or
(b) it is in the process of being constructed or adapted for such use.
There are more extensions which I do not discuss here.
ATED is only concerned with expensive single residences, rather than with the value of the property as a whole. Little reliance can be placed on this in general planning, though in appropriate circumstances, ATED considerations might result in partitioning one dwelling into multiple dwellings.
An odd point which I encountered is that if suitability is a test, then there are many converted offices (or should that be converted homes?) which inhabit former Georgian residences in the Mayfair area which might be subject to ATED! In Lincoln’s Inn, some floors are used as chambers and others as residences for judges. As far as suitability is concerned, there may not be much between them. Unfortunately, in such circumstances, it would appear that one has to place reliance on the reliefs (an in-out solution) instead of being able to discount ATED altogether.
11. Under section 99, the amount of chargeable tax is the annual chargeable amount in cases where the person chargeable is within the charge to tax on the first day of the chargeable period. In any other case, it is a relevant fraction of the annual chargeable amount, this fraction being by reference to the first day on which the chargeable person is within the charge to tax with respect to the interest. The annual chargeable amount is:
£15,000 £2 million to £5 million
£35,000 £5 million to £10 million
£70,000 £10 million to £20million
£140,000 More than £20 million
In addition to this, there is, at section 105, the ‘adjusted chargeable amount’ which is a fraction of the annual chargeable amount, calculated on a pro rata basis for each day on which the chargeable person is within the charge to tax – most relevant to cases where the chargeable person does not hold the property all throughout the chargeable period. Relief needs to be claimed at section 106.
It is important to note that the column on the right represents the taxable value of the interest. The taxable value is defined at section 102 by reference to the market value on the 1st April 2012, the 1st April every 5 years and on the dates of substantial acquisition and substantial disposition:
(3) The following are also valuation dates in the case of any single-dwelling interest to which a company is entitled on the relevant day (otherwise than as a member of a partnership)—
(a) the effective date of any substantial acquisition by the company of a chargeable interest in or over the dwelling concerned;
(b) the effective date of any substantial disposal of part (but not the whole) of the single-dwelling interest.
A substantial acquisition or disposal is where the consideration is £40,000 or more. In the case of connected persons, the consideration is the market value. In the case of linked transactions, the consideration for the various acquisitions or disposals is merged.
(6) For the purposes of subsection (2) the market value of the chargeable interest acquired is taken to be the sum of the market values of that chargeable interest and any chargeable interest in or over the same dwelling that is acquired in a linked transaction.
(7) For the purposes of subsection (3) the market value of the part of the single-dwelling interest disposed of is taken to be the sum of the market values of that chargeable interest and any chargeable interest in or over the same dwelling that is disposed of in a linked transaction.
The test of linkage is the same as in SDLT. The legislation doesn’t appear to me to answer the relevant question of when the two transactions become linked. For instance, if I buy a share in property in 2012-13 for £35,000 and then another for £50,000 two years later (assuming that there is no arrangement but still a series of transactions), then it is not clear whether there is a substantial acquisition in 2012-13. Whichever rule applies (i.e. whether the linkage is retrospective or not) must apply uniformly to acquisitions and disposals. So, in appropriate cases it may be possible to accelerate or postpone the date of valuation within the obligatory 5 year frame.
12. The reliefs apply on a day-by-day basis. They include:
(A) rental property business relief;
(B) property trade relief;
(C) property to provide accommodation to an employee;
(D) financial institutions;
(F) a relief for dwellings open to the public.
13. I do not intend to cover all the reliefs here, but I do discuss one. Section 133 provides:
133 Property rental businesses
(1) A day in a chargeable period is relievable in relation to a single-dwelling interest if on that day the interest—
(a) is being exploited as a source of rents or other receipts (other than excluded rents) in the course of a qualifying property rental business carried on by a person entitled to the interest, or
(b) steps are being taken to secure that the interest will, without undue delay, be so exploited in the course of a qualifying property rental business that is being carried on, or is to be carried on, by a person entitled to the interest.
(2) A day is not relievable by virtue of subsection (1) or section 134 in the case of a single-dwelling interest if on that day a non-qualifying individual is permitted to occupy the dwelling.
(3) In this Part “qualifying property rental business” means a property rental business that is run on a commercial basis and with a view to profit.
This provides a very significant caveat to the charge – it takes out in one stroke all pure investment residential properties. It is important to note that under (1)(a) the business must be carried on by the person entitled to the interest. In addition, if arrangements are structured to qualify for this relief, then it is worth noting that the income tax charge on the rent may be more than the ATED charge (though the rent may be required to be paid in any event in light of the benefits-in-kind charge).
14. A problem will arise here in relation to the occupation by non-qualifying individuals:
(a) the relief not available on the day of such occupation;
(b) the relief is not available for any subsequent day in that chargeable period or subsequent three chargeable periods on which the same person is entitled to the interest unless there is a day of ‘qualifying use’ in the interim: section 135(2) – i.e. a day on which relief can be claimed under section 133(1)(a);
(c) a similar restriction applies to the earlier days in that chargeable period under section 135(5);
(d) occupation by a NQI also restricts other reliefs – such as property trader relief at section 141: section 141(2).
15. Section 171 is worth noting:
171 References to the state of affairs “on” a day
In determining for the purposes of any provision of this Part whether or not a state of affairs obtains on a particular day, it is to be assumed that the state of affairs obtaining at the end of the day persisted throughout the day.
This may provide a let-out in certain circumstances.
16. To me ‘occupy…the dwelling’ also sets a high threshold and arguably denotes exclusivity throughout the dwelling. This is consistent with the exclusion of licenses from the definition of chargeable interests. Section 135 provides an extension of ‘occupation’ for these purposes:
(8) For the purposes of this section—
(a) “day of qualifying use”, in relation to a single-dwelling interest, means a day that is relievable in the case of the interest by virtue of section 133(1)(a);
(b) occupation of any part of a dwelling is regarded as occupation of the dwelling.
The extension there indicates the intention here. This thus may also provide another let-out.
17. A third let-out may be found in the meaning of ‘non-qualifying individual’ itself. This is at section 136:
136 Meaning of “non-qualifying individual”
(1) In sections 133 and 135 “non-qualifying individual”, in relation to a single-dwelling interest, means any of the following—
(a) an individual who is entitled to the interest (otherwise than as a member of a partnership),
(b) an individual (“a connected person”) who is connected with a person entitled to the interest,
(c) if a person is entitled to the interest as a member of a partnership, an individual who is, or is connected with, a qualifying member of that partnership,
(d) an individual (“a relevant settlor”) who is the settlor in relation to a settlement of which a trustee is (in the capacity of trustee) connected with a person who is entitled to the interest,
(e) the spouse or civil partner of a connected person or of a relevant settlor,
(f) a relative of a connected person or of a relevant settlor, or the spouse or civil partner of a relative of a connected person or of a relevant settlor,
(g) a relative of the spouse or civil partner of a connected person or of a relevant settlor,
(h) the spouse or civil partner of a person falling within paragraph (g), or
(i) an individual who is a major participant in a relevant collective investment scheme or is connected with a major participant in a relevant collective investment scheme.
(2) In subsection (1)(c) “qualifying member”, in relation to a partnership, means a member of the partnership who is entitled to a 50% or greater share—
(a) in the income profits of the partnership, or
(b) in the partnership’s assets.
Let us consider partnerships. For the purposes of subsection (1), section 1122(7) and (8) CTA 10 do not apply – section 136(6), so that there is no connection simply by virtue of partnership. The ATED guidance says at 36.11:
Exception to Connected Persons rule – the normal rules for connected persons contains, in section 1122(7) CTA 2010, a rule that a partner in a partnership is connected with:
(a) any partner in the partnership
(b) the spouse or civil partner of any individual who is a partner in the partnership, and
(c) a relative of any individual who is a partner in the partnership
For ATED this rule will not apply when identifying a non-qualifying individual. However, it should be noted that this is an express exception to that rule and it is only in relation to interests owned by partnerships that meet the ownership condition in section 94(5) FA 2013.
However, it is not clear to me that this is what section 136(6) says:
(6) For the purposes of subsection (1), section 1122 of CTA 2010 (as applied by section 172) has effect as if subsections (7) and (8) of that section (application of rules about connected persons to partnerships) were omitted.
It seems to me that partnership connection does not apply at all for the purposes of the NQP definition, irrespective of whether the partnership condition is met or not.
18. So, if Co holds the interest (but not as a member of the partnership) but still is in a partnership with A, an individual, then provided that there is no other connection between them, A is not connected with Co and does not fall within (b). A does not fall within (a) either. (c) is not satisfied either. A can live in the property. In what circumstances would A wish for the land to be owned and profited from by an unconnected company? It would not be a company which was in a settlement of which he was the settlor or a relative of the settlor – else he might fall within (d) to (h). It could be a company the shares of which he had absolutely given away by way of (say) PET.
19. This thus presents a solution to the NQI restriction involving unconnected companies. I next consider whether things might be pushed even further and whether there may be a solution involving connected companies.
20. There appears to be a strain between (1)(b) and (c), which you pick up the first time you are reading those sub-paragraphs, even if doing so quickly! If A is connected with another person who is entitled to the interest, then he, on a technical level, falls within (b). However, (c) suggests that in the case where a person is entitled by reason of partnership, the other person with whom the individual is connected must be a qualifying member of the partnership – in other words, the other person must not just be entitled to the interest but must also be a ‘qualifying member’ (with the requisite 50% interest). It could be that the bar is being raised at (c). But if this is the case, then it must also be true that (b) only applies where the interest is not held by the connected person as a member of a partnership.
21. There are three ways to look at this.
First, it might be that (c) is really catching circumstances other than those at (b) i.e. where the other connected person does not have an entitlement to the interest but still has a 50% share of the profits or partnership assets. However, if the aspiration was to widen the scope of NQP, it seems strange that ‘qualifying member’ (which is introduced only for this purpose) would be defined so as to set so high a standard. If the other connected person has a 50% share of the partnership assets then he ought to have some interest in the property. (If (c) is to apply, then, according to its opening words, the property ought to be a partnership asset.) In other words, a person falling within (c) should, on a literal basis, already fall within (b). So, the argument that the purpose of (c) is to extend the scope of NQP has flaws.
Second, that in (c) the legislator is really raising the bar in the context of partnerships. The ATED Manual provides (regarding the restriction of the partnership connection test in this context) at 34.11:
Its effect is to ensure that connection between persons otherwise with no familial or trust connection is not established through business partnerships.
HMRC appear to believe that in the context of partnerships any connection will suffice – including section 1122(7) partnership connections. They state at 34.4:
If a person is entitled to the chargeable interest as a member of a partnership, any person who is connected with a partner in that partnership
Example two: A partnership has several members, including Mr A and B Ltd.
B Ltd is entitled to a single-dwelling interest as a member of that partnership (but, for whatever reason, Mr A is not so entitled). As Mr A is connected with B Ltd, he will be a non-qualifying individual for these purposes. Note that this specific rule is not affected by the provisions in sections 136(6).
This appears to me to be wrong on both counts! Note that this discussion is in the context of (c) and not (b) (see the bold italicized part – also, the manual provides a separate example for (b) at 34.3). This analysis which is italicized is clearly not correct – or at the very least misleading. The truth is that under (c), B Limited would need to be a qualifying member in order to render A a NQP. Also, as seen above, it does not appear that the underlined parts are correct either – the restriction of partnership connection applies for all the purposes of subsection 136(1). Furthermore, if the partnership connection restriction were not applied here, then it is hard to see why there is at (c) a requirement for connection with a particular kind of partner, as the individual would be linked with all of them.
Third, that the legislator has simply gone for the shot-gun approach and has attempted to describe as many classes without concern for the overlap between them. Whilst this cannot be discounted as a matter of policy, the points made above in relation to the two other approaches argue against this.
22. If it really is the case that the bar is being raised at (c), then the implication must be that (b) should only apply in cases where the other connected person is not entitled as a member of a partnership. The opening words of (c) corroborate this. So, too, does the parenthesis at (a). It would highly anomalous if there was an individual, P, who:
(1) was entitled to the interest as a partner (and so did not himself fall within (a)); and
(2) who was not connected to a qualifying member (and so did not fall within (c)); and
(3) so was not an NQI;
but another individual, N, connected to P, fell within (b) by reason of N’s entitlement as a member of partnership and therefore constituted an NQI. Not only would N be an NQI but so too would all his relatives, his spouse or civil partner and their relatives. (P might be caught by reason of this, though it seems a roundabout and uncertain way to bring him within the definition).
23. If the second approach is correct, then a possible structure would be where there were three corporate members of a partnership who were each entitled to a third of the interest in the property by reason of partnership. None of the companies constitute qualifying members. But they are each connected to the individual. (a) is not satisfied as the individual does not have any entitlement himself. (b) does not apply on this construction. And there is no qualifying member for the purposes of (c). Relief from ATED is possible whilst at the same time, corporate ownership allows for IHT relief.
24. The attractiveness of any of the planning routes may depend on whether a disclosure is required under DOTAS. It is therefore worth bearing the following points in mind as we consider the strategies.
25. The draft DOTAS Regulations provide:
Citation and commencement 1.— These Regulations may be cited as the Annual Tax on Enveloped Dwellings Avoidance Schemes (Prescribed Descriptions of Arrangements) Regulations 2013 and come into force on 1 October 2013.
Prescribed description of arrangements in relation to annual tax on enveloped dwellings 2.—
(1) For the purposes of Part 7 of the Finance Act 2004 (disclosure of tax avoidance schemes) the arrangements specified in paragraph (2) are prescribed in relation to annual tax on enveloped dwellings.
(2) The arrangements are prescribed if they do not comprise excluded arrangements under the Schedule to these Regulations and as a result of the arrangements, or any element of the arrangements—
- . (a) a company, partnership or collective investment scheme ceases to meet the ownership condition in respect to the chargeable interest;
- . (b) the taxable value of the chargeable interest is reduced to £2 million or less; or
- . (c) the taxable value of the chargeable interest is reduced with the consequence that the chargeable interest falls within a lower tax band than it otherwise would.
26. The Schedule provides a definition of ‘excluded arrangements’:
Arrangements are excluded from being prescribed arrangements for the purposes of these Regulations if they comprise a transfer of the chargeable interest from a company, partnership or collective investment scheme (a “transferor”) to a transferee where—
(a) the transferor and transferee are not connected persons, and the transfer is on arm’s length terms;
(b) the transferor and the transferee are members of the same group of companies, the transfer is on arm’s length terms and the transferee meets the ownership condition;
(c) the transfer constitutes a company distribution, and the transferee is an individual, a corporation sole or a person who meets the ownership condition; or
(d) the transfer constitutes a settlement.
However, I understand that the following changes are forthcoming:
- Definition of distribution now amended so that distributions by companies in liquidation will be excluded from disclosure (previously it relied on CTA definition which didn’t include a distribution by a company in liquidation);
- Distributions to trustees will be excluded;
- Transfers on arm’s length terms will be excluded (previously only if between unconnected persons);
- No retrospection at all.
27. As for timing, paragraph 2 of the draft regulations provide:
Time for providing information: transitional provisions
3.—(1) Where paragraph 2 applies, the period or time (as the case may be) to be found in accordance with regulation 5 of the Tax Avoidance Schemes (Information) Regulations 2012(3) shall end on 30 November 2013 instead of the day on which it would end by virtue of that regulation.
(2) This paragraph applies in respect of proposals or arrangements (as the case may be) that are notifiable by virtue of regulation 2 where—
. (a) for the purposes of section 308(1) of the Finance Act 2004 the relevant date in relation to a proposal falls within the period beginning with 13 December 2012 and ending on 30 September 2013;
. (b) for the purposes of section 308(3) of the Finance Act 2004 the date on which the promoter first becomes aware of any transaction forming part of the arrangements falls within the period beginning with 13 December 2012 and ending on 30 September 2013; or
. (c) for the purposes of section 309 and 310 of the Finance Act 2004 the date on which any transaction forming part of the arrangements is entered into falls within the period beginning with 13 December 2012 and ending on 30 September 2013.
So, does anything need to be done?
29. When considering solutions, one has to start with the question as to whether there is a problem in the first place. If there is no problem, then nothing needs to be done. The rule of thumb for any advisor has to be: do no harm!
30. In many cases of corporate ownership, ATED will not result in a charge – for instance, where reliance can be placed on rental business property or property trade relief.
31. Problems may, however, arise where occupation by an NQI is permitted. In addition, the ATED regime brings with it administrative burdens, the need for five-yearly valuations and the prospect of disputes with HMRC. ATED is subject to counteraction by GAAR – section 206(3)(g), so a structural change with fundamental economic consequences might be preferable in cases where the ambition is to mitigate the charge by simply falling outside its scope.
32. In addition to those problems, the charge under ATED may not be the worst aspect of falling within the ATED regime. Schedule 25 of the FA 2013 introduces a 28% charge on ‘persons’ (effectively including companies – both resident and non-resident (see the exception to section 2 TCGA inserted in the form of subsection (7A)) and those in a partnership – and certain CISs) on ATED-related gains on ‘relevant high value disposals’. In simple terms:
(a) there is a ‘relevant high value’ disposal where a chargeable interest is disposed of which includes a single-dwelling interest, where the consideration exceeds £2 million and the person was within the ATED charge with respect to that interest on one or more days and those days were not relievable under the ATED reliefs;
(b) the ‘ATED-related gain’ allows for rebasing from the 5th April 2013 (unless an election is made or the property is acquired after that date) and also allows for pro rata relief to the extent that a day was day on which the person was not within the charge to ATED or was a relievable day.
(c) the new section 2F also allows for marginal taper relief. One considers the difference between the sale price and the £2 million threshold and increases this gap this by 5/3. The extent by which the ATED-gain exceeds this amount is then relieved. If only a percentage of the relevant reference period comprises of ATED chargeable days, then this amount is then reduced to that percentage of itself. (If the property was held on the 5th April 2013 and no election is made, then the references period looks to post-5th April 2013 days which are ATED chargeable days. In any other case, one simply looks to the entirety of the period of the ownership.) The ATED-gain is reduced by this amount. So, (say) if one acquires a property for £X million and then sells it for £Y million. The gain is £(Y-X) million. The amount of available relief is (Y-X million) – [£(Y-2 million) * 5/3] (assuming that all the ownership days are ATED chargeable days). This can also be expressed as:
If this is to be a positive figure, then the following must also be greater than zero:
In such circumstances:
2Y+3X must be not more than 10.
We also know that Y must be at least 2. If Y is 2, then X can be up to 2. If Y is 3, then X can be just over 1. If Y is 4, then X must be 2/3 of a million. So, the relief will be limited to cases where Y is just under 5. Interestingly, as Y increases, X must decrease, so that the gain must be larger. The maximum relief will be in cases where Y is just under 5 and X is negligible – in such cases the tax will be on £1.66 million, with the relief peaking there at around £3.34 million (or 66.8% of the gain). However, the problem with taper relief will be satisfying the conditions pertaining to applicability.
To conclude on ATED-related gains, the position is likely to be fact-sensitive. The increase on the tax rates may be 5% (or lower depending on the relief).
33. We have considered the disadvantages. Are there any arguments for staying within the ATED regime?
(A) Many non-domiciled clients will simply be reconciled to the property tax, which is common in other jurisdictions. Client expectations are paramount.
(B) Are there any issues arising from foreign taxes?
(C) The intentions of the client are clearly very important. One would not wish to unravel a structure only for the client to return the following year with the announcement that he no longer wishes or needs to reside in the property! The question to the client should be along the lines of: Are you committed to residing in this property or, in the even that this property is sold and another is held in the same structure, that property?
(D) Will the trustees (where any) accede to the unraveling? All too often I hear advisors assume that the trustees would co-operate. Lawyers of all people mustn’t neglect to ask this question as a matter of form!
(E) SDLT is a very material consideration, which I see is being overlooked. The view might (very reasonably) be taken that an increased 5% charge on ATED-related gains is justified by a 7% or 15% reduction on SDLT (i.e. on the whole price of the property) to a prospective buyer. (I include the 15% charge here as the property may be held by the purchaser for investment purposes, in which case ATED and ATED-related gains may not be a concern to him or her. A vast proportion of London properties are brought for investment purposes. Or it may be that the buyer simply doesn’t care about ATED. Or it may be that he values more the 15% saving to the next buyer when he sells!). This argument may appear less attractive with the forthcoming lowering of the main rate of corporation tax from 2014. In addition, as time progresses, a greater part of the gains on the sale of property may constitute ATED-related gains.
But even then, the saving of 15% of the value of the property to the hypothetical future buyer of your house must be a concern. The SDLT on a £20 million house would be £3 million. The ATED would be £140,000.
Question: How many years do you have to pay ATED before you arrive at £3 million?
Answer: More than 20!
(F) The question may be determined by how pressing a concern IHT is in the case at hand – as the IHT position under the existing trust-company structure may be the most secure. Let us assume in the interests of caution that IHT would be payable in the case of the property being held in a settlement. IHT of 6% would be payable every 10 years. If the property was kept in the trust-company structure, ATED would be payable. What would the rates be? I find it curious that this is not covered in the speeches or opinions I have read. As it turns out, the effective rate of ATED really varies – on the value of the property but, more particularly, on where the value is within the relevant threshold. If you are at the lower end of the relevant threshold (whichever it may be), then the effective rate is 0.7%. At the higher end, it is as low as 0.3% (and once one breaches the last threshold, it may even less). So, what must be a consideration is where the property sits on the scale. If I am paying ATED at the rate of only 3% every 10 years, then it might not be worth incurring the risk of IHT at 6% every 10 years to avoid it.
(G) Unraveling existing structures will come with complications. DOTAS may not be as much of a concern in light of the widening of the scope of excluded arrangements. SDLT may be a concern where the property is subject to a charge. HMRC also indicate that where the shareholders assume a debt on liquidation then this ought not to constitute chargeable consideration either: Technical News Issue 5 November 2007. In the case of a transfer between companies on liquidation, section 53 and 54 FA 03 will also be relevant.
(H) In the context of CGT, the GAAR Guidance indicates that conventional methods of washing out gains may be subject to counteraction:
Option 2 – The settlor adds £4m cash to the trust in year 1. In the same year the trust liquidates the company and holds the property direct thus realising the £4m gain. It then pays the £4m cash back to the settlor in the same year.
Year 2 – the property is distributed to the son with a small amount of inheritance tax. The £4m cash payment made in Year 1 washes out the trust gains and so on the distribution of the property to the son there is no capital gains tax.
D21.7 Proposed counteraction
D21.7.1 The likely counteraction would be that the addition to the trust and payment of cash to the settlor would be ignored and the son will pay tax as under option 1.
This seems to take an extreme example and is likely to be a million miles away from the solutions which will most often be used.
A simpler solution would be payments to the other domicile (or elsewhere), with fresh payments coming in to fund the new structure.
A second would be for the property to be purchased from the offshore company with borrowing from a bank. In such circumstances, it would be arguable that the receipts by the offshore company constitute excluded property.
In certain cases, a more onerous solution would be for a UK-resident beneficiary to become non-resident for the requisite period.
To be published in December 2013.
 It is also interesting to note that the taxable amount is purely a function of Y in circumstances where marginal taper relief applies (assuming first that there is the requisite excess). Suppose that the gain is (Y-X). The amount to be reduced from this is the amount by which the gain (Y-X) exceeds the stated difference 5/3(Y-2). So the gain after relief is really:
(Y-X) – [(Y-X)-5/3(Y-2)]
This is really the same as:
Y-X – [Y-X] + [5/3(Y-2)]
This is same as:
The purchase price does not appear to have a bearing on the deemed amount of the gain. This seems to work with the HMRC example at CGM 73650:
The consideration for a disposal is £2.6 million and threshold amount for that disposal is £2 million.
5/3 of the difference between these figures (£0.6 million) is £1 million. If the whole of the gain on the disposal is ATED-related, the chargeable gain is capped at £1 million.