Tax Disputes and Investigations – April and May 2024

Our regular newsletter highlighting recent developments in the law and practice around Tax Disputes and Investigations.

Remuneration Trust Structures – an Update on HMRC activity

HMRC have notched another success in their efforts to target Remuneration Trust structures with the decision of the Upper Tribunal in Marlborough DP Ltd [2024] BTC 514.  This is the latest in a lengthening list of successful cases (see for example CIA Insurance [2022] UKFTT 144, Strategic Branding [2021] UKFTT 474 and Northwood [2023] UKFTT 351).  The case was particularly important because the First Tier Tribunal had taken an unusual approach in deciding that sums paid to the Remuneration Trust should be treated as distributions.  The Upper Tribunal overturned this decision and held that the contributions should be subject to tax under the Disguised Remuneration provisions. 

Remuneration Trust structures typically involve the contribution of funds to a trust established for the benefit of providers of finance or services.  It is usually the case that participators in a close company making contributions (or a sole trader) are excluded from benefit.  A Court of Appeal decision (Barker v Baxendale Walker [2017] EWCA Civ 2056) indicates that the exclusion from benefit is likely to impact all living associates of those persons.  Typically, the funds contributed to the trust structure are nevertheless held by a UK-based company in a fiduciary capacity.  

Following the decision in Northwood we understand that HMRC are now issuing Follower Notices requiring some users of these arrangements to withdraw appeals under threat of penalties. 

The decision in Marlborough DP illustrates the significant downside risk which users of these arrangements now face.  As well as establishing that the contributions to the trust would be subject to PAYE and NIC under the Disguised Remuneration provisions, the tribunal also held that contributions to the trust could not be deducted from profits for Corporation Tax purposes as they were not made wholly and exclusively for the purposes of the company’s trade.  This finding accords with the approach adopted by the tribunal in CIA Insurance and Strategic Branding.  The net tax exposure which is likely to arise if that rationale is applied is very significant and could greatly exceed the value of contributions made once interest and penalties are considered.

HMRC published settlement terms for users of these arrangements but formally withdrew these some time ago.  However, we understand that HMRC will consider whether a proposed settlement in accordance with those published terms could be accepted on a case-by-case basis.  HMRC may also be willing to settle in accordance with the EBT Settlement terms published in November 2020.   The tax and legal issues arising from these structures are extremely complicated.  As well as the complex tax analysis, users of these structures will also need to consider the implications from a trust and corporate law perspective.  This can also be extremely challenging.  An example can be found in Dukeries Healthcare v Bay Trust International [2021] EWHC 2086 (Ch) where an application to set aside contributions to the trust on the basis of a mistake was not granted.  Our recommendation in light of the recent developments is that users of these structures take advice as to both their tax and legal position and engage with HMRC as soon as possible with a view to minimising any potential downside risks.  A particular concern must be that HMRC now have Upper Tribunal authority which would enable a very significant tax charge to be levied and there must therefore be some doubt that they will continue to offer relatively benign settlement terms going forward.    

Electronic Sales Suppression nudge letters

HMRC are continuing to issue ‘nudge’ letters to taxpayers who it suspects have used Electronic Sales Suppression (‘ESS’) methods to under-report income to HMRC.  The letters invite a disclosure within 30 days.  HMRC direct taxpayers to their website which includes information about Electronic Sales Suppression and links to guidance on how to make a disclosure to HMRC.  There is now a separate disclosure mechanism for ESS which enables taxpayers to make an online disclosure. 

In our view, a disclosure in respect of ESS needs to be very carefully handled.  The use of ESS methods is likely to be regarded by HMRC as deliberate behaviour and it may be more appropriate for taxpayers to make disclosures under HMRC’s Contractual Disclosure Facility (‘CDF’) rather than use the stand-alone ESS facility.

Pandora Papers nudge letters

Meanwhile, HMRC are continuing to issue “nudge” letters in connection with the data obtained from the Pandora Papers.  The Pandora Papers are made up of date from offshore services providers which was released to the Consortium of Investigative Journalists and is freely available online.  This was the largest release of offshore financial data in history and comprises 11 million individual records obtained from 14 different offshore service providers.

Any clients receiving such a letter will need to consider their position extremely carefully before responding to HMRC given the significant additional risks around offshore tax issues, including both enhanced penalty regimes and the risk of HMRC criminal investigations or enquiries under Code of Practice 9.

The Labour Party’s plans for HMRC

There has obviously been a great deal of discussion about the proposals from both the Labour and (latterly) Conservative Parties to radically reform the Remittance Basis of taxation.  This will undoubtedly continue to be a significant issue for tax advisers and clients who are currently impacted by the domicile rules or who are coming to or leaving the UK.  However, the Labour Party has also announced plans which are likely to have a considerable impact on HMRC’s compliance activity going forward.  The plans include –

• Recruiting 5,000 new compliance officers who will be able to undertake investigations,
• Providing specific ring-fenced funding so that more significant and strategically important criminal cases are well-resourced,
• Further investment in AI to support HMRC’s compliance activity,
• Considering whether it would be appropriate to use deferred prosecution agreements in cases of tax fraud.

The Labour proposals also include the suggestion that HMRC will be required to provide quarterly reports on criminal investigations and the Public Accounts Committee have recently pressed HMRC for evidence that their approach to criminal investigations is having an appropriate deterrent effect given recent reductions in those investigations. 

It can therefore be expected that if, as anticipated, the next government is formed by Labour, there will be an increased focus on investigations into tax fraud and it seems highly likely that the current limited number of criminal investigations into tax evasion and enquiries under Code of Practice 9 will increase. 

Case Law update

An interesting decision of the First Tier Tribunal in Cooke v HMRC [2024] UKFTT 272 (TC) dealt with circumstances where a taxpayer fell short of the required 5% shareholding for Business Asset Disposal Relief by a miniscule amount.

Mr Cooke sold a 4.99998% shareholding in his company and realised a Capital Gain of £600,000.  HMRC contended that BADR was not available because Mr Cooke did not hold 5% of the shares.  The reason for his failure to acquire 5% of the company in the first instance was apparently a rounding error in a spreadsheet.  He had acquired 245,802 shares rather than the 245,803 which he needed.  It had however always been the intention that Mr Cooke would acquire 5% of the company.  Mr Cooke argued that, if an application had been made to the High Court, an order for rectification would be given to ensure that Mr Cooke held the required 5% and therefore he should be treated as having acquired 5% of the shares in any event.  Perhaps surprisingly, the tribunal agreed and allowed his appeal. 

The case is another example of the approach adopted following Lobler v R&C Commrs [2015] BTC 515 under which it can be argued that the Tax Tribunal should proceed on the basis that rectification will be granted if an application to the High Court would be successful. 

In Christopher Purkiss (as Liquidator of Ethos Solutions) v Tim Kennedy and others [2024] EWHC 1081, the High Court dealt with a claim by the Liquidator of Ethos Solutions Ltd, an umbrella company whose workers were paid via a tax scheme.  The scheme involved the payment of a small salary and the balance by way of loan through an Employee Trust.  The liquidator sought an order against various individual workers on the basis that the payments to workers constituted transactions defrauding creditors under s423 of the Insolvency Act 1986. 

The success of such a claim could have had profound implications for users of other similar arrangements as an order under s423 would effectively have required the workers to repay funds paid to them under the scheme.  However, the court refused to grant the order because, although it was clear that the motive for the transactions was tax avoidance, this was not sufficient to meet the requirements of s423.  Section 423 requires that the motive for the transaction must, broadly, be to put assets beyond the reach of creditors.  The court followed earlier precedent which established that a tax avoidance purpose is not, of itself, sufficient to meet the requirements of s423 because a person entering into a tax scheme in the genuine belief that it was effective cannot have had done so with the purpose of prejudicing an HMRC claim. 

The case provides some helpful clarity on the limits of liquidator’s powers to recover assets in tax avoidance (and particularly Disguised Remuneration) cases.