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HMRC

Around £1bn per year lost to fraud and error in R&D tax relief claims

20th July 2023 by Claire Ralph
  • £1.13bn – revised estimate of error and fraud in 2020-21 (previously £338m)
  • 24.4% – revised rate of error and fraud in SME scheme (previously 5.5%)
  • £1.05bn – estimated error and fraud in 2022-23

HMRC have finally published initial data from their random enquiry programme (REP) into R&D tax relief claims which indicates significant underestimates in previous calculations of fraud and error in the schemes.

Data only enables them to restate 2020-21 figures at this stage (due to time lags in completing enquiries) but these suggest £1.13bn was lost to fraud and error in the schemes in that year, up from the £338m previously reported. The bulk of this problem arises within the scheme for small and medium sized enterprises (SMEs) which accounts for over £1bn of that loss. This equates to a staggering 24.4% rate of error and fraud in the SME scheme.

HMRC’s initial estimate of the most recent tax year (2022-23) is £1.05bn lost to error and fraud related to R&D tax schemes.

TaxWatch has been reporting on problems within the R&D claims industry for some time. In particular we have focused on the increasing number of largely unregulated advisers operating as ‘claims farms’. These have used hard sell sales techniques to persuade businesses to make claims for spending that at best pushes the boundaries of the rules and at worst clearly does not qualify. The advisers take a percentage cut of the benefit received so have an incentive to claim the largest amount possible. HMRC’s pay now, check later process means that money is paid out initially, resulting in firms claiming they have a 100% success rate. However, we are aware of cases where,  when HMRC subsequently challenge a claim, the problem advisers leave their clients to deal with the enquiry, keeping the cut they have already taken.

Despite widespread discussion of these issues within the R&D claims industry, HMRC have been slow to tackle this problem. With almost 85,000 claims made in 2020-21and limited detail about each claim provided to HMRC then policing the schemes is a huge task.  However, the failure to get a grip on this issue is likely to have fuelled abuse of the schemes as advisers’ confidence in their ability to get away with it increased.

Recent increases in compliance activity by HMRC have been widely reported. Unfortunately this is alongside recurring reports of lack of skilled and experienced staff to deal with what is complex legislation. TaxWatch has long identified concerns about resourcing of HMRC for compliance activity, particularly when skilled staff recover much more than they cost (HMRC report rates of return of around 18:1). An additional concern here is that poor handling of enquiries is discouraging genuine claimants from pursuing relief through these schemes. We are aware of one business that has actually moved its R&D facility outside the UK following frustrations at how their claim was being investigated. This could end up with the worst of both worlds whereby the businesses intended to be supported do not claim and those that don’t qualify walk away with the money.

HMRC has had its resources cut by large amounts over recent years while having to deal with significant extra responsibilities of Brexit and the Covid support schemes. The nature of the work means that new investigation resources cannot just be produced at short notice as it takes some years for people to be fully trained. The problem with R&D tax reliefs identified by this new data puts a spotlight on a more widespread problem of inadequate long term funding and planning of resources for HMRC. This requires attention before large amounts more money are lost.

A pile of British bank notes.

HMRC’s 2023 Tax Gap report: Proportion of tax going unpaid unchanged from previous year

21st June 2023 by TaxWatch
  • Latest HMRC estimate of non-compliance unchanged from previous year, at 4.8% of all tax owed
  • Absolute Tax Gap figure is £35.8bn – up from £30.8bn the previous year
  • Changes to small business corporation tax methodology reveal a significant increase in this tax gap

The amount of tax lost in the 2021-22 financial year was 4.8% of the total tax owed, the same figure as the previous year, according to HMRC’s latest Tax Gap report.

In absolute figures, the amount of tax lost was £35.8bn – up from £30.8bn in the previous year.

HMRC has been collecting data and making estimates of the Tax Gap since the early 2000s, and has published them every year since 2008.  It’s the only tax authority in the world that publishes an annual estimate of tax losses for all forms of taxation.

The Tax Gap is defined as “the difference between the amounts of tax that should, in theory, be collected by HMRC, against what is actually collected”. This is a broad measure of tax non-compliance, which covers tax losses arising for a variety of reasons – from innocent mistakes to complex frauds carried out by criminal gangs.

The Tax Gap takes into account the amount of tax collected through HMRC’s enforcement activity – known as the ‘compliance yield’.

Despite a long-term reduction in the reported percentage tax gap figures, there are a number of data points in HMRC’s report which deserve a closer look.

Points of interest

Small businesses are responsible for the largest proportion of the overall tax gap –  56%. Their share has been consistently increasing over the last few years, from a low of 38% in 2016-17. It’s clear that the main problem is with Corporation Tax, where small businesses have had a tax gap of almost 30% for the last three years – up from around 17% in the mid-2010s. No other major tax type has seen an increase in its tax gap figure of anything like these amounts. One possible explanation is that data collection has improved, as the report refers to a new random enquiry programme into small business corporation tax.

A recent House of Lords Finance Bill Subcommittee[1] in relation to R&D reliefs, hearing also heard evidence of a new random enquiry programme, which was expected to provide more accurate data around error and fraud in the small and medium enterprise (SME) scheme. It therefore seems likely that some of the increased corporation tax gap for small businesses is a result of R&D fraud and error, but this data is unlikely to be published before the HMRC annual return and accounts for 2022-23 are published in July. HMRC has already reported that 7.3% of claimed R&D by SMEs is thought to be incorrect, so it will be interesting to see if this increases by a significant amount.

Last year, HMRC committed to publishing figures for the “offshore” tax gap during 2023. HMRC receives data about assets owned by UK taxpayers in other countries via an automatic exchange of information programme. HMRC now says it will use this data in a random enquiry programme to calculate a standalone offshore tax gap for the Self-Assessment population. This will be published in the autumn[2]. The data included in the latest Tax Gap report uses a random enquiry programme to arrive at estimates for non-compliance, stratified to give more weight to wealthier taxpayers. However, with a total sample in 2019-20 of fewer than 2,000 enquiries, it seems unlikely that this will accurately reflect offshore compliance – which is, presumably, the reason for the new data.

Individuals classed by HMRC as wealthy – which covers around 800,000 people – are responsible for around 5% of the tax gap, while all other individuals combined are only responsible for around 6% of the gap. While wealthy taxpayers are dealt with by specialist teams and have a much greater level of scrutiny, it seems apparent that more could be done with this group of taxpayers to increase compliance. It’s also assumed that this group will be more likely to feature in the offshore tax gap, which is to be measured separately (see above), so the 5% figure may actually be an underestimate of their share of the tax gap.

Error and carelessness account for around 45% of the tax gap, indicating that other, more serious, behaviours are involved for over 50% of the gap – a sum of nearly £20bn.

Last year’s Tax Gap report specifically excluded figures for fraud and error arising in the Covid schemes. The CJRS and SEIS ended on 30 Sept 2021[3], but it isn’t clear from the 2023 HMRC Tax Gap report whether the data includes the Covid schemes. However, the estimate for Covid scheme fraud and error in the HMRC Annual Report and Accounts for 2021-22 is £617m, which wouldn’t have a significant impact on the overall percentage.

[1] House of Lords Economic Affairs Committee Finance Bill Sub-Committee – corrected oral evidence: Draft Finance Bill 2022-23 https://committees.parliament.uk/oralevidence/11607/pdf/

[2] HMRC Tax gaps: Methodological annex https://www.gov.uk/government/statistics/measuring-tax-gaps/methodological-annex#chapter-a-introduction

[3] Gov.uk – Claim for wages through the Coronavirus Job Retention Scheme https://www.gov.uk/guidance/claim-for-wages-through-the-coronavirus-job-retention-scheme

Public Accounts Committee says HMRC not doing enough to deter tax cheats

2nd May 2023 by Alex Dunnagan

HMRC must do more to deter and punish tax cheats following disruption to its compliance programme caused by the pandemic, according to a new report by the Public Accounts Committee.

It shows HMRC opened 32% fewer cases in 2020-21 than the previous year, after 4,000 compliance staff were redeployed to work on Covid support schemes. This led to a £9 billion reduction in the amount of tax collected through its compliance work.

HMRC has said publicly that it isn’t planning to prosecute as many people as it did before the pandemic, and the Committee – which was given evidence for its report by TaxWatch – says it’s concerned this means there won’t be a credible deterrent effect.

Dame Meg Hillier MP, Chair of the Public Accounts Committee, said: “HMRC’s ability and efforts to draw in the tax that is so desperately needed to pay for public services were seriously compromised by the pandemic. That alone is bad enough in the current economic crisis but we need to see more effort from HMRC get this back. It is simply not doing enough to deter and punish cheats, even at very high levels.”

The report also called on HMRC to do more to help those who want to pay their taxes correctly, by supporting those with tax debts and improving its customer service levels. The Committee says it wants to ensure “it is never easier for people to cheat the tax system than to comply with it.”

One of the report’s recommendations, that HMRC should build in more resilience to the tax system given the strong value for money case for increasing resources, mirrors one of TaxWatch’s own recommendations in its submission to the Committee. TaxWatch has consistently argued that HMRC needs to have long-term resource planning and funding because of the positive return on investment, with each pound spent bringing in as much as £18 of additional tax revenue.

Beyond the Loan Charge: Will the most recent proposals finally shut down disguised remuneration schemes?

24th April 2023 by Dr Pete Sproat
  • In 2016 Chancellor George Osborne declared the introduction of the loan charge would “shut down disguised remuneration schemes”.
  • Yet HMRC estimates 31,000 people used such schemes in 2020-21, resulting in a loss of £400m in tax.
  • The authorities have attempted to address the demand and supply of such schemes, using mainly administrative and civil penalties.
  • While tens of thousands face the loan charge, few enablers have faced hurtful sanctions.
  • Fewer than six financial penalties for enabling defeated tax avoidance schemes have been issued since 2017.
  • Fewer than five investigations into disguised remuneration tax avoidance schemes resulted in a criminal charge since 2017.
  • Recent proposals are unlikely to shut down the disguised remuneration schemes anytime soon.

In the recent Spring Budget the government proposed to consult on a new criminal offence for those who fail to comply with a legal notice from HMRC to stop promoting a tax avoidance scheme1. This is welcome news, for the latest official estimates suggest that in 2020-2021, approximately 31,000 people were still using such schemes, and the UK lost £400m in tax as a result2. A staggering 99% of the tax avoidance market3 involves disguised remuneration (DR) – contrived arrangements that use schemes which use loans, annuities, shares or other valuables to make allegedly non-taxable payments in lieu of wages. Hospital workers constitute the largest group who are involved in such schemes today4. Many do not know they are participants in such schemes – at least until later when HMRC demand the tax owed. Others are unaware of HMRC’s view these schemes do not work5.

However, in terms of penalties it has been the users, not those promoters and enablers of unsuccessful schemes, who have been the most heavily penalised, most notably in the form of the Loan Charge imposed upon 50,000-100,000 people6. Introduced in the Finance Act 2017, the controversial policy places an income tax charge on the value of outstanding ‘loans’ on 5th April 2019 held by people who used disguised remuneration schemes. As originally drafted, the charge applies to any ‘loan’ entered into since 1999. In the 2016 Spring Budget speech, then Chancellor of the Exchequer George Osborne declared the introduction of the loan charge would: “Shut down disguised remuneration schemes”7. It is clear that his prediction has yet to come true.

Action taken

Over the past two decades, the authorities have correctly attempted to address both sides of the tax avoidance problem. In terms of demand, legislative changes have required the earlier payment of tax in dispute, as well as the loan charge. HMRC has been gathering lots of information about the tax avoidance market and this has enabled it to try to nudge and prompt the public into compliance, using emails, blogs, webpages, dedicated agent services and a helpline8.

The collection of information has also facilitated HMRC’s attempts to deal with suppliers of schemes operating outside of the spirit of the laws on tax. Thus, tax advisers have been required to disclose details of their avoidance schemes promptly under the Disclosure of Tax Avoidance Schemes (DOTAS) regime since 2004. However, while this enabled HMRC to identify many potential problems more quickly, within a decade the government felt the need to introduce the Promoters of Tax Avoidance Schemes (POTAS). It empowered HMRC to impose conditions on the behaviour of: “a small number of promoters who operate in a culture of non-disclosure, non-co-operation and secrecy”9. It also enabled the issuing of notices to promoters to stop them from selling schemes that had been defeated.10 Since then, HMRC has been authorised to impose financial penalties upon any enablers involved in the managing, marketing, designing or financing of defeated, abusive tax arrangements that were entered into on or after 16 November 2017.

HMRC has introduced, or supported, new codes of behaviour including its own Standard for Agents (2016), and the tax and accountancy professions’ Professional Conduct in Relation to Taxation (2013), and it reports tax advisors to their professional bodies. In addition, it can suspend tax agents’ access to its systems, or refuse to deal with any who seriously abuse the tax system11. HMRC frequently litigates civil action in tax tribunals, and occasionally it takes action against tax evaders and the promoters of tax avoidance schemes in criminal courts.

As a result of these changes and legal decisions, the nature and focus of disguised remuneration schemes have changed over the last decade or so. A HMRC policy paper states: “their creation and promotion have moved to the more disreputable and shadier end of the market”12. These days, marketed avoidance schemes almost always involve employer businesses and “umbrella” companies engaging larger numbers of contractors or agency workers, operating arrangements which falsely claim to reduce Pay As You Earn and National Insurance Contributions. Umbrella companies can provide a legitimate business structure and services for contractors, but in some instances, they facilitate avoidance schemes.

Currently, HMRC estimate there are around 70 to 80 non-compliant umbrella companies in operation13. This is no improvement on its suggestion there were 60 to 80 of these operating14 in 2019-20. Similarly, each of its recent reports on the marketing of disguised remuneration schemes note about 20 to 30 promoter organisations: “are behind most of the tax avoidance schemes that are marketed to the UK public”15. The fact that as many new promoters and companies have entered the market in recent years as have left, suggests HMRC’s actions have failed to shut down disguised remuneration schemes. One result is the authorities have proposed or introduced, even more changes in the last few years.

 

Will the latest approaches defeat disguised remuneration schemes?

Recent ideas to reduce demand include; publishing a guide to help contractors engaged through umbrella companies, greater cooperation between HMRC and the Advertising Standards Authority (ASA), and listing promoters and enablers of tax avoidance schemes in the hope recipients of their advice will leave these schemes.

However, it is difficult to suggest these will have more than a marginal impact on the demand side. It is incredibly optimistic to expect most contractors to read official guides, or the newly employed to walk away if they find out they are paid in an unusual manner16.Similarly, even if the enablers are ‘named and shamed’ contemporaneously – presently it can take years to be listed, and names are removed from the list after 12 months – it is unrealistic to assume tens, if not hundreds of thousands of temporary workers will conduct regular checks on those who pay them A slight decrease in the number of deceptive adverts may mean some people do not fall for the schemes. The ‘naming and shaming’ list may also have a marginal impact on the supply side, in that some potential enablers may not risk the listing of reputation, or may fear being reported to their professional body as a result.

Interestingly, it was a listing on 18th August 2022 that triggered TaxWatch’s examination of Gateway Outsource Solutions and its complaint to the ICAEW about its director Paul George Ruocco17. However, while better contact with professional bodies may deter a few potential suppliers, these days promoters are almost never members of the professional bodies – as HMRC itself noted18. This then takes us on to consider other recent approaches to address the supply side.

To address the problems arising from the non-cooperation, delaying tactics by those promoting tax avoidance schemes and their dissipation of assets in order to avoid fines, the DOTAS and POTAS regime has been toughened to allow HMRC to obtain information from promoters earlier than in the past. The Finance Act 2022 authorised HMRC to apply for freezing orders when it has a good arguable case there may be a dissipation of assets to prevent the imposition of a tax penalty. It also enabled the organisation to petition a court to wind-up companies operating against the public interest. This can include persistent non-compliance with anti-avoidance rules, or a repeated failure to respond to HMRC’s requests for information19.

To address the problem of ‘phoenixism’ – the re-birth of a company by people involved in one that has been dissolved in order to avoid tax obligations – the government amended legislation to allow POTAS obligations to be transferred to other scheme-promoting entities controlled by the same individuals. To facilitate this, HMRC proposes better cooperation with the Insolvency Service. It has also suggested giving relevant cases to the Financial Conduct Authority. Finally in this regard, the government introduced legislation which allows HMRC to impose a new penalty on UK-based entities that assist the activities of offshore promoters. In general, these people are more difficult to deal with because of the complex nature of schemes and the UK’s reliance on the authorities elsewhere. The value of the new penalty on the UK promoter can be as high as the total fees earned by all those involved in the development and sale of that tax avoidance scheme – potentially including fees paid directly to the offshore promoter, and any other entities or persons who formed part of the ‘promotion structure’ for the scheme.20

These moves are a step in the right direction, in particular the stiff financial penalties facing UK-based entities in league with overseas promoters contained in the Finance Act 2022. However, to produce a sudden step-change HMRC needs to implement all of these approaches – especially the tougher ones – at speed and at scale. Unfortunately, this seems unlikely.

For example, HMRC has had the ability to charge an enablers penalty since 2017. However, it requires the scheme use to be defeated and an opinion from the General Anti Abuse Rule (GAAR) panel. The first opinion of the panel in respect of an enablers’ penalty was published in October 2022. In addition, while it has been possible to obtain freezing orders and winding-up orders for almost a year, not one of either21 had been obtained by the time we spoke to HMRC in March 2023. This suggests each process either takes a long time or HMRC did not have targets in mind when the legislation was introduced.

The speed at which various sanctions and financial penalties can be imposed by HMRC is unlikely to increase anytime soon. This is because the number of cases outstanding at the First-tier Tax Chamber has increased by 52% to 45,000 in the last year – primarily, as a result of it receiving a high number of cases and the time it takes to decide each22.

The scale of implementation is important for if enablers are to be deterred, they need to believe there is a good chance they will face a strong sanction. This seems unlikely, given HMRC has not implemented the tougher sanctions at scale in the recent past.

It did make 75 professional interest disclosures for any breach of its Standards for Agents to professional bodies23 between 2018-19 and 2021-22, but this is will have little impact given most promoters are not members. HMRC has ‘named and shamed’ 27 promoters of tax avoidance schemes24 as of 23rd March 2023. While we will not find out the impact of this until next year, it is unlikely to put a stop to the problem of mass-marketed avoidance schemes given HMRC’s belief new companies continue to join this illicit market as others leave.

As for the use of sanctions that have a greater chance of deterring, HMRC has issued fewer than six financial penalties for enablers of defeated tax avoidance schemes25 since 2017. Similarly, it opened only 15 criminal investigations in relation to arrangements that it categorised as disguised remuneration tax avoidance schemes between 1st April 2017 to 8th March 2023. Of these, fewer than five progressed to a charging decision or resulted in a criminal conviction26. Surely, this is a major reason the number of promoters has remained the same in recent years?

As for the ideas in the recent budget, the idea of expediting the disqualification of directors of companies involved in promoting tax avoidance is unlikely to be a game-changer for disqualified directors can simply find others to front their companies. The proposal to prosecute those who refuse to stop promoting schemes is more promising – especially if it contains strong sanctions including imprisonment. However, even if it is proposed the new law will cover schemes in operation now, it is unlikely to be applied at the appropriate scale anytime soon. The consultative and legislative processes take a while, and not everything gets through it – as advocates of compulsory professional indemnity insurance for tax advisers will remember. Similarly, the proposal could be shelved afterwards – as happened recently to the plan to create a single enforcement body to monitor the treatment of employees by umbrella companies and others.

Unless HMRC decides to change its criminal investigation efforts from focusing on “very serious evasion and organised crime”27, the number of enablers prosecuted is unlikely to change dramatically. In sum, he main reasons the number of promoters is not declining is because enforcement action takes too long, many of the actions are weak and stronger sanctions are rarely applied. What needs to happen is for HMRC to use its wide-ranging set of powers – including criminal investigations – at speed and at scale. Perhaps then the government will be able to do what George Osborne’s loan charge failed to do, shut down disguised remuneration schemes. Hundreds of millions of pounds a year in lost tax revenue are at stake.

This story was featured in The Times

 

1 Spring Budget 2023, HM Government, 15 March 2023, https://www.gov.uk/government/publications/spring-budget-2023/spring-budget-2023-html

2 Use of marketed tax avoidance schemes in the UK (2020 to 2021), HMRC, updated 30 November 2022, https://www.gov.uk/government/publications/use-of-marketed-tax-avoidance-schemes-in-the-uk/use-of-marketed-tax-avoidance-schemes-in-the-uk-2020-to-2021

3 Use of marketed tax avoidance schemes in the UK (2020 to 2021), HMRC, updated 30 November 2022, https://www.gov.uk/government/publications/use-of-marketed-tax-avoidance-schemes-in-the-uk/use-of-marketed-tax-avoidance-schemes-in-the-uk-2020-to-2021

4 Use of marketed tax avoidance schemes in the UK (2020 to 2021), HMRC, updated 30 November 2022, https://www.gov.uk/government/publications/use-of-marketed-tax-avoidance-schemes-in-the-uk/use-of-marketed-tax-avoidance-schemes-in-the-uk-2020-to-2021

5 Tax avoidance loan schemes and the loan charge, HMRC, updated 9 February 2022, https://www.gov.uk/government/publications/loan-schemes-and-the-loan-charge-an-overview/tax-avoidance-loan-schemes-and-the-loan-charge . For a more detailed discussion of the law with regards to tax avoidance see TaxWatch’s briefing: Is Tax Avoidance Legal? Available from: http://13.40.187.124/is_tax_avoidance_legal/

6 Ray McCann, President of the Chartered Institute of Taxation in answer to Q.105. Oral Evidence: The conduct of tax enquiries and resolution of tax disputes, House of Common Treasury Sub-committee, HC 733, 10 December 2021, https://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/treasury-subcommittee/the-conduct-of-tax-enquiries-and-resolution-of-tax-disputes/oral/93722.html

7 Budget 2016: George Osborne’s speech, Gov.uk, 16 March 2016, https://www.gov.uk/government/speeches/budget-2016-george-osbornes-speech

8 Managing tax compliance following the pandemic: HM Revenue & Customs. SESSION 2022-23. National Audit Office. 16 December 2022. HC 957. https://www.nao.org.uk/wp-content/uploads/2022/12/managing-tax-compliance-following-the-pandemic-report.pdf

9 HMRC Investigations Handbook 2016/17 (Bloomsbury, 2017), M. McLaughlin, (ed). p147

10 New powers for HMRC: fair and proportionate? House Of Lords, Economic Affairs Committee, 19 December 2020, p11.

11 Raising standards in the tax advice market, HMRC, 10 March 2022, https://www.gov.uk/government/publications/raising-standards-in-the-tax-advice-market-hmrcs-review-of-powers-to-uphold-its-standard-for-agents

12 The Rt Hon Jesse Norman MP, the then Financial Secretary to the Treasury in: Tackling promoters of mass-marketed tax avoidance schemes, HMRC, updated 23 March 2020, https://www.gov.uk/government/publications/tackling-promoters-of-mass-marketed-tax-avoidance-schemes

13 Use of marketed tax avoidance schemes in the UK (2020 to 2021), HMRC, updated 30 November 2022, https://www.gov.uk/government/publications/use-of-marketed-tax-avoidance-schemes-in-the-uk/use-of-marketed-tax-avoidance-schemes-in-the-uk-2020-to-2021

14 Use of marketed tax avoidance schemes in the UK (2020 to 2021), HMRC, updated 30 November 2022, https://www.gov.uk/government/publications/use-of-marketed-tax-avoidance-schemes-in-the-uk/use-of-marketed-tax-avoidance-schemes-in-the-uk-2020-to-2021

15 Use of marketed tax avoidance schemes in the UK (2020 to 2021), HMRC, updated 30 November 2022, https://www.gov.uk/government/publications/use-of-marketed-tax-avoidance-schemes-in-the-uk/use-of-marketed-tax-avoidance-schemes-in-the-uk-2020-to-2021

16 In addition, Meredith McCammond of the Low Incomes Tax Reform Group suggested: “The list will also do nothing for those who may have little choice to be paid by a non-compliant umbrella company if they want the work.” ‘HMRC adds three AML schemes to its tax avoidance blacklist’, Contractor, Simon Moore, 31st January, 2023, https://www.contractoruk.com/news/0015769hmrc_adds_three_aml_schemes_its_tax_avoidance_blacklist.html

17 Director of suspected HMRC tax avoidance scheme continues to be member of professional body, TaxWatch, 02 Februart 2023, http://13.40.187.124/hmrc_name_shame_complaint/

18 Use of marketed tax avoidance schemes in the |UK (2018 to 19), HMRC, updated 30 November 2022, https://www.gov.uk/government/publications/use-of-marketed-tax-avoidance-schemes-in-the-uk/use-of-marketed-tax-avoidance-schemes-in-the-uk

19 Clamping down on promoters of tax avoidance: summary of responses, HMRC, updated July 2021, https://www.gov.uk/government/consultations/clamping-down-on-promoters-of-tax-avoidance/outcome/clamping-down-on-promoters-of-tax-avoidance-summary-of-responses

20 Clamping down on promoters of tax avoidance: summary of responses, HMRC, updated July 2021, https://www.gov.uk/government/consultations/clamping-down-on-promoters-of-tax-avoidance/outcome/clamping-down-on-promoters-of-tax-avoidance-summary-of-responses

21 According to a spokesperson from HMRC, 13 March 2023.

22 Tribunal Statistics Quarterly: July to September 2022, Ministry of Justice. 8 December 2022, Section 8. www.gov.uk/government/statistics/tribunal-statistics-quarterly-july-to-september-2022/

23 During the period 2018-19 to 2021-22. HMRC FOI2022/72035, 05 December 2022.

24 According to a spokesperson from HMRC, 14 March 2023.

25 FOI2023/12152, HMRC, 23 March 2023. HMRC used a legal exemption in the Freedom of Information legislation to avoid providing a more precise answer.

26 FOI2023/08373, HMRC. 08 March 2023. HMRC used a legal exemption in the Freedom of Information legislation to avoid providing a more precise answer.

27 Jim Harra, Chief Executive and First Permanent Secretary, HMRC, in answer to Q 176. The Work of HMRC, Oral Evidence. House of Commons Treasury, 30 November 2022, https://committees.parliament.uk/oralevidence/11972/html/

 

R&D relief – still not working?

6th April 2023 by Alex Dunnagan

This piece on research and development tax relief was originally published in the R&D Tax Credit Insider newsletter on LinkedIn.

What does the money achieve?

R&D tax relief is an important government policy intended to incentivise businesses to incur expenditure on R&D that is ultimately expected to bring economic benefits. Efficient operation of the system behind it is vital to achieve this. One issue around tax reliefs more generally is that, once introduced, their costs and benefits generally get much less scrutiny than other direct government spending, even if they end up costing significantly more than forecast. It is critical that what is essentially government spending is producing beneficial results for the taxpayer alongside the claimant businesses.

There has long been debate about whether and how much R&D tax relief benefits the economy. Most advisers have stories of businesses that would not have been able to fund their innovations without the reliefs, and the generally held view is that businesses bring forward their R&D investment due to a greater appetite for risk resulting from the existence of the support. However, it also seems clear that at least a proportion of claims are made in relation to expenditure that was incurred without the businesses being aware of the relief so they could not have been incentivised to carry out that R&D.

The complexity of the schemes means many businesses and their ordinary advisers do not feel able to make claims themselves. This has resulted in the large market for R&D claims specialists in the same way that the increasing complexity of tax generally has increased the tax advice market. Of concern for R&D relief is the clear growth of firms of advisers using inappropriate marketing and promotion to persuade businesses to make unreasonable claims, taking a percentage cut in the process. It seems to be well accepted (and confirmed by HMRC estimates of fraud and error) that a proportion of the relief has been going to businesses who do not qualify, along with the fees to their advisers, in some cases a significant percentage of the claim. Recent years have seen little in the way of scrutiny from HMRC which has presumably encouraged more of this approach.

A further cut of the pot also goes in interest and fees to finance companies offering upfront loans against future receipt of claim repayments. It is understandable that businesses wish to improve their cashflow when waiting for repayments. However, the reliefs were not intended to support businesses changing their croissant recipe along with their associated advisers and finance companies.

These concerns have led to the legislative changes coming in this year, including the reduction in benefits in the SME scheme, which will ultimately impact genuine R&D claimants and their advisers alongside the less reputable end of the market.

‘Problem’ advisers

This piece will not rehearse the extreme examples of R&D projects claimed to be eligible for relief by a variety of less reputable advisers but it is clear that these are the source of significant numbers of problem claims.

The changes to legislation requiring pre-notification of claims six months after the end of the accounting period will go some way to preventing speculative backdated claims that appear to be part of the ‘overmarketing’ problem.

The requirement to identify advisers compiling the claims alongside a responsible officer within the claimant business is also expected to improve compliance. However, the first pre-notifications won’t happen until around September 2024 and it will be getting on for two years before HMRC are receiving information in a digital format to enable proper targeting of risk assessment. This is plenty of time for many more spurious claims, which could lead to further losses in the region of £1bn based on most recent estimates of fraud and error, which would further discredit the system.

Many people within the industry have been advocating for compulsory professional regulation for R&D advisers (and more widely in the tax adviser industry)1. Research has shown that 80% of advisers that are not members of professional bodies have no professional qualification2, which is surely unusual in the financial services industry and gives rise to significant risks to both clients and HMRC. However, consultation last year on improving the tax advice market resulted in no changes and intentions for a further consultation that has not yet appeared. In the meantime, problem advisers, who are generally unregulated, are continuing to abuse the system and potentially cause financial damage to those unwittingly accepting their advice if boundary-pushing claims are eventually refused.

The issue of regulating tax advice is obviously a complex one and there is no straightforward answer but the fact that HMRC are still failing to deal properly with problem agents results in poor outcomes for everyone involved in R&D reliefs. It is therefore critical that targeted compliance efforts against problem advisers are stepped up prior to the new legislation kicking in.

HMRC approach and resources

TaxWatch recently submitted evidence to the Public Accounts Committee enquiry into managing tax compliance following the pandemic and many of the issues raised are relevant to how R&D policy is formed, how it works in practice and how HMRC handle compliance3.

The report highlights issues with increasing complexity of tax legislation alongside the closure of the Office for Tax Simplification, reductions in the numbers of tax professional staff in HMRC and inexperienced staff working in compliance, lack of long term funding and resourcing for compliance, and lack of evaluation of new legislation and different compliance approaches.

Recommendations included:

  • urgently explaining the new mandate to be given to HMRC and the Treasury to simplify the tax code
  • committing greater funding to compliance given its positive return on investment
  • putting in place long term resource planning to ensure a consistent and robust compliance response
  • putting in place a programme of evaluation in relation to all new legislation and compliance projects
  • considering what other action can be taken against problem advisers.

As Malcolm Henderson said in a previous piece, the majority of staff at HMRC want to provide good customer service, and the experience held within the previous specialist R&D units encouraged claims where they were due as well as ensuring compliance with the rules4. Obviously that level of support has been overwhelmed by the huge increase in the numbers of claims, and the current rush to tackle compliance concerns has resulted in the reported scattergun approach to identifying risks and inconsistent treatment between different officers.

Of particular concern is recent evidence from the Institute for Government that between March 2016 and March 2022 there has been a reduction of 8,160 Full Time Equivalent (FTE) staff working within the tax profession in the civil service.5 A reduction of that level of highly qualified staff within HMRC obviously impacts on their performance across all sectors and will almost certainly affect the department’s approach to R&D compliance.

There is clearly a concern in the R&D industry that HMRC’s approach to compliance is not working. It has been suggested that compliance staff are not properly trained for the role and do not have enough experienced support to advise on the R&D definition. There appears to be a general feeling that they are often challenging the wrong cases, costing businesses time and money, creating a disincentive to make future claims

The definition of R&D belonged to the Department for Business, Energy, and Industrial Strategy (BEIS) (possibly now Science, Innovation and Technology?). That definition is a specific difficulty as it is vital for establishing eligibility but is not a tax concept. The original R&D teams had sector specialist who were available to assist with applying the definition. It is not clear whether those roles still exist, except for software cases where staff from the Chief Digital and Information Office (CDIO) are providing guidance. However, this raises the question whether there are non-tax professionals within government who would be better able to test claims against the eligibility definition, alongside the tax compliance staff dealing with other aspects.

It seems clear that without a significant improvement in HMRC’s compliance performance on R&D cases, the schemes are likely to suffer further damage impacting on the overall benefits to the economy.

1Raising standards in the tax advice market: Summary of responses and next steps, HMRC, November 2020, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/934614/Raising_standards_in_the_tax_advice_market_-_summary_of_responses_and_next_steps.pdf

2Understanding the characteristics of unaffiliated tax agents, HMRC, November 2021, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1037031/Understanding_the_characteristics_of_unaffiliated_tax_agents.pdf

3Written evidence submitted by TaxWatch, Public Accounts Committee, January 2023, https://committees.parliament.uk/writtenevidence/115783/pdf/

4R & D tax credits: Customer service examined, R & D tax credit insider, 2 February 2023, https://www.linkedin.com/pulse/rd-tax-credits-hmrc-customer-service-examined-rufus-meakin?trk=news-guest_share-article

5Civil Service Staff Numbers, Institute for Government, 15 December 2017, https://www.instituteforgovernment.org.uk/explainers/civil-service-staff-numbers

Director of suspected HMRC tax avoidance scheme continues to be member of professional body

2nd February 2023 by Alex Dunnagan

Despite his company being ‘named and shamed’ by HMRC for alleged involvement in disguised remuneration schemes, Paul Ruocco continues to be a member of the Institute of Chartered Accountants of England and Wales.

TaxWatch have submitted a formal complaint to the ICAEW about one of its members, Paul Ruocco, the director of Gateway Outsource Solutions Limited which HMRC suspects may be promoting disguised remuneration tax avoidance schemes. This is the fourth complaint lodged by TaxWatch to professional bodies.

The scheme

Last year HMRC began ‘naming and shaming’ companies with its ‘Current list of named tax avoidance schemes, promoters, enablers and suppliers’.1 One company that features on this list is Gateway Outsource Solutions Limited, whose director is Paul George Ruocco. It appears from information published by HMRC, that users of Gateway’s scheme entered into an employment agreement with a Maltese company, Gateway Outsource Solutions Limited (Malta), before receiving two salary payments – one paid at minimum wage, and a second which is described as a loan or an advance, which is not taxed. HMRC suspects this to be a disguised remuneration scheme, a scheme that HMRC has been stating for years does not work, and the so-called loans to individual workers, are subject to income tax and National Insurance contributions.

The company’s financial statements for 2018, 2019, 2020, and 2021 all state that there is only one employee of the company – with Companies House listing Mr. Ruocco as the sole director during these years.

Mr. Ruocco is also a member of the Institute of Chartered Accountants of England and Wales (ICAEW), an organisation which is supposedly governed by the Professional Conduct in Relation to Taxation (PCRT). The PCRT was developed by the ICAEW and others including the Chartered Institute of Taxation in response to the government’s challenge to the professional bodies to take a greater lead in setting and enforcing clear professional standards around the facilitation and promotion of tax avoidance.

According to the Purpose of the Principles and Standards section of the Code:

“PCRT applies to all members providing advice on UK tax matters regardless of, contracts of employment, membership of other professional organisations or where in the world they work and reside”.

Moreover, in relation to: “Advising on tax planning arrangements”, section 3.2 of the PCRT notes:

“Members must not create, encourage or promote tax planning arrangements or structures that: i) set out to achieve results that are contrary to the clear intention of Parliament in enacting relevant legislation; and/or ii) are highly artificial or highly contrived and seek to exploit shortcomings within the relevant legislation.”

In sum, if members of professional bodies are involved with what is effectively tax avoidance, then action should be taken in accordance with PCRT. TaxWatch has submitted evidence to ICAEW about Gateway Outsource Solutions Limited and Mr Ruocco for review and possible investigation following HRMC’s decision to list the company. We hope that ICAEW will review the evidence provided to them and take the necessary action. We look forward to seeing evidence of the PCRT working in practice.

The Isle of Man connection

Our research also reveals that Mr. Ruocco was previously appointed as a director or designated member of the same company or Limited Liability Partnership on the same day as Mr. Douglas Alan Barrowman, Chairman of the Knox Group of companies on at least nineteen occasions. Mr. Barrowman is husband of Conservative Peer Baroness Mone who recently requested a leave of absence from the Lords “to clear her name”, amid allegations she benefited from a company she recommended for a PPE contract.2 Recently, Mr. Barrowman was charged with corporate tax evasion by prosecutors in Spain.3 He denies the charges. Although it is not suggested Mr. Barrowman has been involved in the company that lies at the heart of this complaint, it is noted that Companies House records Panda Holdings Limited of Knox House, 16-18 Finch Road, Douglas, Isle Of Man, IM1 2PT as the ‘active person with significant control’ over Gateway Outsource Solutions Limited.

Incidentally, a Knox House of Finch Road, Douglas, is the headquarters of Mr Barrowman’s Knox Group of Companies, as well as the correspondence address for Braaid Limited – which Companies House records as the ‘active person of significant control’ for AML Tax (UK). Readers may recall TaxWatch’s complaint about Arthur Lancaster, the director of AML Tax (UK), to the ICAEW in March of last year. In the judgment of the Upper Tier Tax Tribunal, in the matter of Revenue and Customs v AML Tax (UK) Limited, the Court described his evidence as “seriously misleading”, “evasive” and “lacking in candor”.4 AML Tax (UK) was added to HMRC’s name and shame list last in January 2023, with HMRC describing a disguised remuneration scheme purportedly operated by the company. Mr. Lancaster is a director of the Knox House Trustees (UK) Limited for which the ‘active person with significant control’ is one Douglas Alan Barrowman.

Mr. Ruocco was contacted for comment by TaxWatch and confirmed he is a Chartered Accountant but was now “all but retired”. He denies that he created, encouraged or promoted any tax planning arrangements and said that Gateway Outsource Solutions Ltd does not provide any tax related services or participate in any tax schemes itself.

The HMRC website states it is possible that when HMRC learns more about such schemes it may find that information which it has published is incorrect or misleading, therefore we expect ICAEW to work with HMRC when reviewing this complaint.

 

1HMRC. ‘Current list of named tax avoidance schemes, promoters, enablers and suppliers’ https://www.gov.uk/government/publications/named-tax-avoidance-schemes-promoters-enablers-and-suppliers/current-list-of-named-tax-avoidance-schemes-promoters-enablers-and-suppliers

It is possible that when HMRC learns more about the scheme it will find that information which has been published is incorrect or misleading.

2Conservative peer Michelle Mone to take leave of absence from Lords, BBC News, 07 December 2022, https://www.bbc.co.uk/news/uk-politics-63871448

3Michelle Mone’s businessman husband faces jail if found guilty of Spanish tax charge, The Mirror, 16 December 2022. https://www.mirror.co.uk/news/politics/michelle-mones-businessman-husband-faces-28752717

4Revenue and Customs v AML Tax (UK) Limited [2022] UKUT 81 (TCC), United Kingdom Upper Tribunal (Tax and Chancery Chamber), 14 March 2022, https://www.bailii.org/uk/cases/UKUT/TCC/2022/81.html

Public Account Committee questions resourcing of HMRC

18th January 2023 by Alex Dunnagan

A new PAC report argues that the government is “missing the opportunity to recover billions”

  • Tax Debt stands at £41.6bn, over £20bn more than pre-pandemic levels, with HMRC estimating it will take “some years” for this debt to be reduced.
  • New PAC report argues that the government is missing the opportunity to recover billions by not resourcing HMRC compliance effectively.
  • Chancellor Jeremy Hunt to consider giving HMRC more funding if the department can improve upon the 18:1 return on investment currently seen with compliance activity.

A new report by the Public Accounts Committee (PAC) has argued that “The government is missing the opportunity to recover billions in lost revenue by not resourcing compliance.”1 The report also highlights disappointment in the amount of money lost to fraud and error in the Covid-19 support schemes, stating that there is a “moral duty to pursue fraud to ensure fairness and maintain a level playing field for individuals and businesses that did not abuse the schemes, rather than HMRC being seen to reward those that were dishonest.”

The committee also recommended that HMRC publish a three-year plan to monitor and improve customer service, saying that taxpayers are “still not receiving an acceptable level of customer service”

Tax Debt

Much has been made of the tax debt owed to HMRC,2 with Dame Meg Hillier, the PAC Chair, saying “the eye-watering £42 billion now owed to HMRC in unpaid taxes would have filled a lot of this year’s infamous public spending black hole.”

HMRC’s Annual Report and Accounts for 2021-2022 state that “The debt balance hit its lowest point since the start of the pandemic in January 2022 at £38.8 billion. Since then, it has steadily increased to £41.6 billion at the end of March 2022.” The main reason for the tax debt increasing is that as people struggled to pay taxes throughout the pandemic, HMRC allowed taxpayers more time, rather than aggressively pursuing debts.

However, while the debt balance has actually reduced from £57.5bn in 2020-2021, it is nowhere near the pre-pandemic levels. HMRC state that the balance is likely to remain above the pre-pandemic average of 2.4% of tax revenues for “some years”. The debt balance in 2017-2018 stood at £18.2bn, and in 2018-2019 was £19.1bn. HMRC was due to publish a plan to tackle the “mountain of tax debt” in September 2022, however, this has since been postponed to January 2023.3 It’s important that HMRC make clear what they mean by “some years”, in order for a greater understanding to be gained as to when this debt will be paid and the overall debt reduced to similar pre-pandemic levels.

HMRC debt balance 2017-2018 through 2021-2022

While this £41.6bn figure is staggering, it is important not to conflate this with the Tax Gap. The debt balance is what HMRC are intending to recover, and is therefore expected to be available to the exchequer at some point.

The Tax Gap on the other hand is the difference between the amount of tax that should be collected, and the amount of tax actually collected. It is the sum total of all of the evasion, avoidance and non-payment that leads to the loss of tax revenue to the government. Almost half of the tax gap, which stood at £32bn in 2020-2021, is resultant from fraud. 4

Returns on investment

On 15 January, the Treasury Minister Victoria Atkins acknowledged that 1,043 HMRC tax compliance staff had been reallocated to work on cases relating to Brexit in 2021-2022.5 This is in addition to the 1,250 staff that had been reallocated to tackling Covid Relief related fraud and error. HMRC’s 2020-2021 Annual Report and Accounts lists 1,237 staff working on ‘COVID-19 response’. This is presumably the administering of the relief schemes, rather than in Covid compliance work.

In order to combat the fraud in the Coronavirus Relief Schemes, a Taxpayer Protection Taskforce was set up. This team is set to wrap up in March, despite collecting less than 25% of the amount lost to fraud and error in these schemes, with HMRC estimating that at least £3.3bn in fraud and error will be outstanding at the end of the financial year. The PAC said they were “disappointed” at the amount set to be recovered. TaxWatch research revealed that staff redeployed to the Taskforce could have produced significantly higher compliance returns in their original teams.6

The lack of returns ultimately stem from HMRC being under resourced, a fact highlighted by the difficulties the department is having in dealing with the sheer amount of fraud that occurred throughout the pandemic, and simultaneously having to deal with the impacts of Brexit.

That said, HMRC compliance work still delivers a very healthy return on investment. The PAC report notes that “for every £1 that HMRC spends on compliance activities, it recovers £18 in additional tax revenue”. Despite this, the Autumn 2022 budget saw an increase of only £15m per year to HMRC for compliance work, a paltry sum compared with the extra £112m per year the Department for Work and Pensions (DWP) is set to receive to tackle fraud.7

In a letter to the Chair of the Treasury Select Committee, the head of HMRC, Jim Harra, stated that the increase seen at the Autumn Budget is “expected to deliver a return of over 9:1 over the period from 2023-24 to 2027-28 with a return comparable to the 18:1 in 2027-28 when staff taking up these roles are fully trained and experienced in post.8” While still a healthy return on investment at 9:1, this highlights the time lag between investment and results. The sooner HMRC is given adequate resourcing, the sooner it can hire and train staff, which ultimately results in greater returns.

In a Treasury Select Committee session on 23 November 2022, Emma Hardy MP (Labour) put some of these figures to the Chancellor Jeremy Hunt, highlighting the 18:1 return on investment, as well as the discrepancy in DWP and HMRC funding models. Hunt responded: “That is why he [Jim Harra, head of HMRC] got an extra £79 million. I hope he maintains that 18:1 ratio. If he can do even better, I will consider giving him even more money because it is very, very important that we do that.”9 The idea that a return of £18 for each £1 spent on compliance is not enough to warrant more investment is baffling. Tackling the tax gap should be a high priority of the government.

TaxWatch has submitted written evidence to a recent PAC inquiry entitled ‘Managing tax compliance following the pandemic’, with our submission touching on many of the themes present in this recent publication. In our submission we argue that HMRC’s long term under-resourcing has been highlighted by the timings of Brexit coupled with the pandemic, with tax administration in the UK facing a difficult task without equal in modern times. We argue that the impact of the stress of the past few years could cause long term damage to the tax administration if government does not invest significantly more funds in tackling non-compliance.

 

Parliamentary copyright images are reproduced with the permission of Parliament.

 

1HMRC performance in 2021-22, Public Accounts Committee, 11 January 2023, https://publications.parliament.uk/pa/cm5803/cmselect/cmpubacc/686/report.html

2The Times and The Financial Times both ran articles centred on the £42bn debt referenced in the PAC report.

3Treasury Minutes Progress Report, HM Treasury, December 2022 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1121672/E02829734_CP_765_Treasury_Minutes_Progress_Report_Web_Accessible.pdf

4HMRC’s Tax Gap 2022 Edition – TaxWatch Briefing, TaxWatch, 27 June 2022, http://13.40.187.124/tax_gap_2022/

5UK tax billions go uncollected as staff tackle Covid fraud and Brexit, Financial Times, https://www.ft.com/content/63ce3722-56bd-46d2-9aad-0ae666e69b3c

6Funding of Taxpayer Protection Taskforce raises serious issues, TaxWatch, 14 November 2022, http://13.40.187.124/taxpayer_protection

7Opportunities Missed – Autumn Statement 2022, TaxWatch, 17 November 2022, http://13.40.187.124/autumn_statement_2022/

8Email from Jim Harra to Harriet Baldwin MP, 06 January 2023, https://committees.parliament.uk/publications/33540/documents/182481/default/

9Treasury Committee Oral Evidence Session, House of Commons, 23 November 2022, https://committees.parliament.uk/oralevidence/11933/pdf/

Funding of Taxpayer Protection Taskforce raises serious issues

14th November 2022 by Alex Dunnagan
  • Taxpayer Protection Taskforce set to wrap up despite collecting less than 25% lost to fraud and error in the Coronavirus relief schemes.
  • HMRC estimates that at least £3.3bn in fraud and error will be outstanding at the end of the financial year when the taskforce shuts down.
  • Very low civil and criminal penalties pursued resulting in almost no deterrent effect.
  • More than half of returns from investigating Covid relief schemes in 2021-22 effectively came from pre-existing HMRC teams, raising questions about the benefits of creating a specialist Taskforce to deal with the problem.
  • Staff redeployed to the Taskforce could have produced significantly higher compliance returns in their original teams

 

After launching the Taxpayer Protection Taskforce to great fanfare, HMRC is set to wind down this team, despite an estimate of at least £3.3bn outstanding as a result of fraud and error in the coronavirus relief schemes. Even after a downwards revision in the estimated amount of fraud and error, it looks like only 25% of that will be recovered by the HMRC, and it seems likely that a significant proportion of the recovery will come from pre-existing teams. In addition, in order to create this team staff have been diverted away from potentially more lucrative compliance work to focus on Taskforce cases.

Fraud and error

HMRC administered three Coronavirus support schemes throughout the pandemic, the Coronavirus Job Retention Scheme (CJRS, or Furlough as its commonly known), the Self Employment Income Support Scheme (SEISS), and Eat Out to Help Out (EOHO). These schemes were rolled out at great speed, and were crucial in supporting workers as the country shut down during the pandemic. However, with great speed came an increased risk of fraud, something which should have been foreseen and mitigated. TaxWatch has reported regularly on the issue of fraud and error in the three schemes raising concerns that significant sums lost to fraud and error seem unlikely to be recovered.

In Spring 2021 the then Chancellor of the Exchequer Rishi Sunak announced additional funding of £100m to form the Taxpayer Protection Taskforce (‘the Taskforce’) starting in April 2021 with a view to recovering the billions of pounds incorrectly claimed. This Taskforce will wind down its work from March 2023 with Covid scheme cases moving to business as usual from September 20231 .

HMRC has recently issued updated reports2 reducing the estimates for total error and fraud in Covid support schemes, but also indicating that work to recover those amounts will produce lower returns than originally anticipated.

Fraud and error for the three schemes across their lifetime is now estimated to be £3.2bn–6.4bn (3.3-6.5% of scheme payments) with a best estimate of £4.5bn (4.6%) (reduced from best estimate of £5.8m for 2020/21 alone previously3).

Amounts recovered from compliance activity to Mar 2022 are as follows:4

20/21 536m
21/22 226m
Total 762m

The revised estimate for total recovery for the Taskforce by the time it winds down is £525m-625m (reduced from £800m to £1bn). Jim Harra (HMRC Chief Executive and First Permanent Secretary) identified that this will be approximately 25% of the best error of fraud and error, leaving over £3.3bn unrecovered5. While lower than the previously reported £4.3bn6, this is still a significant sum.

In addition, the National Audit Office (NAO)7 has raised concerns that the estimated returns will not be achieved, identifying that forecast yield for 22-23 is £343m but open enquiry cases at April 22 only indicate returns of £150m,8 potentially leading to greater unrecovered amounts.

Resourcing

Although additional funding was announced for HMRC to form a Taskforce of around 1,250 staff, the posts were filled by moves from elsewhere within HMRC9.. The £100m funding is in fact being provided to HMRC over a period of five years from 20-21 to 25-26 to compensate for the diversion of staff from other compliance activity10. The Treasury reported external recruitment was used to backfill vacancies created by these moves11 but, when asked, HMRC did not provide details of numbers recruited in relation to the Covid scheme funding and two and a half years later there still appear to be billions of pounds outstanding that have not been recovered.

Jim Harra stated in October 2022 that there had been 4,200 staff recruited into the compliance group12. It seems likely this includes staff funded by the Covid scheme investment, but also from other investment in compliance previously announced for HMRC13. Harra stated that training and mentoring recruits diverts trained resources from compliance work, so that overall they anticipate reduced total returns up until 2023, with returns recovering from 2024 onwards14. The suggestion is that these lost amounts will be recovered when new staff are fully functional in later years. However, legislative time limits in relation to opening enquiries and raising assessments will mean it is not possible to pursue all older cases, and investigation and recovery becomes harder as time passes because people move on, spend money and businesses cease.

This all raise concerns about the success of the Taskforce and whether the creation of a separate compliance team was the most efficient way to tackle Covid scheme fraud and error, particularly given that Covid scheme compliance activity is planned to continue in 2023 but within ordinary compliance teams.

The NAO reported that, within returns from individual enquiry cases for 2021-22, £122m arose from Fraud Investigation Services (FIS). FIS are a pre-existing team of specially trained investigators that tackle the most serious cases of tax fraud and avoidance across all taxes and reliefs. It seems likely that they would have investigated the largest and most complex Covid relief scheme cases regardless of the additional investment (though per the NAO their staff working on these cases are included in Taskforce numbers). The FIS returns suggest that the specific Taskforce resources only brought in £104m in that year, less than half of the total returns. In addition, a single case worked within FIS brought in £83m. This one case worked outside the Taskforce will have distorted the return on investment (ROI), suggesting that in fact, excluding that case, it is significantly lower than the reported 4:1 in 2021/22, though it should be noted that return on investment is expected to be higher in 22-23.

More importantly, the Public Accounts Committee previously reported a ROI on compliance activity across the board for HMRC at 17:115 suggesting that diverting limited staff for this work may have actually resulted in lower returns for HMRC There will be permanent opportunity costs in terms of non-Covid relief cases that cannot be pursued with subsequently increased resources. HMRC themselves recognised in late 2020 that reallocating staff to deal with error and fraud in the schemes would reduce overall compliance returns for the department, but that there was no other option as there would be an 18-month lag to recruit and train additional staff16.

An HMRC spokesperson said “We remain dedicated to tackling error and fraud in the COVID-19 support schemes. The Taxpayer Protection Taskforce was the appropriate response to the fraud risk faced at the time, and it will recover £625m across its lifecycle. Looking ahead, moving this work into business-as-usual compliance activity is the most efficient way to ensure we protect and recover taxpayers’ money from those trying to cheat the system.”

Civil and criminal penalties

Another area of concern is the lack of more serious consequences for the vast majority of cases identified so far. Where a civil investigation has taken place, HMRC are able to charge a penalty up to 100% of amounts incorrectly claimed but only where there was deliberate behaviour by the taxpayer in not reporting those amounts within certain deadlines. The burden of proof is on HMRC to demonstrate such behaviour which is difficult in many circumstances.

By March 2022, the only civil penalties charged were as follows17:

Scheme CJRS SEIS
Amount £1.1m £3.5m
Percentage of total recovered 0.5% 7%

This indicates that only a tiny proportion of civil investigations resulted in financial penalties being charged, meaning that the majority of those that did fraudulently claim on the schemes received no financial penalties.

In addition to this, at March 2022 there were 24 criminal investigations ongoing into suspected fraudulent claims of £13m, including 23 arrests in relation to nine cases18. HMRC updated this to 29 criminal investigations into claims totalling around £15m in October 2022.

Conclusions

Even with concerns about return on investment and design of compliance teams, all evidence indicates that properly investing in HMRC compliance resources produces a net positive return to the exchequer. It is therefore not clear why more resources could not be put into recovery of incorrect amounts claimed from the Covid schemes and compliance more generally. HMRC has previously said that they have not formally written off these amounts19 but effectively they will not be actively pursuing them so there is little likelihood of significant recovery. The failure to pursue these, along with very limited punishment for incorrectly claiming support, creates little deterrent effect against taxpayers behaving in a similar way in the future.

This also puts a focus on problems with one-off funding pots for specific HMRC compliance activity which potentially results in less efficient deployment of limited resources. While it is welcome news that HMRC have recently recruited significant numbers of compliance staff, as identified at the PAC, investment in new trained resources takes time and has opportunity costs in terms of diversion of trained resources. This all points towards the benefit of long-term, consistent funding of HMRC compliance efforts being the most efficient way to tackle fraud and error rather than piecemeal allocations of funding.

This research was featured in The Times among others.

 

1Tackling error and fraud in the Covid-19 support schemes, Gov.uk, 13 October 2022, https://www.gov.uk/government/publications/hmrc-issue-briefing-tackling-error-and-fraud-in-the-covid-19-support-schemes/tackling-error-and-fraud-in-the-covid-19-support-schemes

2Tackling error and fraud in the Covid-19 support schemes, Gov.uk, 13 October 2022, https://www.gov.uk/government/publications/hmrc-issue-briefing-tackling-error-and-fraud-in-the-covid-19-support-schemes/tackling-error-and-fraud-in-the-covid-19-support-schemes

3HMRC Annual Report and Accounts 2021 to 2022, Gov.uk, 18 July 2022, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1091379/HMRC_Annual_Report_and_Accounts_2021_to_2022_Print.pdf

4Tackling error and fraud in the Covid-19 support schemes, Gov.uk, 13 October 2022, https://www.gov.uk/government/publications/hmrc-issue-briefing-tackling-error-and-fraud-in-the-covid-19-support-schemes/tackling-error-and-fraud-in-the-covid-19-support-schemes

5 Including the figures for 2020/21 (ie. pre-Taskforce) of £536m, HMRC estimates a total recovery of £1,061m – £1,161m

6HMRC’s record on Covid support and tax fraud under the microscope, TaxWatch, 14 February 2022, http://13.40.187.124/hmrc_record_covid_support_fraud/

7Delivery of employment support schemes in response to the Covid-19 pandemic, National Audit Office, 13 October 2022, https://www.nao.org.uk/wp-content/uploads/2022/10/NAO-report-Delivery-of-employment-support-schemes-in-response-to-the-COVID-19-pandemic.pdf

8Delivery of employment support schemes in response to the Covid-19 pandemic, National Audit Office, 13 October 2022, https://www.nao.org.uk/wp-content/uploads/2022/10/NAO-report-Delivery-of-employment-support-schemes-in-response-to-the-COVID-19-pandemic.pdf

9Funding to fight covid related tax and benefits fraud, TaxWatch, 29 December 2021, http://13.40.187.124/covid_fraud_spending_dwp_vs_hmrc/

10Delivery of employment support schemes in response to the Covid-19 pandemic, National Audit Office, 13 October 2022, https://www.nao.org.uk/wp-content/uploads/2022/10/NAO-report-Delivery-of-employment-support-schemes-in-response-to-the-COVID-19-pandemic.pdf

11Rishi Sunak’s Covid fraud unit staffed with novices, The Times, 29 April 2022, https://www.thetimes.co.uk/article/rishi-sunaks-covid-fraud-unit-staffed-with-novices-h2vztwhm8

12Oral evidence: HMRC Annual Report and Accounts 21-22, HC 686, Public Accounts Committee, 20 October 2022, https://committees.parliament.uk/oralevidence/11385/default/

13((Autumn Budget and Spending Review 2021, Her Majesty’s Treasury, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1043688/Budget_AB2021_Print.pdf

14Oral evidence: HMRC Annual Report and Accounts 21-22, HC 686, Public Accounts Committee, 20 October 2022, https://committees.parliament.uk/oralevidence/11385/default/

15HMRC Performance in 2020-21, Public Accounts Committee, 11 February 2022, https://committees.parliament.uk/publications/8862/documents/89198/default/ 

16Implementing employment support schemes in response to the Covid-19 pandemic, National Audit Office, 23 October 2020, https://www.nao.org.uk/wp-content/uploads/2020/07/Implementing-employment-support-schemes-in-response-to-the-COVID-19-pandemic.pdf 

17Delivery of employment support schemes in response to the Covid-19 pandemic, National Audit Office, 13 October 2022, https://www.nao.org.uk/wp-content/uploads/2022/10/NAO-report-Delivery-of-employment-support-schemes-in-response-to-the-COVID-19-pandemic.pdf

18Delivery of employment support schemes in response to the Covid-19 pandemic, National Audit Office, 13 October 2022, https://www.nao.org.uk/wp-content/uploads/2022/10/NAO-report-Delivery-of-employment-support-schemes-in-response-to-the-COVID-19-pandemic.pdf

19HMRC’s record on Covid support and tax fraud under the microscope, TaxWatch, 14 February 2022, http://13.40.187.124/hmrc_record_covid_support_fraud/

Putting a stop to the tax fraud game

27th October 2022 by Alex Dunnagan

27th October 2022

How ‘legal avoidance’ means getting away with tax fraud, and what needs to be done about it

A joint policy paper by the All Party Parliamentary Group on Anti-Corruption and Responsible Tax and TaxWatch

Introduction

Tax avoidance is legal, tax evasion is illegal. That clear and unambiguous dividing line has been the foundation on which an entire industry of tax avoidance has been built. The reality is however that this celebrated distinction is a myth, fostered by the tax industry that profits from it and left undisturbed by the public body that knows better: HMRC. In this report we demonstrate that much that is considered ‘legal’ tax avoidance (or at worst, a failed but lawful attempt to avoid tax) could in fact potentially be subject to a criminal prosecution. And we show that, in so-called ‘legal’ avoidance cases where in fact fraud is suspected, even if there are millions or perhaps billions of pounds in tax at stake, HMRC choose not to pursue criminal investigations. These points are illustrated by means of a series of case studies appended to the report.

Given the controversial nature of this report it is important to be clear about what we mean. The most serious tax fraud in the UK is prosecuted under the criminal offence of ‘cheating the public revenue’ and, at the heart of that offence, lies the question of whether the defendant was being dishonest in their actions. A determination as to whether or not any particular individual was dishonest, so as to be guilty of that offence, can only be arrived at by a jury after the defendant has had the opportunity to present their case. Accordingly, in this paper, we are not seeking to establish whether any particular individual has acted dishonestly. What we are saying, however, is that based on the extensive evidence in the public domain on these avoidance schemes, the conduct of those involved in them could appear dishonest to a jury, and it would therefore be open to HMRC to investigate the schemes with a view to criminal prosecution.

The cases we consider are not unknown to HMRC. In all cases they involve well-known companies or schemes. The facts we have based our conclusions on are largely drawn from legal documents, including cases litigated by HMRC under civil as opposed to criminal law. The question therefore arises, why has HMRC not pursued these schemes under their powers of criminal investigation? The answer is straightforward. It has been the long-standing policy of HMRC (and the Inland Revenue before it) to not pursue the vast majority of tax fraud cases under the criminal law, and instead use civil procedures to recover any tax lost.

There are practical reasons for this approach. HMRC’s primary role is as a tax collector and in most cases it will be cheaper and quicker to use civil procedures to reclaim tax lost from tax avoiders than to pursue criminal charges. This has the perverse effect, however, of setting standards of behaviour in the tax industry far below the standards imposed by existing criminal law. Certain types of fraud (usually involving the creation of false documentation, or non-disclosure of relevant information) are seen as unacceptable, whereas other forms of fraud – for example basing a purported tax saving on an economic fiction – are almost invariably treated as acceptable. This is despite the fact that under the criminal law, there is no distinction between these two different types of fraud. The distinction lies only in what HMRC acting in accordance with their policies will, and will not, investigate as a criminal matter.

It is entirely appropriate that policymakers and legislators should question whether HMRC’s policy to not enforce the criminal law in large numbers of cases of tax fraud is the right approach. The last time that Parliament took an interest in the enforcement powers of the revenue departments was in the early 1980s with the publication of the Keith Committee reports. In the interim, the issue of tax avoidance has become an issue of huge public concern and, to a large degree, the public debate on the issue has proceeded on a false premise: the idea that all tax avoidance is by definition a lawful activity. This premise, propagated by the media, by the tax industry, and by academics, all with the complicity of HMRC, has undermined the ability of parliament and through it the Government to grapple with the issue.

We hope that this report, by setting out clearly the facts and the law in relation to tax avoidance, and setting this against HMRC’s practice, can facilitate a proper debate on this important subject.

Recommendations

If we were to sum it up in a single sentence the recommendation of this report it would be this: HMRC should be enforcing the law of the land, not the ‘rules of the game’. To do this HMRC needs to take a far tougher approach when it comes to the promoters and enablers of tax avoidance schemes, using the powers it has under the criminal law to bring forward more prosecutions of the enablers of tax crime. Calls for HMRC to do more to tackle tax crime have been made before. In 2016, the Public Accounts Committee called on HMRC to do more to tackle tax fraud, and yet the number of prosecutions has since that time continued to decline. Now is the time for concrete action.

We recommend that HMRC officers should be required by law to consider for separate investigation and potential prosecution the promoters and enablers involved in tax avoidance arrangement. The case should then be referred for prosecution unless a determination is made that a successful prosecution would be unlikely or contrary to the public interest. Further, any civil settlement reached between HMRC and a taxpayer should be conditional on a requirement on the taxpayer to co-operate with any future criminal investigation into their advisers.

The legal framework

In assessing their tax own liabilities, it is possible that an individual or a company will take a different view of what their obligations should be than HMRC. If HMRC disagree with the position of the taxpayer, they can issue their own assessment of the amount of tax due. The taxpayer can then challenge this assessment at a tax tribunal. The purpose of a tribunal is to determine the right amount of tax that should be paid, in accordance with the applicable tax legislation. Crucially, this is a wholly civil mechanism. It is not the tax tribunal’s job to determine whether the taxpayer’s behaviour was dishonest, fraudulent, or otherwise criminal. This means that the question of whether tax fraud has taken place or not is very often not considered by a court, even where HMRC has had to take formal steps to recover unpaid tax.

The central feature of tax fraud is that it involves dishonest behaviour. The common law offence of cheating the public revenue is the primary offence that tax fraud comes under, although there are other offences where dishonest tax conduct is outlawed. Cheating the public revenue is an extremely broadly-defined offence. In short, anyone that engages in any form of dishonest conduct that risks prejudice to the public revenue can be tried on indictment with the potential sentence of life imprisonment. There is no need for the prosecution to prove that the defendant profited from their actions, or even that the revenue suffered a loss. As the leading textbook on criminal law, Smith, Hogan and Ormerod explains, the breadth of the offence means that often the only live issue at trial will be dishonesty.1 The offence can also be charged as conspiracy to cheat the public revenue, further widening the scope of the offence to anyone involved in the creation or operation of a dishonest tax scheme e.g. professional advisers, promoters and so on. Any perception that the offence is somehow intended for or targeted specifically at the taxpayer is mistaken.

Crucially, under the criminal law, what constitutes dishonesty is to be determined by a jury applying the standards of ordinary decent people – not a group of tax experts. It is perfectly possible that a tax scheme which is dealt with through the civil process described above could be one which a jury in a criminal trial would consider to be dishonest. So-called ‘legal’ tax avoidance and tax fraud should therefore be treated as categories which substantially overlap. The question of which process is followed in which case is therefore often a discretionary one for HMRC, rather than being driven by whether or not a crime was committed.

That discretion is a broad one. While HMRC has an extensive range of investigatory and law enforcement powers, including powers of criminal investigation broadly similar to those of the police,2 its primary role is to obtain ‘the highest net return that is practicable having regard to the staff available […] and the cost of collection’.3 Accordingly, HMRC’s function as the body responsible for investigating crimes committed in connection with the taxes under its charge is ‘ancillary to, supportive of and limited by’ that duty to maximise revenue.4 This means that there is no obligation on HMRC to investigate any incidence of fraud as a criminal matter. Instead it is open to the department to pursue an investigation through an entirely civil process. How it exercises that discretion is (aside from the exceptional circumstances where judicial review might be appropriate) entirely a matter of policy for HMRC.

HMRC policy

HMRC’s civil fraud investigations – COP 8 and COP 9

HMRC’s Fraud Investigation Service operates two civil fraud investigation procedures, referred to as Code of Practice 8 or Code of Practice 9 (‘COP 8’ and ‘COP 9’).5 Both COP 8 and COP 9 are civil processes where the goal is to reach a private agreement with the taxpayer to settle any taxes due and impose civil penalties where appropriate.

Under COP8, a taxpayer is invited to meet with HMRC and disclose all relevant facts relating to the issue which HMRC wish to enquire into. In a COP 8 investigation, there is no explicit allegation of fraud that is made against the taxpayer. The purpose of the COP 8 process is to allow HMRC gather as much information as possible in order to make a correct assessment of any tax due. Under COP9, by contrast, there is an explicit allegation of fraud, and in return for admitting to fraudulent conduct HMRC will agree not to pursue a criminal prosecution. Instead, a contractual settlement will be reached where the taxpayer agrees to provide a full disclosure of their assets and pay any taxes and penalties due. In these processes the possibility of criminal prosecution is explicitly used as a threat to encourage the taxpayer to make a full disclosure of all relevant information.

It is a serious (but widespread) error, to infer that HMRC’s classification as between these two procedural pathways serves to distinguish between ‘legal’ tax avoidance on the one hand and, on the other, unlawful tax fraud handled through civil enforcement mechanisms. In fact the determination of whether to follow COP 8 or 9 is a tactical one taken right at the outset of the investigation rather than a forensic one taken in full view of the evidence.

HMRC’s criminal investigations policy

Under the Police and Criminal Evidence Act, HMRC can conduct criminal investigations with a view to prosecution by the Crown Prosecution Service or the equivalent bodies in Scotland and Northern Ireland. HMRC’s Criminal Investigations Policy6 sets out when the department will consider using its powers of criminal investigation. It makes clear that in the majority of tax fraud cases, the preference will be to use HMRC’s civil fraud procedures outlined above, stating that it is ‘HMRC’s policy to deal with fraud by use of the cost-effective civil fraud investigation procedures under Code of Practice 9 wherever appropriate’. A criminal investigation, in contrast to those civil processes, is resource-intensive, and provides the taxpayer with little incentive to be cooperative with regard to the information HMRC requires in order to be able to recover all the tax that is due.

There are some cases of criminality where HMRC will ‘consider’ going straight to a criminal investigation. These include cases involving money laundering or organised crime, cases where the taxpayer is in a position of trust or responsibility, and cases which involve active deception. As HMRC characterise this latter category, they will tend to consider prosecution where there is ‘any deliberate omission, concealment or misinterpretation of information, or the false or deceptive presentation of information or circumstances in order to gain a tax advantage’. HMRC illustrate this category with examples of what they will consider to be tax fraud i.e. deliberately submitting false tax returns, falsely claiming repayments or reliefs, hiding income, gains or wealth offshore, and smuggling taxable goods. These forms of active deception are indeed, needless to say, examples of behaviour which a jury might consider to be dishonest. They are, however, by no means the only forms of dishonesty that occur in a tax context. We consider certain others below.

It should be noted that, in addition to those categories of cases, HMRC will occasionally use their powers of criminal prosecution to serve make an example out of somebody, to remind the public that those powers exist. It is for this reason that in the past HMRC pursued criminal convictions of celebrities, due to the high profile these cases would attract. However, this strategy also brought with it the risk of a high-profile acquittal, as happened in the prosecutions for tax offences of Ken Dodd and Harry Redknapp.7 Ordinarily, however, absent aggravating features such as evidence of active deception, a person whose tax behaviour might amount to a crime is highly likely to face no more serious sanction than (i) a requirement under threat of criminal investigation to make full disclosure, and (ii) civil penalties.

Criminal conduct in cases of ‘legal avoidance’

Criminal conduct on the part of the taxpayer

Tax avoidance typically begins with a tax adviser (or sometimes, in the case of a big business, an in-house tax function) creating a scheme. This is a kind of blueprint or plan setting out a number of steps which, when implemented, will make it appear that the taxpayer has a tax position which does not correspond to their economic reality. For example, a scheme may make it appear that a taxpayer has suffered a loss or incurred an expense that entitles them to a tax benefit, when in fact no such thing has happened. Alternatively, a series of contracts can be constructed to make it appear that income in the hands of an employee or contractor is something else – a loan from a third party, say – when in reality there is no intention on anyone’s part for the loan to be repaid. In the corporate world, contracts can be constructed that mean that a transaction between group companies can be significantly overvalued or undervalued, with the consequence that the real value ends up in a tax haven. These are the kinds of arrangements generally treated as ‘legal avoidance’ rather than fraud. These transactions are professionally designed to misrepresent to the tax authority the true economic reality of the taxpayer, leading to a loss of tax revenue.

Owing to HMRC’s policies, juries very rarely get to consider these kinds of schemes. Although these schemes generally rely on misrepresenting the economic substance of an arrangement, there is generally no active deception of the kind that HMRC’s criminal investigations policy focuses on – it is not necessary to (for example) falsify documents or hide sums of money in order to purport to obtain these tax advantages. Ordinary reasonable people, however (i.e. the members of a jury, who are not steeped in the self-justifications popular among tax professionals) are likely to think that it is dishonest to artificially create tax losses attributable to a business activity that isn’t a real business, whether or not the losses are inflated by false documentation.

Indeed, as the case studies appended to this report demonstrate, when juries do get to consider these schemes, they often do see dishonesty in them. These are scenarios which the tax industry would normally indignantly defend as ‘legal’ and which HMRC would normally choose to deal with through the processes of civil assessment to tax. But where HMRC has (exceptionally) deemed it fit to pursue the matter as a criminal one, the prosecution will positively encourage the jury to see those same kinds of fact patterns, normally treated as ‘legal’, as evidence of dishonesty.

On these exceptional occasions where ‘legal avoidance’ is prosecuted as tax fraud it is very likely to be advisers, enablers or promoters who are in the dock, as opposed to taxpayers, and with good reason – the taxpayer can say by way of defence that they were professionally advised that the scheme would be effective. This defence is not necessarily absolutely watertight, but in most cases of so-called ‘legal’ avoidance any criminal culpability will be with the advisers and enablers.

Criminal conduct on the part of professionals, advisers and enablers

The features of tax avoidance schemes discussed in the previous section – i.e. that they may be dishonest whether or not they involve ‘active deception’ – could all be valid grounds for a criminal investigation into the actions of the advisers and enablers, and those participants lack the excuse that they knew no better and were acting under advice – it was they who were giving the advice! But there is more to their potential liability than that.

For example, another key feature of avoidance schemes is that, when they are presented to the client (or to management, in the case of an in-house scheme), they are almost invariably accompanied by professional advice about the effectiveness of the scheme. This advice may be wildly optimistic because the scheme is obviously ineffective as means of reducing tax and would be highly likely to fail any scrutiny by HMRC or the tax tribunal. It may therefore be that a jury would consider the advice to be dishonest – the adviser has promoted a scheme which they know will not ultimately work. Again, this category of dishonesty is highly unlikely to make it as far as a jury. Indeed, despite the pageant of self-evidently preposterous arguments that have failed at tribunal as a matter of legal analysis in avoidance cases, resulting in tax being payable after all, it is almost unheard of for the adviser giving the original favourable opinion (often a QC) to have faced prosecution for that aspect of their role in the scheme. And this is despite the fact that QCs in this field of practice are notorious for giving opinions which do not withstand the scrutiny of the courts.8

In addition to the QC giving the opinion, there will generally be a variety of other professionals involved: solicitors and accountants for example. These professionals will generally be aware from the QC’s opinion that, in order for the scheme to be effective, certain steps have to be taken. For example, it may be that activities which are said to be taking place on paper must actually take place in the real world. Similarly, in order for the scheme to be effective, basic implementation must be effective – for example formal documents must be properly executed in the right order and so on. Very often these steps are not taken at all, or are taken negligently, and the scheme could fail by reason of inadequate implementation as much as by reason of the legal analysis being wrong. In these circumstances, continuing to advise that the taxpayer may file a tax return claiming the saving may well be a dishonest act. This is because the advice would be given in the knowledge that the tax benefit is not available in any event, whether or not the legal analysis is valid. A jury may well conclude that this is dishonest conduct, and yet in the overwhelming majority of such cases, even if the implementation is sloppy, HMRC will treat the matter as ‘legal avoidance’.

In view of all these potential routes to a conviction vis-à-vis the enablers and advisers, it is worth noting that a prosecuting authority is likely to have a wealth of evidence to support any such approach. Following a full disclosure by a taxpayer to HMRC under either COP 8 or COP 9, there should be ample evidence to open a criminal investigation into the professionals, enablers and advisers involved. Having collected any tax lost to the avoidance scheme from the taxpayer, however, there is little financial incentive for HMRC to pursue those other participants, and no statutory or policy requirement for them to do so either.

The tax fraud game

The rules of the game

HMRC’s highly selective enforcement of fraudulent tax conduct, and in particular the more-or-less exclusive focus on what we here describe as ‘active deception’, creates a wide arena of possibility for unscrupulous tax advisers. It is possible for them to design schemes that probably do not work, promote them to users, and see them through to implementation, without significant risk of criminal prosecution either of themselves or users, irrespective of the degree of dishonesty at play. To minimise risk of prosecution, all they need to do is comply with what we here describe as the ‘rules of the game’. To be clear, this is not a formal set of rules which HMRC operate as a parallel regime alongside the strict legal one they are meant to be enforcing – but that is the practical effect of their policy. Broadly-speaking the rules of this game are as follows:

  1. A tax avoidance scheme should be created by qualified lawyers and accountants, executing genuine documents. The economic position being claimed may well be a fiction, but it must at least purport to exist on paper.
  2. Secondly, there should be no ‘active deception’ in the implementation or reporting.
  3. Finally, once the scheme is uncovered by HMRC or investigated, the taxpayer should disclose everything.

If these rules are followed, no matter how dishonest the scheme is, whether on the part of the taxpayer, or the advisers, or both, they are almost certainly safe from prosecution.

There are any number of ways that such a scheme can succeed by default even if the legal arguments are invalid. It is possible that HMRC will not detect the scheme,9 or, if they do, not fully understand it, resulting in the taxpayer’s position being accepted. Perhaps they will make a procedural error, allowing the taxpayer to challenge HMRC’s assessment on a technicality – there are lawyers that dedicate their careers to making procedural challenges to HMRC’s attempts to counter tax avoidance. Perhaps, faced with a barrage of legal firepower deployed by corporate opponents, HMRC will give up and settle for a significantly lower amount. Mistakes become more likely of course as HMRC’s resources become increasingly stretched. And there is always the possibility that the scheme, even if it ends up having the legal arguments tested at tribunal, will survive even that stage, deliver the tax advantage, and mark the taxpayer out as having achieved a ‘legal’ outcome, irrespective of any criminal dishonesty that may have taken place. In all of these ways, tax fraud may well have been committed, and HMRC may well know about it, but public money (in vast quantities) ends up in private hands nonetheless.

Accordingly, it adds insult to (fiscal) injury for there to be a widespread claim that, where HMRC choose not to enforce the criminal law, and challenge avoidance through civil means, or reach a settlement with the taxpayer, that means that what has been done is ‘legal’. This is a myth which has the effect of reinforcing the rules of the game at the expense of the actual law. A non-criminal outcome absolutely does not mean that in law these schemes are ‘legal’, much though the tax avoidance industry will insist that it does. On this point criminal law expert David Ormerod is authoritative:

The difficulty in distinguishing the shades of avoidance and evasion means that it is always possible for the Revenue to charge a defendant with cheating in respect of a scheme which is alleged to be dishonest evasion and which the (non)taxpayer believes to be, at worst, an ineffective avoidance scheme. Commentators on the decision in Charlton10 asked how what they perceived to be merely ineffective tax avoidance could be criminal. The criminal lawyer’s response to that is simple: the schemes might be classified as ineffective tax-avoidance in civil law, but that does not prevent them being criminal because the cheating offence is now so broad that it turns solely on the question of dishonesty.11

The fact that tax crime is simply permitted to happen without enforcement measures being taken against it was recently set out in blunt terms by Janet Alexander, the head of HMRC’s Taxpayer Protection Task Force, the body set up to recover money stolen from HMRC-administered covid support schemes. ‘In the UK’, she said ‘we use civil powers to recover the monies, we don’t normally criminally prosecute – that is the way that we handle tax investigations in the UK. It doesn’t mean it’s not a fraud, it’s just not the way that we deal with it.’12 The point we make in this report is that that needs to change.

Why this matters

Avoidance-based tax fraud continues to be endemic in the UK, as demonstrated by constant stream of avoidance cases before the tax tribunal. It is clear that there are significant numbers of practitioners that continue to design and market schemes, and senior lawyers willing to sign off on them. Civil processes for reclaiming the cash from their clients provide no disincentive for tax professionals to carry on playing this game. In fact, a recent analysis of HMRC’s published figures on tax avoidance schemes known as ‘disguised remuneration’ schemes shows that the numbers of people involved increased considerably after several legislative interventions were made to stop them.13 Furthermore, the prevalence of tax avoidance is not limited to individuals using schemes. As demonstrated by HMRC’s diverted profits tax compliance facility (an amnesty for large multinational companies involved in artificial schemes) big business continues to engage in avoidance.14 HMRC will say that the market has changed since the heyday of artificial tax structuring prior to certain legislative and cultural changes in the 2010s, and this is true to an extent, but the perverse incentives created by their policies remain.

Given HMRC’s primary focus on revenue collection, their strategy of extracting the full amount of revenue from a taxpayer as quickly and cheaply as possible through civil investigation procedures will always have an important role. However, it is our contention that HMRC’s strong preference for civil investigations creates several issues for the tax system that need to be addressed, and that the systematic failure to apply the criminal law to the enablers of tax fraud misses an opportunity to strike at the source of the problem. We break the issue down into four aspects. The first is deterrence, the second effectiveness, the third is fairness, and the fourth is justice and the rule of law.

(1) The issue of deterrence is clear. Tax advisers know that, provided they comply with the rules of the game, they can perpetrate criminal conspiracies to cheat the public revenue with effective impunity. HMRC’s deliberate removal of the deterrent effect of criminal prosecution for professional advisers has created a legal and moral vacuum that has allowed tax avoidance to flourish. Indeed the infrequency with which HMRC will seek to apply the criminal law to the enablers of tax avoidance has encouraged a culture in the tax industry and its supporters that maintains that tax avoidance is all perfectly ‘legal’, and that tax avoidance cases arise from a morally neutral dispute between the taxpayer and HMRC over the application of the law to the facts.

So powerful has this narrative become, that when tax campaigners draw attention to the moral outrage of tax avoidance, their protestations are dismissed by experts, and they are told that their outrage is down to their failure to understand how complicated tax rules work. In fact it is these so-called ‘experts’ who have failed to understand: specifically, they have mistaken the rules of the game for the law of the land. If a taxpayer and their advisers conduct themselves in a way that a jury would consider to be dishonest, then a fraud has most likely been committed, even if HMRC’s treatment of it and the tax industry’s claims about it are to the effect that what has happened is ‘legal’. Far from being the result of a failure to understand the law, the sense on the part of ordinary decent people that tax avoidance is a moral outrage might well accurately reflect the fact that a criminal offence has indeed been committed in the matter in question.

Apologists for the tax avoidance industry love to treat the question of whether ‘morality’ plays a role in tax as a debate, so that they can argue from their purported position of expertise that it does not. But in fact the pretence that this is even up for debate serves to reinforce a false narrative about how the law in this area works, thereby positively exacerbating the precise moral problem that they claim does not exist. By way of analogy, suppose a residential area where there is a 30 mph speed limit, but the speed cameras are set only to go off if people are driving at 67 mph. Suppose then that some drivers are speeding through the area at 58 mph and nothing is being done about it. Suppose further that the response of the motoring lobby, when people complain, is to say that there is no morality in the speed at which you drive through a residential area, and that the acceptability of driving at 58 mph is simply a legal question to be determined in motoring law enforcement proceedings. That is the situation we are in when people say that tax avoidance is perfectly legal. They are taking advantage of catastrophically weak enforcement to create a culture of impunity around criminal acts that adversely affect the rest of us.

(2) Secondly, it is not at all clear that the balance struck by HMRC between civil and criminal approaches is effective even on its own terms. There are cases where recourse to a criminal investigation early on would in fact have been more effective at collecting the tax. One powerful example of this is a case involving Rangers Football Club, which ended up dragging on through the civil courts for many years before the Supreme Court finally found in favour of HMRC. HMRC lost their case in the lower and upper tax tribunal, however, and those losses were used as marketing tool for accountants selling similar tax avoidance schemes, convincing many thousands of people to become involved in tax avoidance. An early criminal investigation of the football club officials found to have misled HMRC in that case could well have brought the matter to a conclusion sooner.

(3) Thirdly, there is the question of fairness. It might be thought that in the interests of fairness all acts of criminality of a similar type (for example acts exceeding a specified degree of seriousness) would be prosecuted, but in fact HMRC are under no obligation to enforce tax law in a manner which is fair as between taxpayers.15 This is an element of their operational independence and there are good reasons for it as a matter of principle; it means that HMRC can address tax abuse on a case-by-case basis without having to constantly second guess what a court might think.

But the fairness we are considering here is on a wider scale: it is about fairness as between the economic strata of society. Research by Taxwatch found that in the 11 years between 2009 and 2019, the government prosecuted 23 times more people for benefits crime (86,000 prosecutions) than tax crime (3,600 prosecutions). This vast disparity was not driven by a greater propensity of benefits claimants to commit fraud, but by government policy which refers all benefits fraud cases worth more than £5,000 to the prosecuting authorities.16 This is in marked (and, we argue, unacceptable) contrast to the billions pounds of tax which are treated as a matter for civil enforcement irrespective of the dishonesty involved, provided that the rules of the game are complied with.

(4) Finally, as regards justice and the rule of law, clearly if serious criminal conduct is systematically not addressed as such, then justice is not being served and the rule of law is being thwarted. While cheating the public revenue is a common law offence, it has a statutory basis insofar as it exists because Parliament chose to abolish the more general offence of cheating except in the case of cheating the public revenue.17 HMRC’s policy in this area is therefore thwarting the will of Parliament that dishonesty in a tax context should be treated as a criminal matter attracting serious sanction.

Recommendations

An immediate legislative fix

The current system of handling antisocial tax behaviour is in large part a matter of policy on the part of HMRC rather than the strict application of a set of rules. We nonetheless propose an immediate legislative fix which will address the most glaring defect in that system. That defect is the virtual immunity from prosecution enjoyed in practice by advisers, enablers and promoters, irrespective of the degree of dishonesty and bad faith they display, provided they comply with the ‘rules of the game’. HMRC’s own research confirms that criminal prosecution remains the biggest deterrent to tax crime among wealth managers, whilst HMRC’s preferred approach of using civil procedures to reclaim tax owed is the least effective deterrent.18 Yet most tax advisers will know that the risk that they or their clients run of ever facing a jury will be vanishingly small provided they take the precautions we have identified.

We therefore recommend legislation requiring that HMRC (a) consider for separate investigation and potential prosecution the promoters and enablers involved in any tax avoidance arrangement, (b) pursue that investigation and refer it for prosecution unless a determination is made that a successful prosecution would be unlikely or against the public interest, and (c) only offer the taxpayer in the case in question a civil pathway in accordance with COP 8 or COP 9 on the condition that the taxpayer agrees to give evidence for the Crown in respect of the arrangement.

There may be concerns that this measure would impede legitimate tax planning and should therefore be expressly reserved for only the most egregious or aggressive instances of tax avoidance. It should therefore be emphasised that from the perspective of this legislative intervention, the egregious or aggressive instances of tax avoidance will be self-selecting: legitimate tax planning has nothing to fear from a review with a view to potential criminal investigation. Indeed to expressly carve out legitimate tax planning based on a civil law understanding of tax avoidance would be to reinstate the precise problem that this intervention seeks to address: the decriminalisation of certain categories of cheating the public revenue on the basis of having the superficial characteristics of legitimate tax planning.

In addition, there may be concerns that this measure would create an additional burden for HMRC. In principle it should not create a substantial additional burden, since (as noted above) HMRC already reviews all the tax avoidance that comes before it for potential criminal investigation. The primary effect of this measure would be to take out of HMRC’s hands the discretion to wave it through civil channels even in circumstances where there is potentially fraudulent behaviour on the part of promoters and enablers. To emphasise, it should absolutely remain within HMRC’s discretion to offer the taxpayer themselves a civil pathway in accordance with COP 8 or COP 9; the purpose here is to remove the effective immunity from prosecution currently enjoyed by fraudulent promoters and enablers provided they play the game according to the rules.

It might further be observed that a legislative intervention is not necessary to modify HMRC policy in this area. While in theory this is the case, a core purpose of the intervention is as a deterrent to anti-social tax behaviour. A change in HMRC policy would be welcome but it would take time to establish and would be uncertain in its scope. This intervention by contrast, it is to be hoped, would stop certain forms of anti-social tax behaviour dead in their tracks more-or-less upon enactment.

As additional support for this recommendation, we note that the proposed measure would be in accordance with recent OECD recommendations specifically addressed to the UK regarding combatting tax fraud.19

Looking ahead

In several European countries, the collection of tax is seen as a separate activity from law enforcement, with the authority to investigate tax crime held by branches of the police specializing in economic crime. An additional recommendation, for the longer term, is therefore that the option be considered of separating the enforcement of tax law from the collection of tax altogether.

Thirty-five years ago the Roskill Committee, recognizing the challenges facing law enforcement in prosecuting serious fraud, recommended that the investigation and prosecution of serious fraud be brought together. This led to the creation of the Serious Fraud Office. A separate body could similarly be established to both investigate and prosecute tax crime, which can be equally as complex as other kinds of fraud. Such a body should be under the oversight of the Attorney General’s Office rather than HM Treasury.

The proposed department could also be revenue generating. When HMRC fails to prosecute a dishonest tax adviser, they may collect the tax due from that adviser’s client, but they will receive nothing from the adviser. By contrast an investigative and prosecuting authority in relation to tax crime would be able to deploy proceeds of crime legislation to make significant recoveries from the advisers in addition to any tax collected from their clients.

Raising additional revenues would not be the primary concern of the suggested body, however. Its primary role (in contrast to HMRC’s) should be to prosecute tax crimes. And with such a body in place HMRC would have no discretion as to whether to refer a matter for criminal investigation. It may of course still be expedient to pursue the tax through civil rather than criminal procedures. Any decision to not pursue criminal charges, however, would have to be authorised by an officer of the proposed enforcement authority.

Institutional arrangements such as these, elaborated upon by operational policies to be jointly determined by the suggested new authority and HMRC in establishing their working relationship, would have the consequence that cases of abusive tax behaviour will necessarily be addressed with both relevant objectives – that of raising revenue and that of upholding the law – in mind.

APPENDIX: Case studies

The case studies considered here fall into three categories. In the first subsection we look at tax avoidance schemes where there was no prosecution. This is, as already noted, the norm. We call it the ‘tax fraud game’ because in these cases, even though there might have been fraud, the activity was within the scope of what HMRC will generally treat as not warranting criminal investigation. In other words it was within the ‘rules of the game’ described above.

In the second subsection we look at some exceptional cases where, in contrast to the norm in these matters, there were prosecutions (and indeed convictions). We call this ‘breaking the rules of the game’ because the question on the part of HMRC does not appear to have been ‘was there conduct which could be characterised as dishonest?’ but ‘did the taxpayer and their advisers play the game?’ By the same token, judging by the reaction on the part of the tax professionals involved, the question on their side appears to be whether HMRC is itself breaking the rules of the game by actually prosecuting in these circumstances. In fact, it is of course wholly within HMRC’s discretion to enforce the law of the land if (exceptionally) they choose to do so, rather than merely the rules of the game.

In the third subsection we consider how the game is played in the big-money realm of international corporate tax avoidance, where HMRC seemingly take an even more generous approach than in cases of domestic avoidance, barely enforcing the rules of the game, let alone the law of the land.

The tax fraud game

a. Working wheels

The ‘Working Wheels’ tax scheme caught the attention of the public because it involved well-known radio personality Chris Moyles. It (alongside certain other more-or-less identical schemes) was defeated by HMRC at the tax tribunal in the case of Flanagan & Ors v Revenue & Customs [2014] UKFTT 175 (TC).20 Like many tax avoidance schemes it relied on a complex structure involving funds going round in a circle and magically attracting a tax advantage for the scheme user en route. The advantage came in the form of artificially-inflated business losses, which were then used to reduce the tax liabilities of scheme users under a provision of the tax code called ‘sideways loss relief’. Sideways loss relief allows a taxpayer to offset losses made in relation to one source of income against another.

Schemes like this which involve money going round in a circle often fail at the tax tribunal by reference to anti-avoidance principles deployed by judges. The tribunal had no need to deploy those principles in this particular instance, however. In order for the scheme to deliver its purported tax saving, the scheme’s users had to be used car dealers, because that is the business the inflated losses were said to arise from. But on the facts they simply weren’t used car dealers. A key factual assertion on the basis of which the scheme’s users filed their tax returns was a falsehood.

Some low-value artificial transactions were entered into in respect of some used cars as part of the scheme’s implementation, but the tribunal found that the scheme’s users ‘took [no] interest whatever in the details of the purchases and sales, that they were indifferent to whether a profit or loss was made, and that they obtained the bare minimum of information solely in order that that information could be entered on their tax returns.’ That being the case the scheme’s users were not, on the facts, the used car dealers that they had claimed to be. This falsehood would not have been enough, it should be recognised, to establish fraud. There needs to be dishonesty.21 And so in a criminal prosecution the question would have arisen whether Chris Moyles and the other scheme users were being dishonest when they falsely claimed to be used car dealers.

It might be thought that the answer to this question depends on the advice they were given. If the advice had been that they had to genuinely start up a used car business and take it seriously as a commercial enterprise in order to be used car dealers for tax purposes, then it would be very hard for them to claim that they had been honest when they filed their tax returns, since they knew that they had not done these things. If, on the other hand (and this is the more likely scenario), they had been advised that they could lawfully claim to be used car dealers for tax purposes without the need for that claim to actually be true, then the allegation of dishonesty would sit most comfortably with the advisers who sold the scheme on that false basis.

This being an appeal against a mere civil assessment to tax, however, as opposed to the criminal proceedings that HMRC could have instituted on the same facts, Chris Moyles’s honesty and the honesty of the other scheme users was not in issue, and still less the honesty of the people who sold him the scheme. The falsehood about being a used car dealer had no legal consequence for anyone, aside from giving the civil tax tribunal an extra reason to deny the purported tax saving.

The case serves therefore to illustrate the practical consequences of HMRC’s early determinations as to whether they are going to treat a case as avoidance or fraud. In this instance there were the superficial signs of purportedly legal but artificial tax abuse (circular transactions with no commercial purpose &c) and no smoking gun showing dishonesty, and so the matter was treated as avoidance. It was not until the evidence was heard by the civil tax tribunal that the findings of fact were made – i.e. that the scheme users were not used car dealers – that made clear that the scheme users’ tax returns were filed on the basis of an outright lie. But by that stage HMRC were institutionally committed to the process of simply recovering the tax owed (albeit with civil penalties no doubt payable in addition).

The fact that cases along these lines play out like this arguably serves to encourage tax abuse of the most egregious kind. Taxpayers can be filing tax returns that contain outright lies, just as in a clear-cut case of fraudulent tax evasion, but because the advisers have dressed the scheme up to look like legal tax avoidance, they stand a chance of being able to defend the scheme at tribunal, without the slightest risk of ending up in prison instead. They are, as it were, playing by the rules of the game, even if they are breaking the law of the land.

b. Eclipse

Film schemes were a popular form of tax avoidance used by many high-net-worth individuals in the past. They made use of various tax incentives the government had put in place to promote the British film industry. The schemes were designed to generate fictitious film investment, which would generate losses, just as in the Working Wheels scheme discussed above. High net worth investors would become partners in a partnership which purported to carry on some film-related business. The partnership would make a loss which could then be offset against the taxable earnings the investors had made in their real jobs.

Typically with sideways loss schemes the losses would be inflated by some sort of external financing which would mean that the amount of tax relief claimed would be disproportionate to the amount invested. As with Working Wheels the borrowed money would go round in a circle, so the losses the scheme users offset against their other income were a fiction. The result was that investors ended up making money out of the tax system and not the film industry.

HMRC had several options for attacking these schemes. The preferred way of dealing with them was to deny the tax benefits to the partners (the investors) on the basis that the partnerships were not engaged in a trade that was set up with a view to making a profit (a condition of claiming tax relief). HMRC’s argument was that the schemes were designed to be loss making, with the only benefit to users coming from the reduction in their tax bill, and so the appearance of a profit-making business was (like the losses it was designed to generate) a fiction. However, it was also possible for HMRC to bring criminal charges on the basis that the fictitious nature of the losses constituted fraud. In this report we look at two contrasting film schemes; one of each was dealt with as a civil matter (i.e. Eclipse, considered in this section) and another of which (i.e. R v Walsh-Atkins, considered in the ‘breaking the rules of the game’ subsection) was dealt with as a criminal matter.

The Eclipse tax avoidance scheme was designed by HSBC for its high-net-worth customers by Neil Bowman, a former partner at EY and Director of Structured Tax Products at HSBC between 2003 and 2009. HSBC are believed to have earned £25m in fees for their part in the scheme. As this scheme was marketed to clients, the clients would be investing in a partnership which would buy the distribution rights to films produced by Disney. These partnerships would then seek to market the film rights for a profit. Invariably, this ‘marketing’ operation was a failure, and the partnerships ended up making a loss on their investment. These losses were then used to reduce the amount of taxable profit of the investors that had been made in their real employment.

The value of any investment in the partnerships was inflated by loans provided by HSBC and other major banks. However, the vast majority of the money raised by these loans was never applied to any commercial activities of the Eclipse partnerships. Instead, through a series of back-to-back transactions, the loans were simply returned to the lending bank. Their only purpose was make the value of the investment by partners in the film partnership larger than it really was practice.

In addition to the circular flow of funds, a subsequent HMRC enquiry into the scheme revealed that the trade in film rights that was the foundation of the scheme was an illusion. The Eclipse partnerships only held the rights for little more than a day, selling them straight back to Disney. Disney, not the partnerships, did all of the marketing of the films. Disney remained in real control over the film rights at all times. The Eclipse partnerships as a result never had any trade. The losses generated by the partnerships were completely artificial. As a result of the ruling of the court on this issue,22 the inflation of the loans worked the other way and left investors facing tax bills higher than their original investment; in some cases up to 20 times higher.

The scheme users are now taking action against HSBC, seeking to claim back losses of £1.4bn on the basis that they were defrauded by the scheme. According to claimants, HSBC should have known that the scheme was not a legally viable means of reducing a tax bill. Further, the claimants point out that Jonathan Peacock QC, whose legal opinion underpinned the scheme, had advised that in order to qualify for tax relief, the marketing agent established by the partnership had to ‘actually undertake the role it had been assigned’. The claimants argue that the scheme was not implemented in line with the original tax advice, noting that Mr Peacock was never consulted on the final implementation of the scheme.

Whether or not that is what happened in this case (the claim is not yet resolved) this is a widespread phenomenon in so-called ‘legal’ tax avoidance that turns out to be legally ineffective. The scheme relies, in some way, on squaring a circle. For example, one party needs to control something for commercial reasons but another party needs to control things for tax reasons. The scheme is nonetheless implemented as a paper exercise, with the professional advisers involved knowing that the square has not been circled – they are just hoping it winds up yielding the tax benefit anyway one way or another.

That knowledge that the scheme relies on an imaginary perfect implementation that does not reflect the reality being implemented could very well be understood as dishonesty, and yet generally HMRC simply comply with their policy and treat these matter as if it was just bad luck on the part of the taxpayers that their clever scheme did not actually work.

Breaking the rules of the game

c. R v Walsh-Atkins

R v Walsh-Atkins demonstrates how some of the same arguments deployed by HMRC when treating film schemes as a civil matter (as to which see Eclipse above) can equally be applied in a criminal prosecution for tax fraud. The case was a criminal trial which ended in the conviction (under the common law offence of cheating the public revenue) of a number of people involved in all the component parts of a film scheme, from film makers to scheme promoters and investors.

The tax avoidance scheme in this case was set up by Terence Potter, a former partner at EY and former senior member of the Chartered Institute of Taxation. In many ways the scheme he constructed was similar to other film tax schemes. High-net-worth individuals with large amounts of taxable income became investors in film partnerships. The partnerships made losses, which were inflated to increase the tax deduction. The losses were then offset against the taxable income of the investors.

There was one key difference, however. The losses in this case were not created through third party loan arrangements but by the inflation of the cost of production via false invoices. The inflation was tax driven, in that the level of losses was predetermined based on the amount of tax losses that were required. The inflation of invoices also allowed the film makers to over-claim film tax credits, a form of subsidy for the film industry which is based on production spend.

In view of HMRC policy in this regard, it is clear that this falsification of documents is what persuaded HMRC to pursue criminal prosecution in this particular case. However, this element of the fraud was not the only issue pursued at the trial. A significant part of the case against the investors and scheme operators involved how sideways loss relief was used to claim tax deductions.

In the case summary the Crown made the point that it would be ‘commercial nonsense’ to increase expenditure to inflate losses, yet that is exactly what happened in this case. As it was put by the Crown: ‘ultimately, if people are putting up their own money then unless they are stupid they want to make some money out of it.’ The fact that these partnerships were constructed to inflate costs and lose money was evidence in support of the overall case that the purpose of the scheme was a conspiracy to cheat the revenue. The prosecution sought to prove that the investors never really had any interest or participation in the trade beyond the opportunity to lower their tax bill, and as such they could not be considered active partners.

This element of the prosecution case is analogous to the findings of fact of the tax tribunal in Eclipse discussed above. In that case, there was no trade. The marketing business which the partnership was supposed to carry out was a fiction. Control over all aspects of the film’s marketing and distribution remained with Disney at all times. In Eclipse, however, rather than adding to an overall picture of criminality, the fictitious nature of the trade was a mere technical feature in a civil legal analysis with no more serious consequence than to deny the intended tax advantage.

Terence Potter received an 8-year prison sentence for the role he played in the scheme, whereas the mechanisms of law enforcement have completely bypassed the people behind the Eclipse scheme and others like it, even though they have sought, by means of similar fictions, to generate tax losses leading to billions in unlawful tax claims. Obviously there is a clear ‘smoking gun’ in the case of R v Walsh-Atkins, in the form of the falsified documents, and that piece of evidence was what HMRC considered sufficient to pass the file over to the Crown Prosecution Service. But once in the hands of the Crown that piece of evidence was treated as merely part of an overall picture of dishonesty that took in the fictional nature of the entire scheme. There is no reason to assume that schemes lacking the evidential ‘smoking gun’ of a falsified document must necessarily be less dishonest.

d. R v Charlton

The case of R v Charlton and others [1996] STC 1481 provides a rare illustration of a tax lawyer facing criminal prosecution for their role in a tax avoidance scheme. A barrister was successfully prosecuted, and sentenced to fifteen months in prison (reduced to nine on appeal), for facilitating what he very obviously thought was perfectly legal tax planning. Accountants involved in the transaction were prosecuted too, but it is the attitude displayed by the barrister in his appeal against conviction and sentence which is particularly revealing for present purposes. He clearly thought he was playing the game according to its rules, and was indignant that HMRC had elected to enforce the law instead.

The scheme involved UK companies buying inputs from third parties at market prices, but buying them through captive offshore companies which applied a mark-up, creating (i) increased deductions from taxable profits onshore and (ii) an accumulating bundle of untaxed income offshore, which the business owners dipped into for personal purposes.

The transactions were highly artificial, the purportedly arm’s length prices were significantly inflated to maximise the tax advantage, and the legal advice that the scheme was viable lacked credibility. These features of the matters were all (rightly) treated by the prosecution as contributing to the overall picture of dishonesty. But to a reader familiar with how HMRC treats abusive tax conduct what is surprising about the case is how ordinary these features are in the world of ‘legal’ tax avoidance. HMRC sees matters like this all the time and doesn’t categorise them as fraud for the purposes of internal procedure, still less actually prosecute.

As well as being highly artificial there were aspects of the scheme which were simply incompetently implemented, and the reason HMRC prosecuted in this instance appears to have been because these features of the implementation were not fully disclosed at the outset of the investigation. The defence of the barrister involved was that he only advised on the basis of what was in his instructions, but he was convicted on the finding that he knew more about the poor implementation as time went on, even past the point where HMRC was investigating and still no disclosure of the full details had taken place. It was seemingly this concealment which sent the handling of the matter down the criminal pathway, resulting in the barrister’s prosecution and imprisonment, notwithstanding that in essence the scheme barely differed from the kind of badly implemented and highly aggressive avoidance which HMRC is accustomed to defeating in civil tax litigation. The judgment of the Court of Appeal in the tax barrister’s appeal against his conviction and sentence notes that he

denied any dishonest involvement with the schemes. It was his case that he acted in the best traditions of the Bar by protecting his clients from any oppressive inquiries by the Revenue. It is apparent that [he] has a certain hostility to the Revenue and he conceives it to be his duty to ensure that the Revenue act within the limit of the powers entrusted to them by statute. He contends that all his actions in these cases were directed to that end and at no time was he acting dishonestly.

As anyone with experience of the tax industry will attest, this kind of attitude – an apparent belief that even the most tendentious avenues of tax avoidance are somehow in the spirit of (rather than running counter to) the core democratic principle of the rule of law – is widespread among tax professionals, and for the most part this barrister was just playing the usual game. In this instance he breached the rules of the game so far as HMRC were concerned, meaning that the fundamental dishonesty inherent in this kind of conduct ended up leading him down the extremely rare path of criminal prosecution.

The game being played on a global scale

e. General Electric

Fraudulent conduct dressed up as legal tax avoidance, and then treated as non-criminal by HMRC, is common throughout the world of international corporate tax planning, and this is something HMRC are quite frank about. In a recent document on the subject of non-compliance in this area they say this:

Our investigations into [international corporate profit shifting] have established that in a large number of cases the factual pattern outlined to HMRC at the start of an enquiry does not stand up to scrutiny once tested. That may be a result of a careless error (for example individuals within a group being unaware of what the actual facts are) but it may also be a result of a deliberate behaviour, that is a group knowingly submitting a [transfer pricing] methodology in a Corporation Tax Return based on a false set of facts. A common issue is an overstatement of functions performed, assets used and risks assumed in entities taxed at lower rates, and an understatement of the functions performed, assets used and risks assumed in the UK [emphasis added].23

And of course transfer pricing based on a false set of facts is just one of the many kinds of dubious conduct on the part of multinationals. In this case study we consider a complex ‘hybrid arbitrage’ tax avoidance scheme.

In 2002 General Electric moved $5bn between the US, Luxembourg, the UK and Australia in just four days as part of a structured transaction. The scheme allegedly generated a tax benefit for GE in the UK of up to £760m over a period of 10 years. The principle behind a hybrid arbitrage scheme is relatively simple, although the schemes themselves can be very complex. Tax lawyers search for mismatches between the domestic tax legislation of different countries in order to try to make sure that their income falls through the gaps of the tax system and is not taxed anywhere. One of the most famous examples of a hybrid arbitrage scheme is the so called ‘Double Irish’ structure that was employed by many technology companies in the previous decade. These schemes used a company in Ireland owned by a US corporation that was not considered to be tax resident in either Ireland or the United States, leading to no tax being paid on any profits generated by the company.

The GE scheme exploited a mismatch between the tax treatment of Australian partnerships under UK and Australian tax law. Under UK law Australian partnerships were considered to be transparent, meaning that the partners were liable for any taxable profits or losses generated by the partnership. However, in Australia, these partnerships were not transparent, meaning that they had their own tax liability separate from any liabilities of the partners. In the GE scheme an Australian partnership had two UK-based companies acting as partners. The mismatch between UK and Australian law meant that expenses incurred by the partnership could be deducted from tax liabilities in Australia, as well as from the partners’ tax liabilities in the UK. GE then granted a multi-billion-dollar loan to the partnership from a third GE company which generated UK and Australian tax losses on the same transaction.

Hybrid mismatches are a well-known form of tax avoidance and tax authorities have been alive to the threat that that companies will seek to exploit them for many years. To counteract this threat the UK has implemented a number of anti-avoidance provisions in legislation. This includes the unallowable purpose rule, which allows HMRC to disregard the effect of any transaction that has been entered into solely in order to gain a tax advantage. In 2005 the government also introduced new anti-arbitrage rules. This allowed HMRC to disallow any tax deduction claimed by a company where there was no taxable receipt somewhere else, or where a company had claimed another deduction for the same expense. However, the rules only applied where the main purpose was to gain a UK tax benefit.

Under the rules companies could seek an agreement with HMRC that the tax authority would not apply the rules in the future to any particular transactions under a clearance process. In 2005 GE approached HMRC to gain clearance under the new anti-arbitrage rules for 107 loan transactions amounting to £21.2bn, including the transactions involving their Australian partnership. Although HMRC were initially highly sceptical that the Australian transactions were anything other than a tax avoidance scheme, they agreed a partial clearance which allowed GE to deduct most of the interest costs associated with the Australian transactions in the UK. HMRC say they did this after receiving assurances from GE that the transactions constituted a commercial investment and that any tax advantage gained from the structure would arise in Australia and not the UK.

In 2019 HMRC filed proceedings at the High Court seeking to void the clearance agreement they had reached with GE on the basis that GE had failed to disclose material facts that relating to the transactions. In particular, HMRC alleged that they were not aware that the creation of the Australian partnership was part of a larger set of transactions that saw money move between the US, Luxembourg, the UK, Australia and back to the US over a period of just four days. This suggested that there was little or no commercial purpose to the transactions, other than the exploitation of the arbitrage opportunity in the UK and Australia.

HMRC alleged that GE had withheld information, specifically by deleting key passages of documentation from the minutes of board meeting before sending it to HMRC. The full minutes would have shown that the amount of money going through the UK was far more than the amount needed to buy assets in Australia, suggesting that the transactions were tax driven rather than being commercially driven. The tax authority also alleges that GE stated that their view was that UK anti-avoidance legislation should not apply to the transactions because the main purpose of the transaction was not to avoid tax in the UK, whereas in 2013 GE told the Australian Tax Office that the purpose of the scheme was “to gain a tax advantage in the UK not Australia”.

HMRC’s original claim against GE was that the company had made an innocent mistake in failing to disclose material facts in the course of the clearance discussions. But they then later attempted to change their claim to allege fraud. HMRC’s change in strategy to openly allege fraud against a major multi-national company sent shockwaves through the tax profession when revealed in the press. It was simply unheard of for HMRC to allege fraud against a professionally-advised large company with regard to their international tax affairs (although such allegations are common in Europe and elsewhere). GE embarked on legal proceedings to challenged HMRC’s attempt to allege fraud, arguing that HMRC was out of time to do so. They won this argument at the Court of Appeal. HMRC applied for, and was granted permission to argue the point at the Supreme Court. However, before the matter was resolved, HMRC reached an out of court settlement with GE accepting a tax liability of just 10% of the original amount claimed.

This case has demonstrated the problems that can arise when HMRC do not raise allegations of fraud in a timely manner of fail to investigate evidence of fraud. The court papers show that HMRC’s Fraud Investigation Service twice turned down the opportunity to investigate the case after it was referred to them. Although clearly HMRC believed that the clearance agreement they entered into was obtained fraudulently, the time it took them to reach that conclusion meant that they encountered procedural difficulties in bringing the claim; difficulties that would not have been an issue if they had investigated the fraud (if that is what it is), as such, in a timely manner. None of the people who perpetrated it appear to be at any risk of criminal prosecution.

This is not an official publication of the House of Commons or the House of Lords. It has not been approved by either House or its committees. All-Party Parliamentary Groups are informal groups of Members of both Houses with a common interest in particular issues. The views expressed in this report are those of the group.

1David Ormerod & Karl Laird, Smith, Hogan and Ormerod’s Criminal Law, 15th edn., Oxford, 2018, pp. 994-5

2See s. 114 of The Police and Criminal Evidence Act 1984, and The Police and Criminal Evidence Act 1984 (Application to Revenue and Customs) Order 2015; see also the Criminal Procedure and Investigations Act 1996 for further details of the statutory framework within which HMRC operates when conducting criminal investigations.

3Inland Revenue Commissioners v National Federation of Self-Employed and Small Businesses Ltd [1981] STC 260 (‘Fleet Street Casuals’) at 269

4R v Werner [1998] STC 550, citing R v Inland Revenue Commissioners, ex parte Mead and Cook [1992] STC 482

5https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/684324/COP8_02_18.pdf & https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/494808/COP9_06_14.pdf

6https://www.gov.uk/government/publications/criminal-investigation/hmrc-criminal-investigation-policy

7See P. Alldridge, Criminal Justice and Taxation, Oxford, 2017 pp. 119-122

8 See House Of Commons, Oral Evidence taken before the Public Accounts Committee, Tax Avoidance Schemes, Thursday 6 December 2012, questions 31-36, available at https://publications.parliament.uk/pa/cm201213/cmselect/cmpubacc/uc788-i/uc78801.htm; see also J. Maugham, ‘Weak transmission mechanism – and the boys who won’t say no’, 7 August 2014, available at https://waitingfortax.com/2014/08/07/weak-transmission-mechanisms-and-boys-who-wont-say-no/

9Disclosure of tax avoidance schemes legislation requires advisers to report schemes to HMRC if they meet certain hallmarks. However, it is possible to procure legal opinions stating that your scheme does not meet these hallmarks.

10 This case is one of our case studies below.

11 David Ormerod, ‘Cheating the Public Revenue’ [1998] Crim LR 627, 630

12 BBC File on Four, Furlough Fraud, Transcript available from: https://downloads.bbc.co.uk/rmhttp/fileon4/PAJ_2707_PG18_Furlough_Fraud.pdf

13 TaxWatch, Use of Disguised Remuneration Avoidance Schemes More than Doubled After Loan Charge, http://13.40.187.124/dr_scheme_stats_2020/

14 https://web.archive.org/web/20190111125155/https://www.gov.uk/government/publications/hmrc-profit-diversion-compliance-facility/profit-diversion-compliance-facility

15‘[T]he Revenue operate a selective policy of prosecution. […] It is inherent in such a policy that there may be inconsistency and unfairness as between one dishonest taxpayer and another who is guilty of a very similar offence.’ (R v Inland Revenue Commissioners, ex parte Mead and Cook [1992] STC 482 per Lord Justice Stuart-Smith at 492)

16 DWP, “Penalties Policy”, section 4.3 Prosecutions, available from: https://www.gov.uk/government/publications/penalties-for-social-security-fraud-and-error/penalties-policy-in-respect-of-social-security-fraud-and-error

17 S.32(1) Theft Act 1968

18IFF Research, “Enablers and Facilitators of Tax Evasion”, HMRC Research Report 600, Para 1.20 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/938747/Research_report_600_Enablers_and_Facilitators_of_Tax_Evasion.pdf

19See recommendations for the United Kingdom in: OECD, “Fighting Tax Crime, The Ten Global Principles, 2nd Edition”, https://www.oecd.org/tax/crime/fighting-tax-crime-the-ten-global-principles-second-edition-country-chapters.pdf

20http://www.bailii.org/uk/cases/UKFTT/TC/2014/TC03314.html

21D. Ormerod & K. Laird, Smith, Hogan and Ormerod’s Criminal Law, fifteenth edition, Oxford, 2018, 23.5

22 Eclipse Film Partners No 35 LLP v HM Revenue and Customs [2015] EWCA Civ 95

23https://web.archive.org/web/20190111125155/https://www.gov.uk/government/publications/hmrc-profit-diversion-compliance-facility/profit-diversion-compliance-facility at section 4.4.1

Cross-party MPs call time on feeble approach to tax avoidance and urge HMRC to prosecute tax fraudsters

27th October 2022 by Alex Dunnagan

The All-Party Parliamentary Group for Anti-Corruption & Responsible Tax and TaxWatch have published a joint report outlining how supposedly ‘legal’ tax avoidance could actually be prosecuted as tax fraud. The report explains that there exists a serious enforcement gap in HMRC’s approach to tackling tax fraud, whereby criminal tax behaviour is systematically dealt with through civil channels provided that it complies with the “rules of the game” i.e. it has the superficial appearance of “legal” tax avoidance.

This means that, even if the tax is recovered, the underlying criminal behaviour goes unpunished. The deterrent effect of the criminal offence of “cheating the public revenue” is therefore disapplied in this context by HMRC policy, with the consequence that unscrupulous advisers, promoters and enablers face no serious downside risk in selling this kind of behaviour to taxpayers. This leads to substantial revenue losses. We argue that HMRC should enforce the law of the land rather than merely the “rules of the game”.

Dame Margaret Hodge MP, Chair of the APPG on Anti-Corruption & Responsible Tax, said:

The myth that tax avoidance is legal and tax evasion is illegal is a false distinction which is reinforced by the tax industry and HMRC’s feeble approach to enforcement. Our bold new paper attempts to explode these myths and recommends that HMRC should be enforcing existing criminal law by prosecuting the enablers of the most aggressive tax avoidance. HMRC should be enforcing the laws of the land, not the rules of the “tax fraud game” that let tax avoiders and their enablers off the hook. We need a real deterrent to stop bad behaviour or these tax cheats will continue to flout the rules while most taxpayers struggle with the cost of living crisis.

At a launch event in Parliament on 25th October  for the new report, Putting a Stop to the Tax Fraud Game, senior Parliamentarians, a Shadow Minister, academics and practitioners called on government to urgently close loopholes which allow egregious tax fraud to go unpunished. The paper argues the following:

  •  Much that is claimed to be “legal” tax avoidance is actually criminal tax fraud. The relevant criminal offence – ‘cheating the public revenue’ – is extremely wide and could include tax avoiders and the advisers that devise, market and enable tax avoidance schemes.
  • HMRC prioritises cases where there is clear “active deception”, like hiding information or falsifying documents.
  • Because of this, tax advisers know they can recommend ineffective tax avoidance schemes with impunity, provided they comply with the notional “rules of the game” by making a cursory effort to present it as legal, with no “active” deception or concealment.
  • Lack of fear of criminal sanction removes any real deterrent to this behaviour and so tax fraud, including supposedly “legal” tax avoidance, goes largely unpunished.
  • HMRC cannot keep up with better-resourced lawyers and accountants concocting potentially fraudulent avoidance schemes for their clients, and so many succeed without so much as a second glance, leading to major revenue losses and the undercutting of our public services, like the NHS and police.
  • The focus of a change in policy in this area should be on the unscrupulous promoters and advisers who are the root cause of the problem by bringing forward more criminal prosecutions against these enablers.

Dame Margaret continued:

For me, tax lies at the heart of the social contract. During this time of crisis after crisis, it has seldom been more important for our country to come together and pull in the same direction – toward security and prosperity for all. We must all pay into the common pot, for the common good, in order to fund the public services and infrastructure that we all rely on, including our NHS, our schools, and our roads. Any person or company that attempts to dodge paying their fair share – the tax avoiders and evaders – should be met with the full force of the law.

Alex Dunnagan, Acting Director of TaxWatch said:

The idea that tax avoidance is legal, and that tax evasion is illegal, has done untold damage to the state of taxation in the UK. Pursuing tax avoidance as a civil matter when there has clearly been fraudulent behaviour, does not act as a deterrent. Put simply, HMRC should pursue tax fraud for what it is – a crime. Laws already exist to prosecute those committing tax fraud. HMRC should use them.

The report can be found as a webpage here, and as a PDF here.

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