HMRC’s quest is to close the tax gap: the difference between the amounts of tax that should be collected against what is actually collected. The most recent figure is for 2011/12 and is estimated to be £35bn (or 7% of total tax liabilities). It is interesting to note the overall value of the tax gap has remained reasonably constant over the past seven years, although as an overall percentage of total liabilities it has generally fallen slightly year after year. The estimated proportion attributable to tax avoidance and evasion is £9.1bn.

This is what HMRC is chasing and along the way it has the clear intention to change attitudes and behaviour in relation to the payment of tax, specifically targeting those who deliberately evade or take part in tax planning and avoidance. The perception from HMRC is that certain sectors have been ‘getting away with it’ for too long. This perception combined with the growing public opinion that wealthy individuals and big business are not paying their fair share, means that tax compliance is both an emotive and political hot potato, and one which politicians, the Treasury and HMRC cannot ignore.

However, political pressures combined with austerity measures mean the tax gap is being pursued by an ever-shrinking department which has been set ever-increasing compliance targets. Understandably, HMRC appear to focus on areas that are likely to be fruitful: high net worth individuals, residence and domicile issues, tax planning, (perceived) avoidance schemes, offshore structures, trusts and property related taxes.

Three areas HMRC have concentrated on in its quest to close the gap are: increased information exchange, greater use of disclosure facilities and a generally more aggressive approach to non-compliance.

Information exchange

It is clear HMRC has fully embraced the phrase ‘information is king’ as it has an insatiable desire to acquire it from whatever source possible.

HMRC has always had and maintains its old favourites – Land Registry, UK bank returns, Voters Register, Housing Benefits, DVLA, etc. However, accessing information about offshore companies and trusts has previously been difficult for regulatory bodies including tax authorities, unless a criminal enquiry into a tax or financial fraud was in process.

A number of coincidental events changed the global playing field, including the financial crisis of 2008, the US attack on Swiss banks and employee client data thefts from financial institutions. The consequences: the US Foreign Account Tax Compliance Act (FATCA), an increase in exchange agreements, increased membership of the Convention on Mutual Administrative Assistance in Tax Matters (including the likes of Switzerland and Luxembourg) and more recently agreements between the UK and its Crown Dependencies and Territories - now extended to incorporate many EU countries. The exchange agreements are becoming multi-lateral and automatic in their capability, which is speeding up the information flow to regulatory authorities.

The pursuit of offshore information has even breached the borders of so called ‘tax havens’, something tax inspectors could have previously only dreamed about. The UK/Swiss Tax agreement effectively ensures taxation of all Swiss bank accounts held by UK residents holding such accounts.

Many countries have launched tax disclosure facilities to allow those with undeclared offshore matters to rectify their position on beneficial terms.

Agreements have been signed between the UK and Isle of Man, Guernsey and Jersey ahead of a planned information exchange between the countries that will commence in 2016 in relation to information from 2014 onwards. These three new facilities have been generated by an increasing movement towards transparency as a consequence of US FATCA. It is clear that this FATCA style agreement is becoming a template for information exchange with the G20 (in conjunction with the OECD) pressing for a worldwide automatic exchange of information system. This will mean that all but the very darkest corners of the world’s financial centres will be passing the financial details of their clients back to the client’s tax authority, namely HMRC in the UK.

Once the Crown Dependencies disclosure facilities expire in 2016 we can expect significant tax compliance activity from HMRC based around those jurisdictions. Details to be exchanged include name, address, year end balance of the account, income and gains generated and the account number. A simple comparison to the individual’s tax return will clearly reveal discrepancies.

For those holding assets in offshore companies and trusts the planned country-specific registries will expose the ultimate beneficial owners to scrutiny. The company register will be publicly accessible in many locations and, for some, so will the trust register. For example, the UK has indicated its company register will be public, suggestions are that France will publicly publish both the company and Trust register and the Cayman Islands is currently undergoing a consultation process on this matter.

What does this increased transparency and the flow of financial information between countries around the world mean for advisors and their clients? Anyone with undeclared offshore tax related matters should take specialist advice and rectify their position via any available disclosure facility open to them. If the tax authority contacts those individuals before they disclose voluntarily, the consequences will be financially severe and in the most serious cases may involve a criminal prosecution.

For individuals, businesses and family offices whose affairs involve offshore companies and trusts, a review of the structure and its compliance with local and home country regimes is advised. Structures which are not needed should be closed and complex arrangements need to be understood and the arrangements captured so that that they can be explained adequately to any inquisitive tax officials. The beneficial owners need to be educated in the nature of the structure, its purpose and their relationship and influence within, ensuring that they undertake the appropriate actions required from them.

Advisors should ensure they have complete records which validate the structure in place and the advice given. That material should be retained, readily accessible and regularly reviewed to ensure it remains relevant. Legally privileged documentation needs to be highlighted and separately filed to retain its confidentiality in any review.

HMRC’s Connect system

In relation to the flow of information, and specifically the volume of information being obtained by HMRC, the questions arise as to how will HMRC cope and can it realistically deal with and analyse this information in any meaningful way? The message from HMRC is most definitely yes!

HMRC has made significant investment in ‘state of the art’ data analytical software, with a system called Connect.

At a recent presentation Mike Hainey, project leader and head of the Risk and Intelligence Service Data Analytics Team for HMRC, was highly enthusiastic about the benefits HMRC is seeing from the Connect system. Over the last 5 years £45m has been expended with a yield of £2.66bn.

The Connect system is an analysing and sorting tool, but it requires good data to be at its most effective. HMRC is ensuring good data is fed into the system and that the data feeds received are easily compatible with the system.

The following interesting facts were relayed at the presentation:

• Integrated Compliance Environment (ICE) – this is the platform available to approximately 3000 front line investigators (soon to rise to 5000). This allows investigators to use a visualisation tool which gives them an overall view of the information held on the taxpayer and anything they are associated with.
• Analytical Compliance Environment (ACE) – this is the platform available to 150 data analysts who look for patterns and footprints in the data to establish certain behaviours. Once the behaviour is spotted it is linked into the network and sent as part of a case pack directly to an investigator who continues the review.
• Both platforms produce spider diagrams which the investigator can easily follow. The entities that Connect can associate with an individual include trusts, partnerships and businesses, and it covers both direct and indirect taxes.
• Currently 28 different data sources are used within Connect and more will be added. This data includes ready available departmental data and bought-in data.
• 62% of case selections made in 2011/12 came from Connect, 77% of case selections were made in 2012/13 and 83% are planned for the current year.
• The information from the UK’s merchant acquirers - companies that process card payment transactions – will be used within Connect to determine the value and quantity of transactions completed by specific traders.

This is a very powerful tool that has been added to HMRC’s armoury and it is fully expected that the profile of HMRC’s Connect system will increase over the next few years as more data becomes available under Inter-Governmental Agreements, such as those signed with the Crown Dependencies and Overseas Territories.

Increased Use of Disclosure Facilities

As previously noted, HMRC is a shrinking department with higher compliance targets. In a drive to increase the revenue take in an efficient manner there has been a move towards using voluntary disclosure facilities and targeted campaigns.

Under a voluntary scheme the majority of the ‘investigation’ is conducted by the individual (or at their expense) and is either preceded or finalised with a cash payment of the liabilities.

Admittedly there is a carrot offered by HMRC for making the disclosure; however, the overall reduction in the full value of liabilities due is clearly considered good value compared with the savings and efficiency of HMRC not having to discover, investigate and collect hitherto undetected tax liabilities.

There have been a number of facilities offered by HMRC and there are several currently available to be used in the right circumstances. Full consideration of the facts should be made before embarking on any one of the facilities; one size does not fit all, and experience suggests this initial decision is often the most crucial in dictating the best strategy to be used to achieve full disclosure.

That said, it is fair to say the Liechtenstein Disclosure Facility (LDF) has consistently proved to be the most suitable facility in many cases in this ever changing world. Originally launched in August 2009, the LDF was a unique disclosure facility offering terms allowing the efficient settlement of long-standing tax issues, including undeclared offshore income and gains and inheritance tax.

The LDF has been extended until 6 April 2016 and as the net closes in on those with undeclared offshore tax matters through the various information exchange agreements, the LDF will continue to assist many to achieve a successful solution.

HMRC has publicly targeted £3bn in revenue from the LDF. As at 30 November 2013 (HMRC’s latest published figures) the LDF shows total registrations of 5,355 of which 3,576 are settled. A total of £833m has been paid to HMRC and the average case settlement is £164,000. Based on these numbers, it seems that HMRC is expecting 13,000 new registrations or a substantial increase in the average yield per case.

The beneficial terms of the LDF allow immunity from prosecution, a reduction in the maximum number of years for which tax can be recovered (currently from 20 to 14 years), a substantially reduced penalty of 10% for all years between 1999/00 to 2008/09 inclusive (20% and 30% for later years), and importantly, the option of a unique tax rate by way of the Composite Rate Option (CRO) which removes, in many cases, any exposure to inheritance tax for years up to 2008/09.

As noted previously, the Isle of Man, Jersey and Guernsey have agreed to specific disclosure facilities relevant to each of their jurisdictions. The terms of these facilities are similar in nature to the LDF but with a number of significant omissions. For example, no absolute immunity from prosecution, the barring of using the facility if the individual has previously had or is currently under a tax investigation and, most significantly, no CRO which can be so beneficial in LDF cases where there are inheritance tax liabilities. Hence the circumstances of each case must be considered and thought given to the most efficient method under which any disclosure should be made and if appropriate which disclosure facility is best suited to that case.

The Crown Dependencies agreements placed an obligation on the relevant financial institutions in each jurisdiction to notify relevant UK persons of the existence of the disclosure facility by 31 December 2013. Relevant clients should have received those letters and may be considering their options right now.

Alongside the use of disclosure facilities HMRC is using numerous targeted campaigns. These campaigns are specifically designed to assist in bringing individuals from specific targeted sectors back up to date with their tax affairs and to change future behavior.

In 2013 HMRC launched its ‘Property Sales Campaign’ aimed at taxpayers who had not disclosed the gains made on property disposals, either in the UK or abroad. This campaign ran until 9 August 2013 and so the favourable terms have now passed. However, this specific campaign is worth highlighting as UK property information is readily available to HMRC and with the increased use of Connect this poses a greater risk for any clients who have failed to come clean. HMRC has a particular interest in property and has confirmed that any individuals found to have undeclared liabilities surrounding property are likely to receive a substantial penalty at best and in the worst cases criminal prosecution.

More Aggressive Approach to Non-Compliance

Underpinning HMRC’s pursuit of greater tax compliance is a more active and growing Criminal Prosecution team. There has been specific investment to increase the number of criminal investigators by 1,200 officers, resulting in an increased number of working prosecution cases. A number of these have been relatively high profile.

HMRC has been open about the increased threat of criminal investigation and has highlighted areas such as tax schemes and abuse on non-domicile rules as specific areas for which it will pursue criminal investigations.

The recent statistics for criminal cases support the message from HMRC and make quite sobering reading. In 2011, 165 people were prosecuted for tax evasion. That number increased to 477 in 2012, and 690 successful prosecutions were made in the period from January 2013 to November 2013. The target for the year 2014/15 is to increase the number to over 1,000.

On the civil side there is no doubt HMRC are charging and pursuing penalties much more vigorously. The introduction of the new penalty regime with FA2007, effective for years 2008/09 onwards, removed some of the inconsistencies of the old regime and placed individuals in penalty bands depending on the default and the perceived behaviour. However, the discussion around penalties has simply moved away from ‘the level of co-operation, disclosure and seriousness’ and on to whether the individual took ‘reasonable care or was careless’. Making sure a client is in the right banding can have significant impact on the penalty payable. I would recommend advisors consider penalties very carefully as HMRC can on occasions apply the penalty as a matter of course. There is significant guidance within HMRC Manuals and several Tribunal cases that should be considered.

The recent Autumn Statement in December 2013 reinforced HMRC’s continued toughening approach towards non-compliance and avoidance. The Chancellor announced the introduction of what he referred to as “the largest package of measures to tackle tax avoidance, tax evasion, fraud and error so far this Parliament”.

Amongst the measures announced he targeted employment intermediaries facilitating “false self-employment” and he introduced anti-avoidance measures where the tax favoured status of charities has been abused, legislation to establish a new information disclosure and a new penalty regime for high risk promoters of tax avoidance schemes. He spoke about penalties for individuals who used avoidance schemes which are found ineffective by a Tribunal, should the individual then not concede. He also made an announcement that the government will consult on the offshore penalty regime to “enhance the sanctions to penalise those who hide their money offshore and enhance deterrence”.

However, one of the most striking announcements was in conjunction with the penalty notice for users of failed avoidance schemes. It is proposed HMRC will require an individual served with an “avoidance follower penalty notice” to pay the tax in dispute. Previously with any appeal the tax would be postponed from collection until the appeal process has expired. However, following a Tax Tribunal decision in HMRC’s favour, HMRC will insist on payment of the previously postponed tax despite the appellant having made a further appeal to the Upper Tier Tribunal. It is proposed this will become effective from Royal Assent to the 2014 Finance Act (July 2014) and will cover current schemes in dispute where HMRC believes it has a decision in its favour. This is a fundamental shift in approach from HMRC and is likely to have a significant impact on a number of litigation cases and individuals involved in on-going tax scheme disputes. This proposal is currently being challenged, so watch this space.

Summary

A number of tax commentators are predicting a tough year ahead in terms of tax investigations and disputes. In this continuingly changing environment, HMRC has a definite strategy to pursue tax evasion, avoidance and general non-compliance.

There is a more thorough approach to information exchange, which is supported by the worldwide clampdown and drive for transparency in the pursuit of unpaid taxes.

With this in mind I noted with interest a recent change in the legislation pushed through in Italy that came into force on 1 January 2014. In order to increase the traceability of payments, and thereby reduce the opportunity for tax evasion, cash payment for certain goods and services will be forbidden. These include residential rental payments and certain costs of building reconstruction. In addition doctors, dentists, lawyers and other professionals will be obliged to have a point of sale terminal to allow clients to pay by bank transfer.

The question is - could this happen here?

Andrew Walker Tax Investigations Partner at Smith & Williamson, the accountancy and investment management group.

Tele: Manchester: +44 (0)161 871 6614

Dungannon: +44 (0)28 8744 7200

Email: andrew.walker@smith.williamson.co.uk

W: www.smith.williamson.co.uk