In 2004 the UK Government introduced legislation to enable HMRC to mount a challenge against tax avoidance schemes which were considered aggressive. This legislation was referred to as the “Disclosure of Tax Avoidance Schemes Legislation” or DOTAS.

DOTAS & GAAR

Under DOTAS, a scheme fulfilling certain criteria required the promoters of the scheme to disclose it to HMRC who in turn allocated the scheme a DOTAS reference number which investors in the scheme were required to include on their Self-Assessment Tax Return in the year that they made the investment. The only benefit for the investor was that by including the DOTAS scheme reference number on their return they avoided a penalty should HMRC successfully challenge the scheme and the tax previously avoided became payable.

The DOTAS legislation was enhanced by the introduction of the General Anti-Avoidance Rule or GAAR from 17 July 2013 which focuses on the substance of the enacting legislation instead of the letter of the law.

HMRC’s war on avoidance secured a major victory in the summer of 2012 when the comedian Jimmy Carr was shown to have avoided tax following a special investigation by the London Times Newspaper. Carr had sheltered millions of pounds worth of earnings in the K2 tax avoidance scheme and ultimately settled circa a £500k tax bill upon departure from this scheme. Many celebrities, footballers, politicians were all to have found to be sheltering tens of millions of pounds of income in similar schemes and the public outrage provided HMRC with the higher moral ground in the avoidance battle.

Following two consultations on tax avoidance in August 2013 and January 2014, HMRC changed the economics of tax avoidance within the Finance Act 2014 by introducing controversial measures concerning Follower Notices, and Accelerated Payments Notices.

Follower Notices

A key weapon in HMRC’s artillery against avoidance is a “Follower Notice”. Essentially HMRC will apply these notices where it has been successful in litigation. As a result it can direct others users of the same or similar avoidance schemes to follow the ruling in the particular case in which HMRC has succeeded. The practicalities driving this legislation is that it is estimated there are over 40,000 cases currently under enquiry within HMRC which could take up to 30 years to resolve through the normal litigation channels. HMRC resources have been stretched to breaking point and the benefit of the Follower Notice legislation is that a taxpayer unwilling to comply with the notice will be levied with a large penalty should the taxpayer not take the prescribed corrective action, for example by amending his tax return or claim or settling a disputed appeal within 90 days of the Follower Notice. The penalty is 50% of the denied tax advantage which may be reduced for co-operation to a minimum of 10%.

Accelerated Payment Notices

HMRC’s second weapon against avoidance is the aforementioned Accelerated Payments Notice (APN). The APN will require the taxpayer to pay any disputed tax despite the matter being the subject of an enquiry or appeal. Historically HMRC had no power to demand payment without a particular case being successfully litigated against. The APN regime will radically change this and such a payment notice may be issued after a Follower Notice has been issued or indeed it can be issued in its own right if taxpayers are engaged in avoidance arrangements which carry a DOTAS number or where a GAAR counteraction notice has been issued.

The APN will usually be preceded (2–4 weeks) by a letter enclosing HMRC factsheet CC/FS24 “Tax Avoidance Schemes – Accelerated Payments” and explaining that an APN will be issued within 4 weeks.

In the APN’s, HMRC will estimate the amount of tax due and the taxpayer has 90 days following receipt of the notice to pay the tax associated with the avoidance arrangement. This payment of tax is essentially a prepayment or payment on account and therefore can be collected through the normal debt management procedures of HMRC. However HMRC has stated that it is open to requests for “time to pay”. There is no right of appeal against an APN.

In July 2014 HMRC published a list of more than 1,000 DOTAS schemes which it considered tax avoidance vehicles and it has started to send out APN’s to many of those invested in these DOTAS schemes. The first of these notices started to arrive in recent weeks creating somewhat of a dilemma for taxpayers and their advisors.

Dilemma

Since the early 2000’s many UK taxpayers invested in Film Partnerships and the returns in which they claimed tax relief are still the subject of an enquiry. Typically, HMRC issued an enquiry notice into the partnership return and then into each individual partners return. These enquiries have been left ‘in limbo’ pending the outcome of the partnership enquiry.

In recent weeks however, HMRC has placed such taxpayers in a dilemma by giving them weeks to accept their ‘settlement opportunity’ which will be withdrawn as leading cases near litigation. Even if the taxpayer declines the settlement opportunity, they face the issue of an APN and the threat of getting no tax relief on their investment should their case ultimately be decided in HMRC’s favour.

On the other hand, acceptance of the settlement opportunity perhaps places the taxpayer in a position where they could, as part of the settlement, negotiate an individual repayment plan more advantageous than what would be on offer otherwise. Typically, investors took their tax relief by reducing their Self Assessment payments years ago so they now owe HMRC money if the investment fails to attract tax relief.

Case Study

Liam & Noel are in partnership in a music shop. In 2004 they each invested £36,000 in a film partnership which was geared up to £100,000 by the partnership. The films were written down by 90% to give them each a loss of £90,000 which they self assessed against their trading profit share in 2004/5 saving £36,000 of tax. In principle the investment funded itself and they have had a small amount of income from the film partnership since.

HMRC wrote to Liam & Noel in August 2014 advising that they have until 31 October 2014 to accept a settlement offer (40% relief on their £36,000 investment only). The 10 year old enquiry is before the First Tier Tribunal on 13 November. If HMRC win, Liam & Noel get no relief. If HMRC lose they will probably appeal. HMRC issue an APN advice letter to both Liam & Noel on 5 October 2014.

Do Liam & Noel:

• Ignore the settlement offer and make the APN of £36k each; or
• Accept the settlement offer and request a “Time to Pay” deal with HMRC on the residual tax due of £21,600 each (plus interest)?

Auditors Dilemma

Auditors faced with auditing a company which has invested in a tax avoidance scheme also face an additional dilemma in dealing with any APN that the company may be about to receive or indeed has received. Firstly, where is the tax demanded posted to in the corporate accounts? Is it a balance sheet item (debtor, repayable if the scheme is successful), is it a P&L item (tax under-provision for prior years tax), is it a contingent liability? Is there a going concern issue? Has the company the cash to fund one or even multiple APNs where the company habitually undertook annual tax avoidance over a number of years?

What about dividends extracted from a company that now receives an APN? The dividend could ultimately turn out to be illegal given that there were insufficient reserves to declare it when the correct tax charge is now factored in.

What about the realisable value of the investment (avoidance vehicle)? Perhaps at best it may only be worth 20% of its initial value (i.e. the tax relief available via a HMRC settlement offer).

With FRS 102 fast approaching and HMRC having an anticipated 18 month roll out plan for APN’s, (estimated at 33,000 to individuals and 10,000 to businesses) this is an area that is set to cause much head scratching by tax advisers, company accountants and auditors.

Paddy Harty is a Senior Director with PKF-FPM Accountants Limited. He is also the current Chairman of the Institute’s Northern Ireland Tax Committee.