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Karen Francis, Tax Partner, PKF (UK) LLP

There is a commonly held view that if the Treasury is to meet the promised spending levels without raising headline tax rates then all the tax that is due needs to be collected - and possibly more besides. This raises questions over the tactics employed by HM Revenue & Customs (HMRC) to ensure that the correct (read “maximum”!) amount of tax is collected. What are these tactics exactly, and how can companies respond to them?

Why now?

Over the past couple of years many companies have suffered bad press about the use of complex avoidance schemes to reduce their tax burden (be it corporate tax, PAYE, National Insurance or VAT). The Treasury’s view, widely publicised (not to scare companies, just for clarity), is that tax avoidance is somehow ethically wrong, and that it results in other businesses and individuals having to bear an increased proportion of the national tax burden.

It is hard to see how such a moral stance can easily be applied to companies. It is true that corporate social responsibility is now a widely accepted concept. However, since tax is also a political issue, and a company has a duty to maximise shareholders returns, this is a moot point.

In the UK, the amount of tax due has always depended on the letter of the law in place at the time, yet, in other European countries, the intention of the law is more important. In the recent Halifax case, the European Court of Justice applied the “abuse of right” principle to decide that Halifax could not use the letter of UK VAT law to defeat its main objective. This is one example of European tax convergence that the Chancellor will be happy about and we understand that HMRC would like to extend the principle to other UK taxes.

Tax planners and HMRC are locked in a time-honoured race, the planners coming up with new schemes as fast as HMRC can change the legislation to close down an existing one. In recent times, the volume of new legislation and its increasing complexity has enabled planners to devise more and more schemes and generally keep one step ahead - the Road Runner to HMRC’s Wile E. Coyote. Frustrated, the Treasury decided that enough was enough, and set about identifying ways for HMRC to find out about schemes sooner.

HMRC tactics

Under corporate tax self assessment no information need be submitted until 12 months after the end of a company’s accounting period. HMRC was only finding out about schemes long after they were implemented and the tax benefit obtained. When the Closer Working Pilot Scheme was introduced (to help reduce bottlenecks and administration costs for all parties), companies taking part had to sign a “Closer Working Contract”. This generally requires a discussion with HMRC about the issues arising in a particular year just after the results are announced. A cynic might consider that one of the drivers behind this was to give HMRC access to current schemes at least six to nine months earlier than normal, and thus enable them to be closed down sooner.

By 2004 the Treasury decided to take drastic action and in Finance Act 2004 introduced disclosure rules for both direct and indirect tax. For direct tax these rules require disclosure by the promoter of certain types of scheme with written details of the scheme (including an outline of the legislation on which it is based) to be submitted to the Anti-Avoidance Unit of HMRC within five days of it being made available for sale. Anyone implementing a disclosed scheme has to include its reference number on the tax return. HMRC rightly see this as a potential deterrent as companies may not want to get a reputation for being implementers of schemes. For indirect tax the disclosure rules require a business to disclose if it is reducing its VAT liability in certain specified ways.

What impact has this had on the tax planners? Has the number of schemes reduced? One impact is that schemes have a shorter life span, so presumably fewer schemes are actually implemented and there is less “tax loss” to the Government. But individual companies are not necessarily paying more tax - those that seek bespoke tax planning to meet the specific business needs are still likely to reduce their tax charge more than companies using off-the-shelf schemes.

HMRC is being particularly aggressive in the area of taxes on employment income. In the past this has been a significant area for tax planners: both SMEs and large corporates are interested in opportunities to reduce their PAYE and NI liabilities, either to pass the benefit wholly to directors and staff, or to simply reduce the costs of doing business. Last year the Paymaster General announced the Treasury’s intention to use what would effectively be retrospective legislation - by introducing new tax laws when future schemes are discovered, which are then deemed to take effect from 2 December 2004 - ensuring that future schemes will never have been tax-efficient.

At some point, this imaginative approach will probably be challenged by a large employer (perhaps under the Human Rights legislation). However, for many companies, the potential benefits of such tax saving arrangements will be outweighed by the costs and risks of going to court. Prudent companies will be looking to make sure their employer compliance procedures are streamlined but foolproof, to reduce administration costs and the risk of penalties, as well as ensuring that they take advantage of low-risk planning options such as salary sacrifice arrangements.

Another tactic HMRC has developed is sending “enabling” letters to thousands of companies or individuals, highlighting an issue that may, or may not, be pertinent to them. For example, HMRC believes that in the construction industry there are significant numbers of individuals who are being paid as self employed sub-contractors but who should actually be classed as employed (and hence more NIC would be due). Letters were sent out last year to both contractors and sub-contractors warning of a review and saying that, if in doubt over the correct status of workers, individuals or companies should contact HMRC. Helpfully, these “enabling” letters also made it clear that penalties would be sought if, on a subsequent investigation, individuals were found to be incorrectly categorised.

Further such letters have been sent this year. These give examples as to what indicates that someone is employed, and suggests that if you answer yes to the questions you are employed. The questions alone are not sufficient to be able to answer the question “Am I employed or self-employed?” but certainly would lead an individual towards thinking that he or she is an employee.

The letters are not targeted at contractors or sub-contractors where HMRC has a reasonable suspicion of evasion or indeed any kind of suspicion. They are being sent to anyone potentially affected. Perhaps HMRC hopes to scare sub-contractors into voluntarily owning up to tax errors (or “enabling” taxpayers to put their affairs in order as HMRC describe this process). While ignoring these letters is not a good idea, anecdotal evidence suggests that a prompt response will promote a company to the top of the queue for an employee status review visit from HMRC.

A similar pilot exercise has recently led to letters being sent to individuals with offshore bank accounts. Again, there is no evidence of individual wrong-doing; HMRC is simply addressing a risk area - it says that much tax fraud involves the use of an offshore bank account at some point. It is clear this tactic is likely to be repeated for other “high risk” areas, so companies that receive such an “enabling” letter should not assume that they face imminent investigation but should take care over how they respond. It may not be possible to ensure that your company is not on a “high risk” list (most firms in the telecoms sector are at high risk of becoming unwittingly involved in a “carousel” VAT fraud), but making sure your tax compliance is watertight will reduce time and money spent on handling future HMRC enquiries.

Most recently there has been a suggestion that many companies are claiming research and development (R&D) tax credits to which they are not entitled. This follows the BE Studios case in which the High Court decided that the company was not entitled to R&D tax credits of £150,000 that had been claimed. This case in being used to challenge other claims, so companies making claims for R&D tax credits can expect enquiries to be raised, particularly if the claim involves the use of software. Anecdotal evidence suggests that in the past, when take-up was lower, R&D tax credit claims have been simply rubber-stamped. It is ironic that now higher tax revenues are required, it is harder to have a claim approved.

Penalties are another area where HMRC is becoming more aggressive. In the past, if an adjustment was made to a tax return as a result of an enquiry, then it was extremely rare for the Inspector concerned to consider penalties if it arose because of a simple error. Now it is far more common for penalties to be sought for even the most minor errors. The rule of thumb seems to be that a penalty is due for any amendment to a tax return.

It appears that the Treasury, through HMRC, is looking to raise as much money from existing taxes as possible. This has led to a more aggressive approach to dealing with tax payers and substantial increases in powers for HMRC. The blurring of the line between legal avoidance and illegal evasion in HMRC statements can only increase uncertainty for taxpayers. The net result will be a significantly increased administrative burden for both good and bad taxpayers alike. Companies who rise to this challenge by making sure their compliance systems are efficient and effective, and who build tax-efficiency into their business structures and transactions from the start, will save tax and control their administration costs. Those who do not do this may see increasingly large bites taken out of their bottom line.

Biography

Karen Francis is Tax Partner at PKF (UK) LLP. She has considerable experience in all aspects of tax affecting corporates. This includes dealing with Inland Revenue enquiries, advising on corporate finance transactions and ensuring that tax efficient structures are in place. Ms Francis has particular expertise in the property, manufacturing and retail sectors. She is a fellow of the Institute of Chartered Accountants in England and Wales and an associate member of the Chartered Institute of Taxation.

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