RegulationJun 19 2014

Opening up the legal floodgates

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To combat that minority, the government “will now require those who have signed up to disclosed tax avoidance schemes to pay their taxes, like everyone else, up front”.

The basic premise is, perhaps, not all that contentious. The government’s message is aimed at taxpayers who join partnerships making highly geared investment in films, intellectual property or other assets that produce substantial first-year tax losses that can be used to offset income from other sources. However, the manner in which the government proposes to execute that plan could give rise to a significant increase in the number of professional negligence claims being brought against financial advisers.

Legislation

The Finance Bill 2014/15, which is currently passing through parliament, contains provisions in relation to an “Accelerated Payment Scheme”. The effect of this is that, if HM Revenue & Customs considers that a taxpayer has made use of a tax avoidance scheme that a court or tribunal has already ruled against (or one that is similar), then the taxpayer can be required to pay the tax HMRC believes is owing, while the dispute or investigation into that particular taxpayer’s investment and claim for relief is going on.

The scheme would apply re-trospectively to investments and it is this that may cause difficulty for some advisers and their professional indemnity insurers.

Under the current regime, the taxpayer can withhold the disputed tax until the dispute has been concluded. Therefore, the onus has previously been on HMRC to challenge the taxpayer’s claim for relief before it can receive the tax.

However, under the scheme, the taxpayer has to pay the disputed tax straight away, giving them an ‘interim’ tax liability purely because HMRC considers that their investment might be ineffective as a tax avoidance scheme.

The Chartered Institute of Taxation and the Treasury Committee have recently expressed concern about the retrospective nature of the proposed scheme. From our perspective as lawyers who regularly defend financial advisers in negligence claims, it appears that there could indeed be unforeseen and undesirable consequences.

It is estimated that HMRC has a backlog of around 65,000 potential tax avoidance cases. If the proposed scheme is enacted, then many of those 65,000 investors could receive Accelerated Payment Notices requiring the prompt payment of very significant alleged tax liabilities.

A ‘perfect storm’ could, therefore, be brewing. For HMRC to issue a notice, it must believe that the investment in question is the same or similar to one that has been found to be ineffective by a court or tribunal.

There have recently been a number of high-profile cases relating to tax avoidance schemes, where HMRC has successfully challenged various schemes. The most recent has been in the Icebreaker litigation. It is not often that a 147-page judgment handed down by the First Tier Tax Tribunal captures the imagination of the national press, but this is no doubt due to the sprinkling of stardust from Gary Barlow and other high-profile individuals who had reportedly invested in one of the partnerships in question.

It is likely that HMRC will rely upon such successes to support the use of notices in relation to the backlog of cases deemed worthy of investigation.

Deluge

Many taxpayers who have invested in schemes that may be vulnerable to notices will have done so on the advice of an adviser.

These notices create a problem for those advisers. Even if the investment is subsequently ‘acquitted’ and the investor secures the relief they were anticipating, in the intervening period the investor will incur a substantial financial liability they had not expected or prepared for.

Investors who are suddenly faced with a large tax demand from HMRC arising from a supposedly tax-efficient investment will often be inclined to question the advice they have been given. There have been claims against professionals involved in the promotion and sale of such schemes to investors, where HMRC has successfully challenged an investor’s tax arrangements, and due to the backlog at HMRC, I anticipate there are many more cases in the pipeline. If the scheme is enacted, it is possible that advisers could face something of a deluge of claims in the near future.

Many advisers included warnings in their reports that their advice was based on the law and practice in force at the time and that legislation could change.

Such warnings may be helpful in defending advisers against claims based only on an unexpected “interim” tax liability, but they would not offer much protection where claims are made against the adviser regarding the initial advice to invest in such a scheme.

Such claims are likely to necessitate the prompt instruction of defence lawyers. For advisers whose professional indemnity insurance provides for significant ‘costs inclusive’ excesses, this will mean a significant outlay on legal fees with all the usual implications for the adviser’s cash flow and profits. It can also be particularly problematic where policies provide for an excess that is payable on “each and every claim made” and which are not capped in anyway. In these circumstances, a sudden deluge of claims can place a real strain on advisers’ cash flow and resources.

Self-defence

So how can advisers prepare for this potential onslaught? There are a few easy steps that should help to ensure they are better placed to deal with any claims that are prompted by these developments.

Advisers should review their electronic and hard copy document storage and retention policies. It might be appropriate to stop any planned secure shredding or deletion of client files for the moment, until it is clear whether any claims are going to be made.

After all, specialist defence lawyers require the original records and documents to put forward the best defence. It has been possible to defend claims with minimal documentation, such as by arguing that the claimant is out of time to bring a claim in the first place, but in most other cases the best results are achieved if all the evidence is available.

Perhaps most importantly, advisers should re-read their professional indemnity insurance policies, and re-familiarise themselves with the procedures they need to follow to let their insurers know about any negligence claims or circumstances that could lead to claims. Advisers should also consider how many of their past or current clients might be affected by these changes to the tax landscape, and go on to have a discussion with their insurance broker or professional indemnity insurers about those cases. This could be a vital part of preserving their insurance cover. Some insurers will decline cover entirely if the adviser does not inform them at the appropriate time about what could potentially ‘come out of the woodwork’ at a later date.

James Field is a solicitor at law firm Robin Simon

Key points

The government’s approach to clamping down on tax avoidance schemes could open advisers up to claims

The new Accelerated Payment Scheme forces those suspected of using tax avoidance to pay the disputed amount owed up front before the dispute is settled

Many tax payers who have invested in schemes that may be vulnerable to Accelerated Payment Notices will have done so on the advice of an adviser.

In such cases, advisers may be held responsible by investors and sued.

With thousands of such cases in the pipeline, advisers could face a deluge of claims.

Advisers can take steps to defend themselves against such claims.