Wednesday, November 23, 2016

HMRC's "hardline" decision to collect tax due nine years ago

BLOG 176

HMRC’s “hardline” decision to collect tax due nine years ago

Last Saturday’s Times contained what seems to me to be an extra-ordinary article by Alexi Mostrous, their Head of Investigations.  It began, “The hardline decision by HM Revenue & Customs to issue huge tax demands to hundreds of wealthy investors in the Eclipse film partnerships marks the culmination of a four-year campaign against such avoidance schemes”.

The complaint seems to be that those wealthy individuals are being asked to pay the tax and interest on their income but they have spent all the money on the assumption that their tax avoidance scheme would work.  Accordingly many are facing bankruptcy and some are considering suicide.  I am not clear what Mr Mostrous thinks HMRC should do.  HMRC are required to collect the tax that Parliament decrees.  Doing just that does not strike me as a hardline decision.

I have never made a secret of my views on tax avoidance.  I do not think that there is any morality in tax.  Tax is a creation of statute.  If the statute says that transaction A attracts £X of tax, the tax ought to be paid.  If the statute says that transaction B creates an expense that can be deducted in calculating the tax on transaction A, the taxpayer is entitled to make that deduction.  There are numerous cases where HMRC collects tax that is not morally due.  Regular readers of this blog will know that I highlight some of these from time to time.  HMRC’s rationale is that they have a duty to collect the tax parliament lays down, however unreasonable that impost may be.

I think that works both ways.  If a person seeks to avoid tax and his scheme fails, he should pay the tax that he sought to avoid.  He is not entitled to look for special treatment because he has spent the money.  Thousands of people who have never attempted to avoid tax do not set aside the tax money but spend it on other things and face financial hardship and bankruptcy when the time to pay the tax arrives and their coffers are bare.  I am not aware of Mr Mostrous having ever proclaimed it “hardline” for HMRC to seek to collect the tax from such people.

In practice HMRC do not like to bankrupt people.  That reduces the person’s earning capacity and therefore their ability to pay future tax.  HMRC are normally willing to enter into a time to pay arrangement.  But they do expect the taxpayer to do his best to pay the tax as quickly as is practicable.  They do expect a wealthy individual to realise assets, to re-mortgage his house, to downsize to release funds, or whatever else is needed to produce the cash.  If a person lives an expensive lifestyle and has accumulated assets, it would surely be an affront to the general body of taxpayers to allow the person to continue to live the high life using money that is due to the Exchequer.

What have these wealthy taxpayers who have gained Mr Mostrous’s sympathy done?  The Eclipse Film Partners No 35 tax avoidance scheme was won by HMRC in the Court of Appeal in February 2015.  The Supreme Court refused leave to appeal on 13 April 2016.  They normally refuse leave only where they believe that the decision of the Court of Appeal is so obviously correct that there is no public interest in its being challenged.

The scheme related to the tax year 2006/07.  The members of the partnership collectively put £50million of their own money into it and also put in an extra £790million that they borrowed from a subsidiary of Barclays Bank.  The partnership paid £44m to Future Films, the promoter of the scheme.  Accordingly virtually none of the members’ £50million went into films.  The scheme was nothing to do with the members helping the film industry; any such help came from Barclays Bank.  The partnership lent £293m of Barclays Bank’s money to the members as an advance against future profits and the members paid that money back to Barclays Bank as a prepayment of 10 years interest on their loans.

The scheme was a deferral scheme.  The idea was that Barclays’ money would be used to buy film rights from Disney Corporation which would then be licenced back to Disney for 20 years.  The licence fee would be income of the partnership and as such taxed on the partners.  However the partners would never see that money; it would be used to repay the Barclays Bank loan.  Accordingly the members thought (or if they did not understand the scheme, should have thought) that they would get tax relief in 2006/07 but would have taxable income in each of the next 20 years for which they would have to fund the tax out of their own resources (or, of course, enter into further tax avoidance schemes each year to seek to shelter that income from tax) as the income itself had to be paid to Barclays.

In general the UK tax system does not grant tax relief for interest on borrowings to make investments.  You do not get tax relief for interest on the mortgage to invest in your house; you do not get tax relief for interest on a borrowing to invest in shares in, say, BP even though you expect the investment to produce taxable dividends; and you do not get tax relief for interest on a borrowing to invest in film rights even though you expect those rights to produce taxable licence fees. (Curiously if you rent your house and borrow to invest in someone else’s house you do get tax relief on the interest by treating it as an expense of generating the rental income.  Personally that does not seem either rational or moral, but it is what parliament in its wisdom has decided and, as I said earlier, in my view we ought to/are entitled to take the tax system as we find it).

If I carry on a trade, I do get tax relief for interest on money that I borrow for the purpose of the trade.  It is a business expense.  If a partnership carries on a trade, a partner can claim tax relief on interest on money that he borrows to finance the trade (presumably parliament feels that such interest is in reality a trading expense of the trade).  The members of Eclipse 35 believed it was carrying on a trade so that they could set their advance loan interest payments against their overall income for 2006/07.  The Courts have held that the partnership’s activities were an investment in film rights, not a trade.  Accordingly they have no right to tax relief for the interest payment in the same way as no one else has a right to tax relief on money borrowed to make an investment.

The issue that seems to have attracted Mr Mostrous’s sympathy is that by now the investors owe tax not only on the £293m income of 2006/07 that they sought to shelter by the interest payment, but they have “received” getting on for half the leasing receipts on which they also owe the tax (as they always expected to do).  These investors have known since April that the tax was due - and because all of the First-tier Tribunal, the Upper Tribunal and the Court of Appeal have held that the partnership did not carry on a trade, they have at least known the tax might be due since the FTT decision in 2012 and so have had four years to find the money.  2006/07 tax was due for payment by 31 January 2008, which is almost 9 years ago.  How much longer does Mr Mostrous think that the Exchequer should wait for its money?  The tax on the licence fees would have been payable even if the activities had amounted to a trade so it is not clear why the partners should still owe the money.  They ought to have been declaring that income and paying the tax on it year by year.

A judge once commented in relation to tax avoidance that he who plays with fire cannot complain of burnt fingers.  That seems to me to be precisely what the investors in Eclipse 35 are now doing.  They want to say the whole thing was a ghastly mistake and HMRC ought to pretend nothing happened and simply collect tax on the £293m.  But that is an extra-ordinary concept.  They entered into real transactions and even convinced the Courts that they were real, not pretend transactions.  They may not like the tax consequences of those real transactions but it is not reasonable to criticise HMRC for enforcing those consequences.

HMRC are not being hardline.  They are simply enforcing the laws laid down by parliament.  That is what they are there to do.  Of course parliament could change the laws.  Mr Mostrous can write to his MP and suggest that parliament should retrospectively exempt from tax those wealthy investors who sought to avoid it and have spent the money because they felt that their fair contribution to society is somewhat less than parliament has decreed.  That would be a perfectly legitimate thing to do.  I somehow doubt that parliament would think such a suggestion reasonable though!


Monday, November 14, 2016


BLOG 175


HMRC recently issued a note about calculating the 2014/15 tax gap.  This tells us that the tax gap for 2014/15 was some 6.5% of the total tax and duties due to HMRC.  It also says that “the estimate announced for the previous year has been revised upwards from £34bn to an actual figure of £37bn”.

I am not sure that it is helpful for the government to lie to the citizenry.  But I suppose that when it ought to be obvious that it is a lie – as it is surely not possible to “estimate” an “actual figure” that may not matter too much.  One can replace an estimate by an actual figure and one can refine an estimate to produce a more accurate estimate – which is what HMRC have done – but there will always be a fundamental difference between an estimate (an educated guess) and an actual figure (a fact).

The briefing note is of course little more than an advertising puff for the full 86-page report, which is a lot more honest.  So what is the tax gap?  HMRC say it is the difference between the amount of tax due and the amount collected.  They point out that it is impossible to collect every penny theoretically due, “for example, we cannot legally collect taxes from companies that owe tax and are insolvent”.  I like that word “legally”.  If HMRC believe that there are illegal ways to collect tax from people who have no money, perhaps they should explain what they are.  In the real world if a person has spent all his money he cannot pay anything.  But I digress.  The full report breaks down the tax gap as follows.

Criminal attacks                                  £4.8bn                                     13%
Evasion                                                  5.2bn                                     14%
Hidden economy                                 £6.2bn                                     17%
                                                                                    £16.2bn           44%

Avoidance                                                                       2.2bn             6%
Non-payment                                                                  3.6bn           10%
Legal interpretation                            £5.2bn                                     15%
Failure to take reasonable care            5.5bn                                     19%
Error                                                    £3.2bn             £13.9bn             9%    
                                                                                    £35.9bn          103%   

I have totalled the first three items together because they are all different forms of theft.  I assume that HMRC have split them because they try to counter them in various ways.

This is an interesting table.  44% of the £6.5bn shortfall, or £2.86bn is lost due to theft.  That is obviously an estimate.  If HMRC knew how much had been stolen from taxpayers they would also know who stole it and would presumably recover it.  The reality is that they do not know, because nobody knows.  Many put the figure much higher.

Bearing in mind the vast amount of both government expenditure and new legislation designed to combat tax avoidance, it is interesting to learn that this actually cost taxpayers only £2.2bn in 2014/15 and represented a mere 0.39% of the tax shortfall.  Indeed the vast majority of this figure is not a shortfall at all.  It will be collected (with interest at a rate that exceeds a commercial rate) in later years because most attempted tax avoidance fails and the tax has to be paid (or will fall into HMRC’s non-payment category) in a later year.  Where avoidance is successful, it is not part of the tax gap either (under HMRC’s definition) as the tax will never have been “an amount of tax due”; it is an error in HMRC’s calculation of the tax due, arising from a misunderstanding by HMRC of the tax laws.

Non-payment is factual and there is not much to say about it; even HMRC cannot stop people becoming insolvent.

The three remaining items are all estimates.  How accurate they are is questionable.  HMRC enquire into a small number of cases.  Those enquiries throw up areas where the taxpayer has taken a different view from HMRC.  In most cases the two sides compromise.  HMRC then consider imposing a penalty for the extra tax that becomes collectible as a result of their challenge.  If the taxpayer accepts a penalty, that extra tax is labelled as arising from failure to take reasonable care; if he doesn’t, it is attributed to error.  If the dispute has not been resolved by the time HMRC prepare their statistics, the tax HMRC are claiming is labelled as lost due to legal interpretation.  The statistics are generally based on HMRC random enquiries.  They do a very tiny number of random enquiries.  I do not know how many but I would be surprised if it is more than 1,000.  They then assume that the extra tax they pick up from that small number is representative of the whole body of taxpayers.  So if they pick up extra tax on, say, 200 of their 1,000 random enquiries they assume that 20% of the 9 million tax returns they receive are similarly wrong.  That may or may not be a correct assumption.  I have no doubt that it is a statistically reasonable one. 

The legal interpretation category is a bit more controversial because most challenges of legal interpretations take years to resolve.  Some, or indeed all, of that £5.2bn may be tax that will ultimately be collected.  It may equally not be tax at all but an amount that HMRC thought was due because they misunderstood the law.  This means that projecting from the sample to the general body of taxpayers is fairly pointless.  It is improbably that other taxpayers will be interpreting or misinterpreting exactly the same bits of legislation.

The real breakdown of the tax gap is therefore as follows:

tax stolen (estimated)                                                                                    £16.2bn
tax lost because HMRC did not manage to collect it in time                3.6bn
tax lost because HMRC have not been given the resources
   to do more enquiries                                                                        £13.9bn

tax that will be paid late as a result of attempted
avoidance will never have actually been due as HMRC
misunderstood the law                                                                           2.2bn

This raises interesting questions about HMRC’s use of resources.