Feature

posted 15 Dec 2005 in Volume 11 Issue 1

Taken the money? Open the box!

Is the disclosure of tax-avoidance schemes working to everyone’s satisfaction? David Earle, a researcher for the Tax Law Review Committee, reports.

Until last year, ‘Disclosure’ was merely a 1994 film starring Michael Douglas. For tax practitioners, this is no longer the case. A new acronym, DOTAS (disclosure of tax avoidance schemes), has now entered our lexicon. Most practitioners are familiar with Her Majesty's Revenue & Customs (HMRC) guidance, and a few have filed their own DOTAS returns.

HMRC have received all these submissions, and thus have an overview of how the regime is working. But advisers have mostly kept their own counsel, and have not shared their views on the legislation.

In view of the importance of DOTAS, and the substantial shift it marks in the UK’s tax regime, the Tax Law Review Committee (TLRC) decided that it was worth trying to collate some early views from the tax profession on the direct tax regime as it affects them.

Scope and caveats

The TLRC therefore approached the 50 largest accounting and 50 largest law firms to ask if they would contribute to the project. Of those approached, around 20 per cent agreed to participate; most of the remainder did not respond to the request. Of the volunteers, around two-thirds were accountancy practices.

Although a relatively small number of tax-advisory businesses agreed to contribute, the TLRC continued with the project because the volunteers represented a reasonable spread of different types of tax businesses. They ranged from firms that were actively involved in the design and marketing of avoidance products through to those who had no direct involvement in structured avoidance at all. Some firms had made a significant number of disclosures; others had made none.

It can be seen that the contributors were thus self-selected out of the original sample. Given that co-operation was voluntary, self-selection was the only ~way to approach the project but, together with the relatively low response rate, not unexpected given the sensitivity of the issues, these factors mean that the results cannot be considered statistically significant. Those who did not participate may have had different, or more extreme, views than the volunteers. Nevertheless, the TLRC found the project’s conclusions interesting and this article reports on these findings.

Representatives from each firm were interviewed in detail between November 2004 and April 2005. However, before considering the conclusions, it is worth summarising the views of HMRC.

HMRC’s view

HMRC have seen all disclosures and are thus in a uniquely privileged position to assess the impact of DOTAS. In June 2005, Dave Hartnett, director general of HMRC told the House of Lords Select Committee on Economic Affairs that: “For direct tax I think this has been a very productive experience and helped us enormously to counter tax avoidance faster than we would ever have done without this legislation.”

Ray McCann, then assistant director at the Avoidance Intelligence Unit at the Inland Revenue, speaking at a CIOT members’ conference in April 2005 put it more simply when he said that: “To the question of ‘whether one year on they have been worth it?’, the answer, from a Revenue perspective, is simply ‘yes’.”

More specifically, the conference was told that the benefits HMRC obtained from the disclosures included the following:

Putting HMRC in a better position to advise ministers about the threat posed by tax-avoidance schemes;
The combination of transparency and swift action by the government has significantly reduced the amount of tax-avoidance activity;
This was particularly true of employment products, where there was much anecdotal evidence that promoters have found it more difficult to operate against reduced customer demand and less certainty of significant fees from the sale of large numbers of schemes;
Individual inspectors are able to have a much wider understanding of the planning opportunities in particular areas and the full benefit of this (in terms of improved drafting and risk assessment) will be increasingly realised over the coming months;
It is “perhaps too early to say that tax-avoidance schemes are a thing of the past but it is … clear that the rules have irreversibly changed the tax-planning landscape”.

In his evidence to the House of Lords, Hartnett said that there had been around 500 disclosures, of which around 25 per cent were employment products. Ray McCann told the CIOT conference that, of these, around 55 per cent had come from the big four accountancy firms and 20 per cent from the next tier, with very few having come from small firms or sole practitioners. Interestingly, he added that there had “also been a huge increase in the number of people saying things (other than disclosures)”.

There is thus consensus on the HMRC side that the regime has been a success; but what about the practitioners’ viewpoint? Responses received to the TLRC project have been clustered around eight issues, set out below.

1. Establishing the DOTAS regime

HMRC’s introduction of the DOTAS regime came in for some robust criticism. The period between announcement and inception was so short that firms had to prepare for the launch based on draft legislation, while consultation continued on the scope of the rules.

The statement of 23 August 2004, issued by the CIOT after discussions with HMRC, narrowed the scope of DOTAS, but came relatively late in the day, as did the decision to amend the employment product regime to introduce premium fee and confidentiality filters, similar to those already provided for financial products. By this stage, most firms had wasted considerable efforts preparing to make significant numbers of disclosures based on the requirements of the original draft regulations and guidance, which in the event were not required.

However, all participants agreed that HMRC was receptive to criticism and willing to consider representations, and that the amendments to the regime were appropriate, albeit too close to the launch date. As a result, there was a consensus that the regime was workable, although only by using a combination of legislation, regulation and guidance (see subheading three below).

2. Ensuring compliance

Most of the accounting firms had established a new centralised process for handling or co-ordinating DOTAS. None of the law firms had done so, which appears to reflect a culture where partners retain more independent responsibility for all aspects of work on their clients than in most accounting practices.

Firms that designed ‘structured tax avoidance products’ had relatively few problems introducing DOTAS procedures in relation to these products. The DOTAS procedures have now become a stage in their product design and approval processes.

In contrast, firms said they had real difficulties identifying DOTAS disclosures arising from day-to-day bespoke client advice. Considerable effort has been, and continues to be spent on this aspect, including some or all of the following:

Proactive staff education;
Mandatory central referral of more complex tax advice;
Establishment of procedures for resolving internal disagreements over whether to disclose;
A requirement for staff to provide evidence of the basis on which decisions relating to DOTAS had been made;
Retrospective quality reviews of partner and staff decisions.

Most firms were concerned by:

The difficulty in identifying with certainty whether disclosure was required in these bespoke cases;
The worry that, despite its best efforts, the firm could be caught out at some stage by late notification, or a complete failure to notify, and the consequences for the firm of this failure, including reputational damage (see 4 below).

Those firms that did not market or sell structured schemes:

Were particularly aggrieved at the time and effort required by DOTAS, and felt that it was totally disproportionate to the number of disclosures that they had to make (none in some cases so far);
Were concerned that, over time, the quality and quantity of effort expended on DOTAS may decrease as a natural reaction to the lack of outputs, and that this, in turn, was more likely to mean that disclosable advice may be overlooked.

Approaches to achieving compliance with DOTAS varied. Some firms preferred to assess whether disclosure would be required on first principles and then considered the filters. Other firms considered the filters primarily as a safe haven and only worried about whether disclosure was required if the filter tests were failed.

Ironically, there were some instances of good tax-planning ideas generated from bespoke work being identified centrally, as a result of the improved procedures around DOTAS, and then being offered to other appropriate clients. This increased, rather than reduced, the amount of tax planning.

In some firms, procedures for complying with DOTAS were credited with leading to improved technical standards.

3. The disclosure tests

There was consensus that the law alone did not provide sufficient guidance as to how to operate DOTAS, and that the gloss of HMRC guidance formed a key element in making it workable.

The filters

Both the premium fee and confidentiality filter tests were considered essential cornerstones of the legislation, eliminating as they do much advice that is not innovative but which might otherwise be caught.

The premium fee filter was considered particularly critical to the day-to-day workability of the regime. The subjective nature of this filter came in for some criticism, in that firms can fail the premium fee test even if they would never charge a premium fee but if another adviser might. Some firms remarked that they never charge a premium fee because all their fees are time based, but recognised that this does not guarantee that the test is not failed. However, there was general agreement that helpful HMRC guidance makes the test extremely useful and effective in practice.

The confidentiality filter tends to be seen in practice as part and parcel of the premium fee. Overall, there was a tendency to apply the filters with pragmatism, erring if anything towards disclosure. Participants used expressions such as ‘smell test’, ‘knowing an elephant when you see one’ and ‘we know what it means’.

Tax advantage

The meaning of ‘tax advantage’ has proved difficult for some because of the need to identify a base level of taxation over which the advantage exists. One firm commented, quite rightly, that the expression is so wide it could catch anything, which is the view taken by the courts, and why the filter tests are so essential.

Other tests

Similarly, for financial products, the need for the advantage to arise from financial products ‘to a significant degree’ has proved difficult, for example, where arrangements include a loan.

The difficulty of interpreting the phrase ‘making available’ came in for considerable criticism and there was general agreement that there was urgent need for better guidance, at the very least. More recently updated guidance has been published by HMRC, but it is not clear that this perceived need will have been satisfied.

4. To disclose or not to disclose

Nearly all the firms said that their policy was one of ‘if in doubt, disclose’. However, on closer examination this apparent similarity embraced a range of approaches.

Some firms had decided as a matter of policy to minimise the risk that they could be caught out by not disclosing if this turned out to be required. These firms made frequent reference to ‘the spirit of what was intended’ by the legislation.

Others took the view that they can and should be able to decide what the law requires as with any other tax issue. Their overriding approach has been geared towards reaching this conclusion. Where the guidance provides a generous gloss on the law, this is taken into account.

But erring in favour of disclosure is then regarded only as the ultimate tie breaker.

However, on the whole there was a bias favouring disclosure in cases of doubt. This appeared to be driven by reputational and/or financial issues:

Reputational issues were mentioned by most in relation to clients, to HMRC, or among peers, and against the background of the higher profile that tax avoidance now has;
Some firms were at pains to emphasise that they wanted to be seen as ethical and professional in operating the regime and were very keen not to be regarded as simply following the HMRC view of the rules. Concern for reputation was nowhere more evident than among firms still involved in creative avoidance activity;
Most firms were keen to be seen to be encouraging full disclosure, although many were at pains to point out that that had always been their approach;
No-one wanted to be the first firm taken to court over a DOTAS failure and there was anxiety about this;
Although some were quite dismissive of the scale of the financial penalties for getting it wrong, others took them extremely seriously and referred to them before any mention of reputation.

A number of firms had amended their client-engagement terms to make explicit their right to decide whether or not to make a DOTAS notification, notwithstanding client confidentiality. Others had considered this but had concluded that such notifications were adequately covered by the existing provision in engagement letters that the firms would comply with their legal obligations.

5. Returns and the AIU

The Avoidance Intelligence Unit (AIU) was set up following the 2004 Budget to manage the DOTAS regime. The AIU has now been reconstituted as part of HMRC’s anti-avoidance group, but for simplicity it is referred to as AIU throughout this article.

Most firms that participated had had no contact with the AIU other than as a post-box for their disclosures. Most used the official form, although there is a view that its declaration exceeds what is required by law. E-substitute forms are used by some firms and these have been accepted. Some firms rely on advice from counsel in drafting disclosures, and most draft the disclosures from scratch although some do adapt existing documentation.

Very occasionally the AIU has asked for clarification following a disclosure, but in general it was reported as processing disclosures immediately and issuing a reference number very quickly and, it was suggested, probably prior to any real consideration of the content.

No firm reported a disclosure that had been rejected and not registered. A number of firms had been directly approached by the AIU, that is, other than in relation to a specific disclosure and, of these, some reported that they had come under pressure to change aspects of their DOTAS reporting approach, notably over the manner and/or content of disclosure.

It was perceived that the AIU, in making these approaches, was drawing on intelligence received from a variety of sources.

Where firms had been approached in this way, most said they had responded co-operatively, although there was reference to being ‘bullied’ by the AIU.

Differences of opinion remain between some firms and the AIU over just how far a disclosure needs to go in explaining the magic of the avoidance. The AIU expressed the view to firms that quoting statutory references is not good enough. Not all firms accept this, although pragmatism seems to have resulted in the AIU view being adopted.

Some firms were disappointed that from the outset the AIU did not have a better understanding of individual firm cultures and attitudes, and consequently had inappropriate expectations of the disclosures particular firms might reasonably be expected to produce.

6. Is DOTAS working?

The consensus, based on each firm’s own experience and what it has gathered from the marketplace, is consistent with the HMRC view set out earlier in this article. Within the boundaries of the DOTAS regime, the firms’ view is that the AIU

is probably receiving notifications about most tax planning in which it would

be interested. There was also agreement that the filters are working reasonably effectively to ensure that the AIU is only notified about the issues it wants to be notified about, and that there is not a lot of ‘chaff’ being included.

7. Has the behaviour of advisers changed?

For those at HMRC and for government ministers, this is, perhaps, the key question. Hartnett, speaking recently to the CIOT’s London branch, put it graphically when he asked “has the balloon burst or should we look for a new bulge elsewhere?”.

At one extreme, some firms were at pains to emphasise that they did not consider the effect of DOTAS itself that significant, because either:

They already proactively discouraged the use of structured avoidance, sometimes because of bad experiences with tax products in the past;
They had an established policy of full disclosure when client returns were submitted – DOTAS merely accelerated its notification.

At the other end of the spectrum, some firms spoke of the need to refine ideas more than in the past before going public. Generally, firms reported that those clients normally most inclined to engage in avoidance were not being deterred but regarded DOTAS as another factor/risk to be considered.

However, most believed that the avoidance industry had been substantially disrupted. They reported some drawing back from the more aggressive avoidance schemes. Where clients with a more marginal inclination to avoid tax (that is, the more risk averse) still wanted to minimise tax, they were now looking for other approaches such as using more traditional bespoke advice. Ironically, this shift supports the continuing inclusion of non-product-based planning within DOTAS, however irritating this is to those who are least engaged in sophisticated structuring (see subheading two above).

It was also clear that the new climate has affected the traditional design and marketing of products. In more than one case the now pejorative term ‘product’ had been outlawed in favour of the more neutral expression ‘solution’. Generally the marketing effort, while not eliminated, has become less overt.

In terms of identifying the causes behind this change in behaviour, firms found it difficult to isolate the effect of the DOTAS regime from other factors; notably a perceived general adverse shift in attitudes to avoidance, including the introduction of a moral dimension and the pre-Budget report threat of retrospection on employment products.

While some behavioural change was generally acknowledged, it was far from clear that it is permanent. Since the end of 2004, the DOTAS regime has more or less stabilised, the extension to SDLT apart, but firms are being very cautious about whether the status quo is temporary or permanent. Some firms not directly involved in designing and marketing products or solutions seemed to be biding their time and monitoring the market. In this context, observations made by the firms about competitors were interesting:

While some were seen as being very pragmatic in applying DOTAS, others were viewed as rather aggressive;
There was a suggestion that niche firms with offshore connections were not complying at all;
There were perceptions that avoidance design and marketing were now being developed in a way that took into account the potentially limited window for selling;
Some law firms were still believed to be sheltering under the legal professional privilege rules and not disclosing.

It is thus possible that, over time, competitive pressures may encourage more firms to take a more aggressive approach.

8. Where will it all end?

There was widespread surprise that it had been considered necessary to threaten retrospective taxation so soon after DOTAS had been introduced, particularly given the official view that DOTAS is achieving its aims. Firms were concerned that the introduction of retrospection might signal that DOTAS will become gradually less relevant with HMRC increasingly deploying more generalised and difficult-to-manage retrospective taxation.

This apart, most thought that the scope of DOTAS would be extended before long and the initial absence of SDLT was remarked upon as surprising prior to the 2005 Budget.

Opinion was divided on whether DOTAS should be replaced by a general anti-avoidance rule. Those who were in favour said their support was conditional on a GAAR being coupled with a pre-transaction rulings service provided by HMRC. Others were very opposed to such an approach, for the reasons already widely given when the idea was previously thought likely.

Mini-GAARs were considered by some to have been used effectively, but this did not mean that this group supported the introduction of a broader rule.

In the meantime, Hartnett’s evidence to the House of Lords Select Committee shows that HMRC has started a new and ‘significant piece of work’. He told the committee that experienced criminal lawyers are looking at some of the avoidance schemes now being seen by HMRC in order to advise on ‘whether some of them were dishonest’. If this does result in prosecutions, it will open a new chapter in the DOTAS regime.

Conclusion

This sort of early review can only shed some light on the position for practitioners, and is far from the last word. Nevertheless, the researcher derived some comfort from the Chinese proverb: better to light a candle than curse the darkness.

This article is a re-edited version of an article in Taxation (October 2005).

David Earle FCA, CTA (fellow) is a researcher for the Tax Law Review Committee of the Institute for Fiscal Studies. The committee would like to thank those firms who participated in the project, and hopes they too will find the outcomes interesting. Comments on this research would be welcome and should be e-mailed to bonnie_b@ifs.org.uk