Law firm Baker & McKenzie LLP (the "Tax Advisers") have successfully defended a claim brought against them for losses arising out of negligent tax advice. The High Court has found that the Tax Advisers had failed to identify or warn their client of a potentail challenge from the relevant tax authority. However, it concluded that, had the client stood up to the challenge, there was a high probability that it would have succeeded in having the tax demand quashed. The High Court, therefore, dismissed the claim for compensation from the Tax Advisors for the tax paid.
The Tax Advisers provided global tax advice to a corporate group headed by Symrise AG ("Symrise") in relation to a complex merger involving consideration of c€1,500,000,000.
The merger was highly leveraged, with approximately two thirds of the total consideration being funded by way of term loan facilities granted by a syndicate of banks. It was structured in a way intended to be tax efficient. The cornerstone of the intended tax efficiency was that there was to be a "pushdown" of the debt finance to various subsidiaries in various jurisdictions in which the interest payments on the debt was capable of receiving tax relief. One such jurisdiction was Mexico. It was common ground that the structure was an aggressive tax mitigation strategy.
The particular advice in question related to the pushdown of debt to a Mexican subsidiary of Symrise (for simplicity, I refer to both Symrise AG and its Mexican subsidiary as "Symrise".) A key part of the pushdown was an intercompany loan agreement under which Symrise would acquire the debt.
In the years after the pushdown was completed, the Mexican tax authority ("MTA") opened enquiries into Symrise's tax position for various years. This may have been triggered, at least in part, by a significant deterioration of Symrise's profitability and the fact that the interest payable under the debt more than extinguished any profits it did make, turning what was previously a profitable and tax paying company into a loss making company paying no tax.
The MTA subsequently determined that the interest payable on the debt was not capable of being relieved in the manner envisaged, leaving Symrise with a large tax liability. Symrise took advice on the MTA's determination (which advice was not the subject of the negligence claim). The advice it received from the Tax Advisers (and other advisers) was robust: in summary, Symrise was advised that the MTA's determinations were erroneous and, in all likelihood, Symrise would succeed in overturning them before the Mexican courts.
In light of the advice received, Symrise issued proceedings in the Mexican courts to challenge the MTA's determinations. However, relatively early in the proceedings, Symrise reached a "settlement" with the MTA. The settlement (or, as the Tax Advisers labelled it, capitulation) amounted to Symrise accepting liability for all the additional tax sought by the MTA, in return for receiving an informal and non-binding promise from the MTA that they would not pursue Symrise for additional tax in later years on the same basis. Unfortunately for Symrise, the MTA did not honour that promise and subsequently sought additional tax in later years.
There was evidence to suggest that Symrise may have capitulated with the MTA on the basis that it would subsequently seek recompense for the additional tax liabilities from the Tax Advisers for negligent advice in respect of the original transaction. To this end, Symrise sought a memorandum endorsing the decision to settle with the MTA from a Mexican law firm which it had instructed to broker the settlement with the MTA. Various drafts of a memorandum were exchanged between Symrise and the Mexican law firm, and the drafts of that memorandum and the related correspondence settling it are referred to at some length in the judgment.
High Court decision
The Court considered:
- whether the advice received from the Tax Advisers was wrong as to the tax relief available on the interest payments following the pushdown; and/or
- if the advice was not wrong, whether the advice should have identified the risk that the MTA might challenge the tax relief on the specific basis they did (which, in summary, turned on whether the debt was repayable on demand and did not, therefore, constitute long term finance capable of obtaining the claimed tax relief). The Tax Advisers' comparable advice in other jurisdictions had noted this risk, which had led to the terms of the relevant agreements in those jurisdictions being amended to reduce that risk.
The Court found for Symrise on the majority of the key issues. In particular, whilst it found that the advice provided by the Tax Advisers had not been wrong (point 1 above), they had negligently failed to identify the risk of the MTA challenging the tax relief on the specific basis they did (point 2 above). The Court found that this failure was causative of Symrise's losses.
The Court then turned to look at whether Symrise had adequately sought to mitigate its losses, bearing in mind the settlement it reached with the MTA. In doing so, the Court followed the judgement of Ramsey J in Siemens v Supershieldin considering whether the settlement was "in all the circumstances within the range of settlements which reasonable people in the position of the settling party might have made. Such circumstances will generally include: (a) the strength of the claim; (b) whether the settlement was the result of legal advice; (c) the uncertainties and expenses of litigation; (d) the benefits of settling the case rather than disputing it". The burden was on the Tax Advisers to show that the settlement did not fall within this range of reasonableness. In summary, the Court held that:
- it was clear from (i) the various pieces of contemporaneous advice received by Symrise at the time, and (ii) much of the other evidence before the Court at the trial, that Symrise's prospects of successfully defending the tax liability before the Mexican courts were high;
- the settlement could not be said to be the result of legal advice, because (i) the vast majority of the advice Symrise received up to the settlement was in Symrise's favour, (ii) the draft memorandums produced by the Mexican law firm which purported to endorse the decision to settle with the MTA were sought by Symrise after it had concluded it would settle and pursue the Tax Advisers in negligence (and were therefore framed with that in mind), and (iii) the draft memorandums failed to analyse a number of the key legal and commercial considerations relevant to any decision on whether or not to settle with the MTA; and
- the overall balance of factors at the time of the settlement with the MTA clearly did not lead to the reasonable conclusion that it was in Symrise's interests to agree a settlement (under which it effectively accepted 100% of a substantial tax liability which had been determined by the MTA on an erroneous basis, with only a non-binding promise by the MTA in return that it would not seek further tax in later years), rather than pursuing litigation in which it had strong prospects of success.
As a result, the Court found that the Tax Advisers had met the burden of demonstrating that the steps taken by Symrise in settling the dispute with the MTA were not within the "reasonable range of responses" required under the test laid down by Ramsay J and the claim for compensation failed.
Taxpayers faced with substantial tax liabilities may well be minded to reach an early settlement with the relevant tax authority, including HMRC, in the hope of subsequently recovering recompense from their tax advisers (or their insurers). This might be particularly true in the current climate, with HMRC pursuing perceived tax avoidance arrangements with ever-increasing enthusiasm.
However, this case acts as an important reminder that any settlement reached with HMRC must fall within a "reasonable range of responses" in order not to fall foul of the requirement to mitigate losses. In short, taxpayers cannot simply go through the motions with HMRC before capitulating and expect to recover recompense from their tax advisers, even if their tax advisers are found to have given negligent advice which caused the taxpayer to enter into the arrangements in the first place.
Despite what HMRC would have you believe, they are not always correct in their interpretation of the law and they do not win every case brought before the tax tribunals and courts. Where appropriate, a challenge from HMRC should be firmly resisted.