INTRODUCTION

It has always been difficult to attribute criminal liability to a corporation for the criminal acts of its representatives because of the high burden of proving that the “directing mind and will” of the corporation - in effect, senior management - was involved. However, with the anti-corruption summit in London, David Cameron announced a potentially far-reaching “failure-to-prevent financial crime” offence that would hold companies to account for the economic crimes of employees.

Failure-to-prevent offences (of which the Section 7 offence under the 2010 UK Bribery Act is one) have the potential to serve as a powerful tool for regulators to use in investigating corporations, and where necessary, bring prosecutions.

However, the Bribery Act aside, it has proven difficult to follow through with other failure-to-prevent offences (the failure-to-prevent financial crime offence was, in fact, first suggested in the Conservative manifesto before being shelved at the end of 2015).

That said, one such offence that has been the most prominent and which is now close to being introduced, is the failure-to-prevent the facilitation of tax evasion.

First proposed in 2015, draft legislation was published and consultations were on-going before Mr Cameron proposed it again in the wake of the leak of the Panama Papers. It has since formed part of the Queen’s speech.

The ingredients of this offence, and the approaches taken by companies in tackling the mischief which it seeks to punish, will challenge companies to ensure that they are good corporate citizens. In addition, the implementation of this offence is likely to reveal what we can expect from any future failure-to-prevent offences.

THE NEW FAILURE-TO-PREVENT TAX EVASION OFFENCE

The proposed rules are in draft but are well-advanced. Modelled on Section 7 of the Bribery Act, the essence of the proposed offence is a failure by a corporation (which includes any body corporate or partnership, whether commercially motivated or not) to put in place adequate measures to prevent its representatives from facilitating the evasion of tax.

WHAT IS THE OFFENCE?

Under the proposals, a corporation will commit an offence if:

  1. a person who provides services for or on behalf of the corporation facilitates tax evasion; and
  2. the corporation did not have reasonable procedures in place to prevent such facilitation.

Whilst the rules depend on a criminal facilitation offence having taken place, there are two reasons why it could nonetheless be applied more widely. Firstly, a facilitation offence is itself defined broadly as any offence which facilitates the commission of a tax evasion offence, for example by aiding, abetting, counselling or procuring the offence. Second, and perhaps more significantly, no actual offence need ever be prosecuted. HMRC emphasises that the fact of conduct capable of being prosecuted is enough.

This is important because HMRC frequently agrees not to pursue criminal proceedings where a taxpayer admits the offence, makes full disclosure and pays the full amount of any tax. Indeed, that practice underlies the various disclosure facilities that HMRC has offered.

In addition, it is worth noting that, unlike the Bribery Act, there is no requirement that any person intended to obtain or retain business for the corporation. The mere fact that conduct amounting to facilitation of tax evasion has occurred is sufficient.

WHO ACTS “FOR OR ON BEHALF OF” A CORPORATION?

A key concern is the question of for whom exactly a corporation must answer. This has been one of the principal difficulties that corporations have needed to deal with in implementing the Bribery Act.

The proposed rules state that a corporation is responsible for anyone “associated” with that corporation and an associated person will be anyone acting for or on its behalf.

In itself this is a potentially broad definition and its application is open to interpretation. In fact, no relationship between the person and the corporation is prescribed at all. It will include employees, agents and subsidiaries of the corporation but, in reality, the test is ultimately determined not merely by the relationship between the person and the corporation, but by reference to all relevant circumstances. For example, where an ex-employee only takes work as a result of referrals from his/her former employer and does so at less than commercial rates, HMRC has said that such a person might be treated as providing services on behalf of his former employer.

In practice, although many such hypothetical situations can be imagined, there are more than enough difficulties to be faced in addressing far more commonplace arrangements such as contractors, sub-contractors, agents and temporary workers, along with counterparties in joint ventures, consortia or other commercial associations.

WHERE DOES IT APPLY?

Failure to prevent the facilitation of UK tax evasion can be asserted against any corporation (wherever located) and, whilst failure to prevent the facilitation of foreign evasion requires a corporation to have a UK presence, this is a broad concept.

It includes not only corporations incorporated or formed in the UK, but corporations with a business establishment in the UK. It also includes any corporation (wherever located) if a step in the facilitation offence takes place in the UK. Given the role of the UK in so much of global commerce, these rules could have a far reach. This is precisely the issue many businesses continue to grapple with in connection with the implementation and monitoring of Bribery Act compliance.

The failure to prevent the facilitation of tax evasion includes offences in foreign jurisdictions that would amount to offences were they to take place in the UK. This raises one of the more problematic areas given that the dividing line between an unsuccessful and a criminal tax arrangement can sometimes appear to be a matter of national perspective and changing mood (see the case study below). In such cases, there may be a lower risk of those within an organisation being treated as having acted dishonestly. Companies will need to consider their wider approach to identifying potential tax risks given there may not always be bright lines to police.

CASE STUDY

It is easy to see why tax evasion is a target given its presence in the news. Even as the Panama Papers were dominating headlines, ProPublica published a story under the headline “Wal Street Stock Loans Drain $1 Billion a Year From German Taxpayers”, following analysis of confidential documents relating to dividend arbitrage trading.

Germany has been seeking criminal prosecutions for so-called cum/ex dividend arbitrage trading for years. The ProPublica story focused on simpler cum/cum trades that were tentatively described as illegitimate, but not illegal. That would surprise few who understand these trades, but the Frankfurt prosecutors reacted to the story by announcing that they had opened a probe into them.

Such trades may not ever be regarded as illegal and the traders are unlikely to be treated as dishonest even if they were. That does not mean, however, that companies will not face difficult questions. It is, therefore, a good example of the difficulties that can be faced by companies when the edges of what comprises tax evasion can change in a news cycle.

WHO IS AFFECTED?

The finance industry, of course, remains a key target. Similarly, advisors and those delivering the “infrastructure” that enables tax evasion to take place (for example, virtual offices, invoicing arrangements, IT systems) are all targeted.

However, this offence potentially applies across a wide range of industries.

  • Any transaction involving a corrupt payment will inevitably also include tax evasion given that such payments will, presumably, not be declared for tax purposes.
  • Tax evasion could be present in any flow of cash or payment arrangement and in respect of any transaction that needs to be accurately reported to a tax authority.
  • Companies with a global reach, and those that deal with certain jurisdictions and certain high risk industries may be subject to scrutiny. Indeed, in the original consultation in July 2015, one of the examples cited by HMRC involved a Panamanian foundation.

Ultimately, many corporations will need to consider the identity of suppliers and customers, payment methods and supply lines, paying close attention to offshore movements of money.

THE DEFENCE: PREVENTION PROCEDURES

If it can be demonstrated that, despite criminal facilitation having occurred, reasonable procedures are in place, the corporation will not be held liable.

It is worth noting that the Bribery Act refers to “adequate procedures”. The reference in these rules to “reasonableness” might suggest a test that will rely more heavily on context – that is, the relevant facts and circumstances. Depending on your view, that could result in a less restrictive, or more arbitrary, application of the offence.

In practice, it may be that this is a distinction without a difference, particularly as HMRC’s guidance is currently based on six principles which essentially mirror those accompanying the Bribery Act:

  1. proportionality: reasonable procedures will depend on the nature of a corporation’s activities;
  2. top level commitment: top level management should be involved and committed to fostering a culture in which facilitation of tax evasion is unacceptable;
  3. risk assessment: what procedures are reasonable will depend on an assessment of the nature and extent of its exposure to the risk of facilitation of tax evasion;
  4. due diligence of those who act on behalf of the corporation (and the corporation’s clients);
  5. communication (including training) with regard to policies and procedures; and
  6. monitoring and review of a corporation’s “prevention procedures”.

This may be familiar territory from the Bribery Act, and for regulated firms following the FCA’s guidance on fostering a culture of compliance, but a corporation cannot simply rely on existing procedures. Tax evasion is a wider and potentially more complex area and HMRC has emphasised that relying on existing procedures may not be sufficient.

Businesses will need to engage seriously with the different ways that tax evasion could be facilitated, potentially cross-jurisdiction, and introduce “reasonable” safeguards. For some businesses, this will require significant expenditure on implementation advice and infrastructure, including technical solutions. It will be important for corporations to put systems in place without unduly hampering their business, and this may be a more significant concern than in respect of the Bribery Act given the potentially very wide (and, arguably, increasing) scope of tax evasion.This may be familiar territory from the Bribery Act, and for regulated firms following the FCA’s guidance on fostering a culture of compliance, but a corporation cannot simply rely on existing procedures. Tax evasion is a wider and potentially more complex area and HMRC has emphasised that relying on existing procedures may not be sufficient.

The necessary response to these rules, therefore, will be for an organisation to understand its tax risks and where facilitation is most likely to occur and to tailor “prevention procedures” that are objectively reasonable in all circumstances.

TIMING

David Cameron has suggested that this offence will be introduced in 2016. It has always been intended that the offence would take effect in September 2017, prior to the common reporting standard which will inevitably provide documentation (and ammunition) in support of offences against corporations. As a practical matter, it is difficult to see corporations being ready to address this offence before 2017.

WHAT NEXT FOR TAX?

As far as tax is concerned, this offence is just the beginning.

The 2016 Finance Act will require companies to publish a “Tax Strategy”, codifying their approach to tax. A special measures regime is expected to monitor co-operation with HMRC, and those that exhibit persistent non-co-operation will be flagged as high risk. Meanwhile, increasing numbers of companies are subject to codes of conduct, whether it is the Banking Code of Conduct or the proposed Framework for Co-operative Compliance.

All of these rules form a tax regulatory framework, putting corporations – and, expressly, the top level management – under pressure to address tax matters directly, and to instil good tax practices as part of the culture of an organisation.

In addition, while the charge is being led by HMRC, it is only prudent for regulated firms to anticipate the imminent arrival of the FCA. Indeed, in recent years the FCA has levied sizeable fines for failures by firms to implement adequate anti-bribery and corruption safeguards and controls, deeming such failures indicative of poor systems and control frameworks; and financial crime and anti-money laundering continue to be a core priority theme for the FCA (including in its 2016/17 Business Plan). There is every reason to expect a similar attitude in respect of the failure-to-prevent tax evasion offence.

The reality is that corporations need to be able to demonstrate that they are responsible tax citizens. This brings its own uncertainties and challenges, but experience has shown that genuine engagement with the issues, and the implementation of sensible procedures is not only a regulatory necessity, it is good business. The offence of failing to prevent the facilitation of tax evasion represents a considerable stick to ensure compliance, and with the information anticipated from the common reporting standard (quite apart from any further Panama-style leaks and more voluntary disclosure), HMRC expects to have reason to investigate and enforce.

KEY TAKEAWAYS: HOW TO RESPOND

Firms would be well-advised to allocate resources to ensuring that it is prepared, not just for this offence, but for the other corporate (and corporate tax) offences and regulations that are likely to come in the future.

We list some practical steps to help start the ball rolling:

  • Understand your tax risks: where are the risks of tax evasion – is it the type of industry, the countries dealt with, the activities undertaken?

Who within the organisation is best placed to identify them – is it your compliance or your tax function?

  • Identify the structure of your organisation: who is acting for and on behalf of the organisation and how are they incorporated into the business?
  • Consider existing infrastructure: administrative systems (and, in particular, IT) will be crucial to ensuring reasonable procedures are in place. How can such systems help you (or how can they be adapted to help you) identify and manage the risks of tax evasion?
  • Training: develop and deliver comprehensive yet bespoke training to inform staff on the nature and possible methods of tax evasion. What actions should ring alarm bells, or at the least, trigger a suspicion? Encourage your staff to understand what the new offence means for them on a day-to-day basis.
  • Due diligence: consider the questions to be asked of clients, customers, suppliers and of staff and others who act on behalf of the organisation? 
  • Leadership involvement: have senior management received a dedicated briefing and do they understand their responsibilities? If the firm is regulated, who has been allocated the relevant senior management function and, if it has not been allocated, consider whether similar steps need to be taken?
  • Monitoring and review: ensure that such procedures are in place and are sophisticated enough/fit-for-purpose. 
  • Consider the approach to be adopted in the event that weaknesses, or indeed, facilitation of tax evasion is identified. The interests of the organisation are more than likely to diverge from that of the individual perpetrator and HMRC (and other regulators) will be looking for a prompt response and timely disclosure.
  • Reflect on the lessons learned by your organisation in implementing Bribery Act and AML complianceFor example: 
    • assess the nature and likely extent of the risk of tax evasion in your business upfront: where are the gaps? Can existing procedures be easily adapted? Do existing policies extend to “associated persons”?
    • ensure your business is prepared well in advance of implementation day: amend or develop policies; educate front-line and back-office staff and introduce effective monitoring methods;
    • join the dots between your tax specialists and your financial crime and compliance teams: engaging their expertise and establishing the communication channels across teams will be critical to identifying the risks and any hot spots;
    • if there is likely to be an impact on your client/customer due diligence, develop a timely contact programme to inform them of the enhanced requirements; and 
    • consider how effective your whistleblowing mechanism is, for employees to report their concerns.

SOME FOOD FOR THOUGHT

Housebuilder Ltd has 30 sites across the UK where it is building new homes. A shortage of bricklayers is putting increased pressure on delivering homes on time. John is a contractor in charge of one of the sites and agrees to pay his bricklayers in cash.

In this case, although a contractor, John may be treated as working on behalf of Housebuilder Co. On the face of it, John appears to be criminally facilitating tax evasion. Even if John were unaware of any tax evasion, as a practical matter, corporations need to be live to activities that could facilitate tax evasion, whether intended or not. 

Marketplace Inc is a successful US online business matching buyers and sellers and has significant operations in the UK. One of Marketplace’s staff arranges for payments to a UK seller to be made offshore with the intention that tax will not be paid on that amount.

In this case, it is irrelevant that the company is based in the US given that UK tax is being evaded.

An employee of a German company arranges for invoices to be issued to a business customer in Germany for a higher amount than is paid so that higher tax deductions can be dishonestly claimed. The invoicing is processed in the UK parent company.

In this case, the fact that German tax is being evaded may be irrelevant if, as a result of processing the invoices in the UK, an act constituting part of the foreign facilitation offence is treated as taking place in the UK.