Documents leaked by the BBC in the so-called ‘Paradise Papers’ at the end of 2017 has focused attention upon tax avoidance schemes. There is an increased demand from individuals who have chosen to protect their money in both domestic and off-shore schemes to review past advice they have received and seek further assistance from advisers specialising in such schemes. A recent Court of Appeal decision helps open the door further to challenge past advice.
The recent Court of Appeal decision in Barker -v- Baxendale Walker Solicitors and another  EWCA Civ 2056 provides useful assistance to investors in terms of the quality of the advice they can expect to receive. Specifically, it addresses whether a solicitor should inform their client of the risk that the court may arrive at a different interpretation from the one which they have advised.
The claimant was the majority shareholder in a company. The principal defendant was a firm of solicitors which specialised in tax planning.
In 1998 the claimant decided that he wished to sell the company. He sought tax planning advice from the defendant firm to reduce his exposure to capital gains tax and inheritance tax. The defendant firm recommended that the claimant use a type of employee benefits and shares trust (EBT) as a tax-efficient vehicle in respect to the proceeds of sale from his shares to the claimant and his family.
The relevant legislation in respect to inheritance tax exemption through an EBT is section 28 of the Inheritance Tax Act 1984 (ITA 1984). The ITA 1984 is ambiguous as to the precise point at which the existence of a ‘connection’ will render a transfer liable for tax.
The EBT was subsequently set up and the company was sold. The claimant received approximately £12 million in cash and shares in the purchase, of which around £5.8 million went into the sub-trust, which had been created in favour of the claimant’s family so that his contribution would be ring-fenced. Such provision, in theory, ensured that the claimant would not need to access the assets in the EBT in his lifetime, whilst after his death, his children would receive benefits free of tax.
In 2005, HMRC commenced formal investigations into the EBT and the sale of the company, specifically whether any capital gains tax should have been paid by the claimant.
In 2010, following detailed investigations, HMRC informed the claimant that it intended to make assessments and confirmed that the tax exemption did not apply, because the EBT did not exclude the claimant’s family as beneficiaries after his death. In essence, HMRC took a different interpretation of the ITA 1984 than the defendant firm and duly pursued the claimant for unpaid tax and interest.
In 2013, following further legal and financial advice that the HMRC’s interpretation was probably correct, the claimant settled with the HMRC for circa £11.3 million.
The negligence claim
Thereafter, the claimant issued professional negligence proceedings against the defendant firm.
At first instance, the High Court dismissed the claim. Roth J decided that it was not appropriate for a solicitor to provide a specific warning about the risk of a post-death exclusion construction by the HMRC. However, he held that the defendant should have clarified to the claimant that since the usage of the EBT was a tax avoidance scheme there was a distinct possibility that it could be challenged in legal proceedings. In failing to set out this risk, the defendant had breached its duty of care. However, the judge ultimately decided that the provision of such a ‘general health warning’, would not, in any event, have stopped the claimant from proceeding with the arrangement. As such, the case failed on the basis of causation. The claimant appealed the decision to the Court of Appeal.
The Court of Appeal allowed the appeal and overturned the decision of the High Court. There was a substantial risk that the EBT arrangement would not produce the promised tax advantages it was designed to deliver, as a result of the post-death exclusion construction which was central to its being. Whilst the defendants were held not to have been negligent for their construction and interpretative view of section 28(4) ITA 1984, the court held that a reasonably competent solicitor ought to have provided the claimant with a specific warning of the risk that:
- their advice may be incorrect
- the EBT might fail to produce the tax advantages it was designed for
- that a subsequent dispute should be envisaged given the likelihood that the scheme would be scrutinised and challenged due to the size of monies involved.
Asplin LJ confirmed the following principles:
- The question of whether there was a significant risk that the EBT would fail to deliver the tax advantages envisaged, was to be determined by the court applying the standard of the reasonably competent solicitor
- Whether a solicitor is in breach of his/her duty by failing to explain a risk that a court may arrive at a different interpretation of legislation is factsensitive
- Important elements considered were the aggressive nature of the tax avoidance scheme, the potential benefits of the scheme (some of which appeared too good to be true), the quantum of potential tax avoidance and the defendants’ fee (in the region of £2.4million). Due to the amount at stake, and the very nature of the arrangement, it should have been obvious to the solicitor that there was a real risk HMRC would take issue with the post-death exclusion point at some stage
- It was deemed irrelevant that the defendant had no knowledge of whether, if warned of a risk, the claimant would have taken a different course of action
- If the construction is clear, the threshold of ‘significant risk’ will likely not be met and, therefore, a solicitor will not be required to explain the risks involved to satisfy his/her duty of care
- It is possible to be negligent, simply by failing to set out the risks involved, even if a solicitor has deployed a correct construction of a legislative provision
- There will be an enhanced duty upon a solicitor to explain the risks, if litigatio n upon the point is on foot
- The position taken by other advisers at the time was deemed irrelevant
The case demonstrates key lessons:
- Beware artificial transactions – the case supports the Tribunal’s established position that it will be reluctant to uphold artificial transactions which have been specifically designed to frustrate tax legislation
- Commercial considerations – solicitors should be aware of relevant commercial considerations and likely risks when providing advice, including the likelihood of HMRC’s likely interest in large amounts of money, held in schemes, whose underlying purpose is to defeat relevant tax legislation and advise accordingly
- Other advisers irrelevant – the courts are increasingly dismissing arguments that other advisers may have agreed with the advice of a defendant firm, particularly in non-medical cases
- Limitation – historic arrangements from the 1990s can be subject to challenge by HMRC and the risk of a large tax bill, interest surcharges and penalties. Primary limitation is likely to have already expired and you may be left with the shortened 3 year secondary limitation period. The judge at first instance found that the date of knowledge, for the purposes of limitation, was the date of HMRC’s contention relating to section 28 IHTA and/or the advice that the contention might have merit. People wanting to claim need to act quickly and probably before the amount they need to pay has crystalised with HMRC
- Health warnings – the decision is extremely helpful for claimant investors who have suffered losses despite having sought legal advice at the outset in that it opens the door for claims relating to nonnegligent wrong advice. There is now a clear expectation upon lawyers to provide sufficient health warnings with their advice, where circumstance demands it