Changes to the EU procurement regime due to come into force by early 2016 – potentially earlier in the UK – require further revision of the UK Government’s approach to promoting tax compliance through tender processes, and may make its policy objectives more difficult to accomplish.
When the new Directives are implemented, a final administrative or judicial finding that a bidder has failed to meet its tax payment obligations will result in mandatory exclusion from public procurement processes. More significant, perhaps, is the recognition that payment of taxes due will remove any ground for exclusion, even if it comes after an unsuccessful appeal process. This change clarifies a key area of uncertainty in the current discretionary policy. It may also suggest that the Government’s formulation of what amounts to tax non-compliance needs updating.
The Government is consulting on the transposition of optional elements in the new Directives and – together with a review of the current policy due by April 2014 – this offers the opportunity to engage with the legislator to seek clear and predictable implementation of European policy in the UK.
New rules – what is changing?
The Cabinet Office’s initial announcement of its intention to assess bidders’ tax compliance as a qualification criterion for public tenders met with concern from the business community at the broad and uncertain scope of the proposals. This led to a material redrawing of the policy that was introduced in April 2013 (see our earlier briefings on this from February 2013 and March 2013).
The resulting position is that, from 1 April 2013 onwards, a bidder for a contract with a Central Government Department that has or is likely to have a value of £5 million or more is required to state whether:
- its tax affairs have given rise to an unspent criminal conviction in any jurisdiction for tax related offences, or to a penalty for civil fraud or evasion; and/or
- any tax return submitted on or after 1 October 2012 has been found to be incorrect as a result of:
- HMRC or a tax authority in another jurisdiction where the bidder is established successfully challenging it under the General Anti-Abuse Rule (GAAR) or the “Halifax” abuse principle (or any rules that have equivalent or similar effect); or
- the failure of an avoidance scheme which the bidder was involved in and which was, or should have been, notified to HMRC under the Disclosure of Tax Avoidance Schemes (DOTAS) or to another tax under any equivalent or similar scheme in a jurisdiction where the bidder is established.
On this basis, a bidder is required to notify the contracting authority of any “occasions of non-compliance” – together with any factors in mitigation – and the contracting authority determines, at its discretion, whether to admit or exclude the bidder from the process.
Under the new Directives approved by the European Parliament on 15 January 2014:
- a bidder shall be excluded from participation in a procurement procedure if it “is in breach of its obligations relating to the payment of taxes or social security contributions”, and such breach “has been established by judicial or administrative decision having final and binding effect” in accordance with the legal provisions of the country in which the bidder is established or with those of the Member State of the contracting authority (the “mandatory ground”);
- contracting authorities may (and Member States can elect when transposing the rules whether to require them to) exclude bidders from procurement processes where the contracting authority can demonstrate “by any appropriate means” (i.e. short of a final and binding decision) that the bidder “is in breach of its obligations relating to the payment of taxes or social security contributions” (the “interim ground”);
- a breach can be cured (in respect of either of the above grounds for exclusion) by fulfilment of tax payment obligations “by paying or by entering into a binding arrangement with a view to paying the taxes or social security contributions due, including, where applicable, any interest accrued or fines”;
- Member states have the option to provide for a derogation from the mandatory exclusion in circumstances where an exclusion would be “clearly disproportionate”, in particular where only minor amounts of taxes or social security contributions are unpaid or where the bidder learned of the amount payable at such a time that it was not possible for it to pay or enter into an arrangement to pay before entering the procurement procedure.
The text of the new Directives is now settled and is expected to be formally adopted this month, with publication in the Official Journal due in March 2014. Member States have two years following publication to transpose the Directives into national law, but the UK Government has signalled an intention to accelerate domestic implementation in order to take advantage of new, more flexible procurement rules.
The new world – cosmetic changes or wholesale revision?
At first glance, the new rules appear to strengthen the hand of contracting authorities by elevating the consequence of non-payment of taxes from discretionary to mandatory exclusion. A closer analysis of the provisions, however, suggests that implementation of the Directives may in fact render the UK Government’s current approach less tenable.
The existing UK policy relies on an interpretation of a ground in the currently applicable Directives affording contracting authorities a discretion to exclude a bidder that “has not fulfilled obligations relating to the payment of taxes”. The policy’s principal objective is to precipitate behaviour change among public sector contractors, for instance by discouraging the use of tax schemes at the riskier end of the spectrum. But it is not clear how far the Directives permit contracting authorities to go in furthering the Government’s anti-avoidance rhetoric. For instance, the policy appears to require a bidder to declare non-compliance where it has completed a tax return, honestly believing it to be compliant in all respects, and has subsequently agreed (and paid in full) an adjustment after challenge by HMRC. This arguably falls short of a failure to fulfil tax payment obligations, so was not clearly within the scope of the existing Directives.
The new Directives seem to make it more difficult for the UK Government to justify its current stance, and may require a narrowing of its definition of what amounts to non-compliance. The mandatory ground is only triggered when an administrative or judicial decision with final and binding effect finds a breach of payment obligations. The interim ground requires a contracting authority to show that the bidder is “in breach” of its obligations to pay. Accordingly, a contracting authority has no basis to exclude a bidder unless there is either an adverse final decision or an extant breach demonstrable by some other means. Significant in this regard is the acknowledgement that payment (or entry into an agreement to pay) removes any basis for exclusion. This eliminates any uncertainty around whether a failed tax planning strategy could lead to exclusion after full payment has been made based on a contracting authority’s exercise of discretion, which might include an assessment of the motivation behind the bidder’s tax planning strategy. It also calls into question whether a breach of obligation can be said to exist while a good faith resolution process is ongoing and there is an intention to pay any and all sums properly assessed as due (as would be the case for the majority of responsible UK corporates in their dealings with HMRC). Where, as is common practice, a postponement of a bidder’s obligation to pay taxes is agreed pending resolution of a tax dispute, it seems clear that the bidder could not be excluded as there would be no current breach of a payment requirement.
It is possible, however, that the Government will see the interim ground as a basis for persevering with its existing policy, albeit within tighter confines. The threat of exclusion pending a final outcome, particularly in conjunction with proposed new rules requiring taxpayers to amend their tax returns where the UK tax authorities consider there has been a relevant judicial ruling in another case, might deter the use of tax avoidance schemes. It may also encourage early settlements, or payments of disputed tax “on account” pending final determination, by prospective bidders.
Opportunity to influence the UK Government’s approach
The Government is consulting on the implementation of the new procurement regime (see the Procurement Policy Note from July 2013, which sets out the optional elements of the EU regime): last week the Cabinet Office released a targeted discussion paper on new provisions relating to exclusion to inform the process of drafting the implementing Regulations, and there will be a public consultation on the draft texts in due course. It has also announced an intention to review the current policy on assessing tax compliance within the year following 1 April 2013. In light of the considerations set out above, and the Government’s margin of discretion in transposing the new Directives, input from UK business will be valuable to ensure that the new Regulations are as clear and predictable as possible. We set out below some areas where the new Directives are likely to require changes to the current approach, and offer some thoughts on issues of contention.
Application of exclusion grounds
The following points are relevant to the nature and scope of the exclusion regime:
- Contracting authorities will no longer be able to exercise discretion in circumstances where there has been a final decision or judgment, so there will be no scope for them to assess factors in mitigation as provided for at present. The only effective points in mitigation will be: (i) evidence of payment or entry into an agreement to pay; or (ii) submissions that the minor infraction derogation should apply (assuming it is adopted in the UK).
- The rules will apply to all procurement processes governed by the EU regime, so the £5 million threshold currently in place in the UK will need to be removed. The threshold was determined in order to avoid adding an administrative burden to lower value procurements, so the Government will need to consider alternative means of minimising the cost of the tax exclusion regime. Similarly, the Government will have to consider how the rules will apply beyond Central Government Departments.
- The UK Government will need to decide whether or not to implement the optional derogation to address circumstances where it would be clearly disproportionate to exclude a bidder. In our view it would be difficult to justify not doing so.
- Under the new rules, the focus remains on the tax record of the bidder itself (the “economic operator” in the nomenclature of the Directives). Accordingly, the Cabinet Office’s clarification that, save where necessary to prevent circumvention of the rules, certification will not extend to other companies in the bidder’s group, suppliers to the bidder or individual members of a partnership, limited partnership or LLP should be retained. Where a bidder is arranged as a joint venture or consortium, all constituent members are likely to need to certify tax compliance. Note that the Directives enable (and include the option for Member States to mandate) contracting authorities to require subcontractors to be replaced if any of the grounds for exclusion apply to them. The Government is also consulting on this option.
What amounts to a breach? What about foreign tax failures?
In order to ensure that the operation of the exclusion provisions is conducted in accordance with principles of procedural fairness, the circumstances that constitute a breach of tax obligations should be clearly defined and identifiable. As noted above, the definition of an occasion of non-compliance adopted in the April 2013 policy is likely to require revision in light of the new Directives.
In relation to tax breaches in other jurisdictions, the current policy requires a bidder to declare non-compliance where a tax authority has successfully challenged it under provisions equivalent or similar to the GAAR or the “Halifax” abuse principle, or where a DOTAS type scheme has failed, in a jurisdiction in which the bidder is established. A conviction or civil penalty for tax related offences, however, appears to trigger exclusion irrespective of the jurisdiction in which it is imposed. The language of the new Directives limits the geographical reach of the mandatory ground: exclusion will arise where a bidder’s breach is determined by final administrative or judicial decision “in accordance with the legal provisions of the country in which it is established or with those of the Member State of the contracting authority.” There is no guidance on the point in the Directives, so it is not clear whether the reference to a country in which the bidder is established is limited to the jurisdiction of incorporation or tax residence, rather than to any country where the bidder has a tax presence. Unless this is clarified in the implementation process, there may be concerns regarding the collateral consequences of an arbitrary finding in an emerging or developing jurisdiction in which a bidder may operate, or one where the rule of law is not well established.
The interim ground does not, however, specify any geographical limits to its scope, apparently leaving it open for Member States to decide whether to extend the operation of the provisions wider. We would anticipate significant concerns if the UK Government were to require contracting authorities to – or leave it open for them to – exclude bidders on the basis of tax breaches in any jurisdiction. We would suggest that this ground be discretionary, and geographically limited in the same way as the primary exclusion – i.e. to cover breaches in the home jurisdiction of the bidder or in the Member State of the contracting authority. Any extension to this territorial application should be subject to an obligation on contracting authorities to properly assess the circumstances of the bidder’s conduct, especially where it takes place outside of the EU, in order to discharge the “appropriate means” standard – which would entail input from tax experts and associated cost and delay.
Exclusion in the absence of a final decision
The interim ground proposed in the new Directives enabling contracting authorities to exclude a bidder on the basis of a finding short of a final judgment or decision – so long as they can demonstrate a breach “by any appropriate means” – is potentially troubling. There is no indication as to what would amount to “appropriate means” for demonstrating a breach, but it leaves scope for uncertainty and inconsistent application.
The Government has an option to make this a mandatory requirement. In its recent discussion paper, the Cabinet Office expressed the view that “leaving this to each authority […] would seem to be the simplest option, and most likely to avoid gold-plating. It is for the authority […] to demonstrate that the economic operator is in breach, therefore it would seem consistent to allow the authority […] to also make the decision on exclusion.” The paper also recognises, however, that there might be an advantage in mandating some otherwise discretionary requirements, for instance to ensure consistency of approach between different bodies and procurements. In our view, the interim ground ought to remain discretionary and the Government ought to issue guidance requiring contracting authorities to exercise their discretion to exclude in rare cases and in accordance with clear and confined principles. As noted above, the discretion should be subject to the same geographical limits as the mandatory ground, or at least contracting authorities should be required to evaluate the adequacy of a finding in non-EU jurisdictions.
We also suggest that contracting authorities should be required to give consideration to mitigating circumstances presented by the bidder. The existing policy identifies by way of example the following mitigating factors, all of which remain relevant:
- changes in senior management or key personnel responsible for the bidder’s tax issues since the sanctionable conduct occurred, together with a statement from the new personnel that they will not engage in similar tax avoidance;
- changes in the bidder’s overall company policy concerning tax planning; and
- evidence that the occasion of non-compliance was an isolated instance not indicative of systemic failings in the bidder.
We note that contracting authorities are able to seek advice from the UK tax authorities in determining whether or not to exercise a discretion to exclude, and we would suggest that such expert input be sought as a matter of course in such circumstances.
Maximum look back
The Directives provide for maximum periods of exclusion of five years for the most egregious conduct and three years for lesser grounds. Although these periods do not apply to the provisions relating to tax compliance, it might be considered disproportionate for the Government to maintain the current six year look back in relation to occasions of tax non-compliance (although we note that the look back in the current policy only relates to conduct that occurs after 1 April 2013 and relates to tax returns submitted on or after 1 October 2012).
In July 2013, the Cabinet Office issued a Procurement Policy Note on measures to promote tax compliance, which includes pro forma language for inclusion in public contracts:
- placing an obligation on the successful bidder to keep the contracting authority informed of occasions of tax non-compliance occurring during the term of the contract; and
- enabling contracting authorities, at their discretion, to terminate the contract in the event of a future breach or failure to notify.
When notifying the contracting authority of an occasion of non-compliance during the contract term, a supplier may detail relevant mitigation factors, which the contracting authority is required to take into account in determining whether or not to terminate the contract.
It remains to be seen how these notification requirements will operate in future, especially if the definition of an occasion of non-compliance is amended when the new rules are implemented.
Participation in the consultation process
We intend to participate in the Government’s consultation processes and would welcome your views on the new Directives or the operation of the current regime. We would be happy to include your input in our submissions, on a named or anonymous basis. The Cabinet Office has requested comments in relation to the grounds for exclusion by 24 February 2014. This will feed into the drafting of the implementing Regulations and there will be a further formal consultation on the texts of the draft Regulations when they are available.
If you would like to offer your views, or discuss any of the issues raised in this briefing generally, please do get in touch.