Tax disputes arise for a range of different reasons: HMRC changes its policy or targets an avoidance scheme, a tax professional provides incorrect advice, or a taxpayer implements advice incorrectly. Irrespective of how a dispute arises, once a taxpayer is faced with a potential tax liability there is the possibility that the taxpayer will point the finger at the tax professional. In such cases, there are likely to be two disputes, first a dispute with HMRC and, depending upon the outcome of that dispute, a professional negligence claim.
Managing the risk associated with tax disputes is about understanding both HMRC’s approach (in order to mitigate the chances of a dispute arising in the first place) and managing the risk of a claim against the tax professional. The difficulty with dealing with a tax dispute is that both the dispute with HMRC and the potential negligence claim converge and end up being managed simultaneously. Due to HMRC’s current approach, not only are tax disputes more likely but under HMRC’s Litigation and Settlement Strategy1 there is an increased chance that a tax dispute with HMRC and a professional negligence claim will progress simultaneously.
HMRC’s current approach
Managing risk is about knowing what the risk is. Part of the process of identifying risk in relation to tax advice is understanding HMRC’s position. Identifying areas where HMRC is taking a revised approach can assist in managing risk through such mechanisms as the engagement letter.
For example, until the recent Court of Appeal decision in Futter v Futter and Pitt v Holt (on which RPC previously reported here) it was widely accepted that a professional was on safer ground advising on a tax mitigation scheme involving a trust structure. In such cases, if the advice was incorrect, it was possible for trustees to apply to court to unwind the transaction, often eliminating any unwanted tax liability. Although HMRC had to be informed that such an application was being made, it rarely intervened in such cases until Futter v Futter and Pitt v Holt. Now, advising on trust-based structures when providing tax advice carries the same risks as any other tax advice.
Another area where HMRC is taking an increasingly tough stance is in relation to what HMRC deems to be “tax avoidance”. Here, HMRC has a three-pronged approach: “prevention, detection and counteraction”. A series of consultations were released in June this year targeting tax avoidance schemes, expanding on HMRC’s/the Treasury’s policy set out in Tackling Tax Avoidance2, published as part of the 2011 Budget. One of the consultation documents targets “high risk tax avoidance” schemes3, such as ‘sideways loss relief schemes’ where artificial losses are generated to offset gains. The consultation contains proposals whereby users of high risk tax avoidance schemes listed by HMRC would be required to disclose the use to HMRC and would be subject to an additional charge on tax underpaid. The proposals target the cash flow advantage a taxpayer can achieve by delaying the payment of tax by using a listed high risk tax avoidance scheme4.
These two examples assist in understanding HMRC’s strategy and mitigating associated risks. However, it is not always possible to remove or mitigate all of the risks involved when providing tax advice. So what can tax professionals and their legal advisers do when mistakes are made, a taxpayer is faced with a dispute with HMRC and the tax professional is faced with a professional negligence claim?
HMRC’s Litigation and Settlement Strategy (LSS)
Whenever a taxpayer is faced with a tax liability and decides to appeal the assessment, consideration should be given to whether it is appropriate to revert to HMRC’s LSS. The LSS sets the parameters for dealing with HMRC in disputes. Following its publication in 1997, the LSS was “refreshed” for the first time earlier this year (the RPC tax team previously reported in their blog on the LSS and its impact on litigating with HMRC here).
The LSS sets out the principles within which HMRC handles disputes and whether disputes are resolved by agreement or through litigation. The aim of the LSS is to ensure HMRC is consistent and effective in its approach to tax disputes and to increase revenues. As with any commercial entity, HMRC has a finite amount of resources and must pick its battles carefully.
There are two principles which underpin the LSS: (i) a tax dispute should be settled on its own merits, so HMRC will not entertain “package deals” where a number of tax disputes are settled at the same time; and (ii) if a tax dispute is “all or nothing” HMRC’s approach is also “all or nothing”; conversely, where a dispute is uncertain HMRC will not “split the difference”. An “all or nothing” dispute is one where HMRC considers that either it is correct or the taxpayer is correct and accordingly there is not a range of possible figures for the tax due.
The “refreshed” LSS remains underpinned by the same two principles. However, it introduces two new elements which raise strategic questions for tax professionals and legal advisers when managing tax disputes with a professional negligence claim in the background. First, it introduces the option of alternative dispute resolution (ADR) as a way to resolve tax disputes and, secondly, there is now the possibility of waiving privilege and exchanging legal advice to ensure that both HMRC and the taxpayer understand each other’s respective arguments.
The introduction of ADR means that in cases where HMRC and the taxpayer use ADR it will no longer be the case that a “wait and see” approach can be taken until after the tax dispute with HMRC has been resolved through litigation. Instead, assessment of a tax professional’s liability may need to be considered at an earlier stage.
The use of ADR by HMRC also raises a number of further questions – should the taxpayer be encouraged to engage HMRC in ADR? If a mediation does take place with HMRC, is it worthwhile having insurers on the end of the phone if a settlement with HMRC is on the table? At the same time, it is important to bear in mind that HMRC’s approach to mediation is not the same as that of a commercial litigator – HMRC is not going to apply a percentage to the amount of tax due to reflect litigation risk.
The reference in the LSS to waiving privilege in legal advice also raises a number of questions – should the taxpayer be encouraged to waive privilege in its legal advice in order to set out their arguments early? If the taxpayer does waive privilege, is the advice going to be available later in the context of a professional negligence claim? In this situation, is there a potential conflict for the tax professional advising the taxpayer in their dispute with HMRC?
These are two areas to consider when dealing with tax disputes under the refreshed LSS. Such considerations sit alongside the old questions of how to deal with a tax professional giving evidence for the taxpayer and managing the risk of the professional going too far in the witness box, or whether to encourage insurers to part-fund a Part 36 offer on appeal to the Court of Appeal where HMRC can be subject to the consequences of Part 365?
More questions than answers?
In recent years there have been a number of well publicised settlements involving HMRC and wellknown corporate taxpayers. The change in HMRC’s approach, reflected in its ‘refreshed’ LSS, does seem to indicate greater pragmatism on the part of HMRC when handling disputes.
The difficulty remains that tax disputes often raise difficult questions of law and are one of the most complicated types of dispute to manage. These difficulties are compounded by HMRC’s increasingly aggressive approach and the refreshed LSS, opening the possibility of ADR and the option of waiving privilege. This increased aggressiveness and the refreshed LSS raise questions over how best to bring such disputes to an amicable conclusion for all concerned, namely HMRC, the taxpayer and, potentially, the tax professional. Until we know how HMRC will interpret the refreshed LSS in practice, we are left with more questions than answers.