Julian Miller and Tom Pangbourne, solicitors at Beachcroft LLP, discuss how advisers can become targets during HMRC investigations.
Since 1997, a number of tax reliefs have been introduced, designed to encourage investment in particular areas of British industry. This included investment in British films, technology start-ups and in research and development.
However despite the best intentions, this inevitably attracted not just those wishing to invest in the relevant sector, but also high-net-worth individuals seeking to use the tax reliefs without any real interest in the underlying asset or the commercial success. This led to increased scrutiny by HMRC, the gradual restriction of the reliefs available, and the failure of several schemes – which has inevitably resulted in an increase in claims against professional advisers.
Investors would typically pay from their own resources a proportion of the sums required for the relevant investment, raising the balance by way of a bank loan. Although the investor would only have contributed 20% of their own funds, with a bank loan for the remaining 80%, a claim for tax relief on the full amount of the investment was made.
Scrutiny by HMRC led to reliefs being withdrawn, often effective immediately on ministerial statements being made. The Finance Act 2002 restricted relief on British films only to those genuinely intended for cinematic release.
Restrictions on the use to which trading loss could be put were introduced in 2004, and prevention of ‘double-dipping’, whereby the same films were used to generate losses twice (for example, for production, then for acquisition), was put in place in 2005.
In addition, HMRC has disallowed some of the reliefs sought on a case-by-case basis. Commonly, its decision was influenced by the use of circular finance, the lack of a trade on a commercial basis with a view to the realisation of profit, or failure properly to acquire the asset. A particular focus has been on whether investors should be allowed relief on the 100% investment or only their own 20% investment.
In cases where HMRC indicates reliefs may be disallowed, some investors negotiate with HMRC for some relief, though inevitably lower than anticipated. It is in those circumstances that the professional advisers may be targets, if the investors have sustained losses or contend that they might otherwise have invested in schemes on which full relief would have been given.
Investors look to the IFAs, accountants and lawyers who advise the schemes to seek recovery of their investments, and the reliefs to which they consider they should have been entitled.
One high profile case involved Tower MCashback, and a key issue in this litigation was circular funding. HMRC argued that expenditure had not been incurred, as the borrowing was on uncommercial terms – consequently there was no real expenditure. HMRC succeeded at first, but the taxpayers prevailed on appeal. The court found that because the partnership had acquired the full rights to the software and was therefore able to use it to generate income, expenditure had been incurred and the tax reliefs should be allowed. This decision may be reviewed in a further appeal to the Supreme Court.
The future holds significant uncertainty for professionals advising investors in such schemes and those insuring them. The combined effect of HMRC’s critical approach to such tax reliefs and the judgment in Tower MCashback means that those who have already invested in such schemes may be susceptible to investigation. Tax enquiries and closure notices are likely to become lengthier and fuller. Where investors are denied relief, or relief is clawed back, their losses may include interest and penalties payable to HMRC.
Most claims have settled out of court, so the full extent of the duties of an investor’s professional advisers, or those advising the scheme promoter, have not been tested. A statement published by Government alongside the budget confirmed that it intends to examine whether the adoption of a general anti-avoidance rule should form one element of a strengthened tax system.
Where reliefs are withdrawn however, it is inevitable that those involved will look to their advisers, and other professionals involved in the schemes – and there appears to be no end to these claims in sight.
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