Tax insurance, ie insurance cover for identified tax risks, by its very nature, gives an insight into what gets a taxpayer’s heart racing (see ‘Uncertainty and risk’, Taxation, 30 July 2020, page 22, tinyurl.com/2p8bjfwr). The concern may be around a difficult point of interpretation, the amount of a tax risk, increasing tax authority aggression, or protecting against a worst-case scenario.
On the other hand, roughly 10% of requests for tax insurance relate to matters being investigated or contested and practitioners receive a lot of information regarding tax authority behaviour. There is now sufficient data to identify trends in tax authority – for the purposes of this article, HMRC – activity.
The current tax environment points to strong revenue collection pressure. The UK is facing a cost-of-living crisis, inflation, supply chain disruption and the looming threat of an economic downturn. There is a mounting need for the Treasury to ‘balance the books’ with interest payments on the UK’s £2.5tn debt at a record high and it being forecast that the deficit will exceed £100bn by the end of the current financial year. There are challenging times ahead.
In this context it is no surprise that HMRC has become more aggressive and is making use of the excellent tools at its disposal. Our tax authority has more information about taxpayers than ever before, including as gathered by Connect (a system developed for HMRC by BAE Systems) or via the uncertain tax treatment provisions, and broad powers to facilitate collection under FA 2008, Sch 36. This is a potent combination and HMRC won 86% of First-tier Tribunal cases in the year to 31 March 2021.
The government estimates that the tax gap (ie the amount of tax that is uncollected but due) is £32bn and so it is understandable that increased efforts will be made to close this gap.
According to HMRC’s annual report, the tax authority impressively collected £731.1bn in tax year 2021-22 representing a 20% increase on 2020-21 and 15% on 2019-20 (ie pre-coronavirus). That said, HMRC is prepared to take (and litigate) some quite harsh positions in the pursuit of tax. Pity the taxpayer in Quayviews Ltd (TC8515) in which HMRC sought late filing penalties because the business had filed its real-time information returns too early.
The most significant area of dispute that I encounter is in relation to the classification of contractors. There are number of well known such cases in the UK courts relating to media presenters.
In my experience, the treatment of contractors is being considered and/or challenged across a wide range of sectors across the economy and the amount of tax at risk varies hugely (from hundreds of thousands to tens of millions). This issue affects taxpayers of all sizes.
Given the technical tax analysis of employment status is driven by the underlying fact pattern and the interpretation thereof it is hard to see anything other than more challenges and litigation without new, clearer law being introduced.
I am aware of increasing HMRC focus on restrictions of interest deductions through the application of the corporate interest restriction (CIR). The recent announcement that CIR returns must be filed online as of 1 September 2022 will provide HMRC with more data and enable errors to be identified.
I understand that this is part of HMRC refocusing how it challenges debt deductions, moving from pursuing transfer pricing adjustments to applying the CIR on the basis that the CIR is an easier and more objective route.
It is easy to imagine increased challenges in relation to reliefs more generally, particularly relating to capital allowances. HMRC has already beefed up its approach to research and development (R&D) with more than a hundred dedicated inspectors, a growing body of case law elucidating the level of supporting evidence (eg Hadee Engineering Co Ltd (TC7969), and a digital submission system to follow in April 2023.
The envisaged increase in the corporation tax rate to 25% for companies with profits exceeding £250,000 means reducing taxable income is more valuable and the ‘super deduction’ creates an incentive for incurring capital expenditure in the period up to April 2023. Similar to R&D, capital allowances case law is growing and, as acknowledged in Urenco Chemplants and another v CRC [2022] UKUT 22, it is impossible to legislate the distinction between what is ‘plant’ and what is merely the setting for ‘plant’. This grey area in the legislation leaves scope for disagreement with HMRC. Perhaps an electronic submission portal will be announced in due course.
I am sometimes surprised by the basis on which HMRC will raise a challenge. It is not uncommon in merger and acquisition (M&A) transactions for points to be negotiated on the basis of what is ‘market’ or ‘reasonable’, but it is entirely possible that HMRC’s view and the commonly held and/or reasoned views of tax advisers diverge.
It is not uncommon in M&A transactions for points to be negotiated on the basis of what is ‘market’ or ‘reasonable’, but it is entirely possible that HMRC’s view and the commonly held and/or reasoned views of tax advisers diverge.
When considering the PAYE position for employment-related securities (ERS) it is market practice to rely on a contemporary third-party valuation as a ‘best estimate’ for the purposes of ITEPA 2003, s 696(2). I am aware of HMRC taking the position that a contemporary valuation is not a best estimate and seeking to assess PAYE and National Insurance. Naturally, much depends on the relevant facts, but the potential for this line to be taken will be of particular interest to advisers working with private equity-backed businesses where ERS is a key part of a management team’s incentive package.
Being a commonplace exemption, analysis of the application of the substantial shareholding exemption (SSE) can be light touch, but in my experience SSE can be the subject matter of some surprising HMRC challenges. The taxpayer in M Group Holdings Ltd (TC8054) might have been confused that, contrary to the intuitive purpose of the law, it was required that the entity disposed of had existed for 12 months – albeit there was guidance warning against this.
Aside from strict interpretations of the black letter law, I am particularly aware of challenges relating to the existence of a ‘trade’ or whether there are ‘substantial non-trading activities’. Sometimes relying, in my view, on a harsh interpretation of the law.
HMRC is particularly interested where a trade has not existed for a long period of time or the business may have the appearance of being non-trading (eg exploiting an intangible asset in the tech or media sectors). In respect of the latter, HMRC may now be emboldened by its success in Assem Allam v CRC [2021] UKUT 0291 where the Upper Tribunal held that
‘activities’ could be substantial without requiring directors or employees doing much.
HMRC is particularly interested where a trade has not existed for a long period of time or the business may have the appearance of being non-trading.
In recent years, HMRC has gone through a period of major change in respect of clearances. In 2020, the tax authority’s lack of capacity – as a result of administering Covid-19 support – led taxpayers to seek tax insurance as a quick alternative to a clearance (the insurance process typically takes a fortnight).
However, since then I have observed HMRC behaving in a way that encourages taxpayers to seek alternatives to clearances more often. A negative or ambiguous response can put the taxpayer in an awkward position, especially where comfort is required to facilitate a transaction.
Further, a drawn out clearance process uses precious time and incurs adviser fees. In a time-pressured scenario, such as M&A, taxpayers do not have time for months of extensive discourse with HMRC. Our team has encountered instances where HMRC has taken weeks to respond and then come back with a series of information requests leading to months passing without achieving a resolution.
In particular, we have noticed HMRC is focused on querying the extent to which a transaction is tax-motivated or whether it is being undertaken for bona fide commercial reasons. Even where the taxpayer is receiving a tax benefit by virtue of a transaction structure which is being imposed on it by a third party. We are regularly told by advisers and taxpayers that they are experiencing delays and uncertainty in respect of clearances.
While the idea of insuring tax – especially a contentious matter – in the current environment may sound risky, it is important to remember that not everything will be considered to be ‘insurable’.
A tax underwriter will, for example, consider the available lines of defence, profile of the taxpayer, contemporary evidence, amount of risk capital required to cover the position, regulatory considerations, and their own risk appetite.
The combination of a need for revenue, data available to HMRC, and laws with room for interpretation means that more investigations and challenges can be expected in the near future.
For example, it is hard not to see FA 2003, s 75A as a key risk area where brushes with HMRC may arise. HMRC has shown in the courts that it has appetite for raising s 75A challenges, it has access to stamp duty land tax returns and data from the land registry, and ‘scheme transactions’ is a very broad concept.
Returning to the tax gap, it is interesting to note that the government sees small and medium-sized enterprises (SMEs) make up 60% of uncollected revenue. This suggests that SMEs can expect more attention in the coming years.
There are turbulent times ahead. It will be interesting to see how HMRC walks the tightrope of collecting much-needed revenue and enforcing compliance without discouraging the business activity which increases revenue available for collection.
Find out more about the author, Richard Taylor-Whiteway