Tax disputes: see you in court

Once upon a time, the Inland Revenue was in charge of direct tax while Customs and Excise did lots of criminal investigations, with a bit of civil VAT on the side. The men and women of the Inland Revenue were a polite, technically orientated lot. The VAT man, on the other hand, tended to be more focused on criminal activity and was a dab hand at sledging down doors at 7am on the way to seize some drugs or other undesirable articles.

All this changed in 2005 when the organisation signed up to become HMRC. Once the initial tiffs that come with many mergers were over – Customs wanted the organisation to be called HMCR rather than HMRC, but that did not roll off the tongue quite as well – the new organisation shook itself down and became increasingly more proactive and aggressive.

Since the merger, HMRC has focused on risk-assessing both large corporations and high-net-worth individuals who are perceived as contributing to the increasing ‘tax gap’. This process has accelerated with the onset of the financial downturn, with UK plc falling ever deeper into the red and the corresponding tax take plummeting.

Following this, it has launched a new litigation and settlement strategy with the intention of discouraging companies and individuals from engaging in any form of ‘unacceptable’ tax avoidance. It has introduced a new penalties regime, designed to impose harsh punishments on non-compliant behaviour. It has also managed to equip itself with sweeping new inspection powers.

The specialist officers of HMRC also co-operate closely with a view to targeting ‘abusive’ tax avoidance. Here, primary responsibility rests with the Anti-Avoidance Group (AAG) for transactions or arrangements that would not have been entered into but for tax considerations which, according to HMRC, have undermined the intended effect of the legislation.

Cases that are referred to AAG often disappear into a tax black hole for lengthy periods of time. In fact, disputes can often go on for many years with no settlement in sight. Sometimes, if no tax has been paid over to HMRC or suitable tax provisions have been made, the company may be perfectly happy with the delay. At other times, if HMRC has the money or the company needs certainty in its financial results, the position is much less satisfactory. What should directors do?

Duties of the director

As every businessman knows, cash is king. Every commercial organisation needs to collect monies due from debtors as quickly as possible. In law, there is a duty on directors generally to promote the success of the company – section 172 Companies Act 2006 (although this provision didn’t come into force until 1 October 2007). A director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole taking into account, amongst other things, the interests of the company’s employees; the need to foster the company’s business relationships with suppliers; customers and others and the need to act fairly as between members of the company.

The tension

There can often be tension between a director’s duty and dealing with HMRC. Public debt is at an all time high. HMRC is hanging on to the cash for as long as possible, even if taxpayers have an excellent case, and particularly if it considers that the taxpayer has engaged in any form of tax avoidance. The temptation for a director, when faced with prevarication from a powerful regulator such as HMRC, may simply be to give up in order to secure a quiet life. However, ceding large amounts of tax may well not be in the company’s interest. Directors have a duty to defend the company's financial health and the livelihoods of its employees and other stakeholders.

The fightback

In our experience it is vital to proactively manage disputes with HMRC in a way that reduces the length of time taken to resolve a dispute and enhances the prospects of a successful outcome. There are a number of factors to consider and there is no one-size-fits-all solution. In the more complex cases, however, we have found that a carrot and stick approach often yields good results. Firstly, a dispute can sometimes be resolved by the process of using HMRC’s independent review process (which has recently been introduced for direct taxes). If this fails, the new tax tribunals can be used as a tactical measure in order to force HMRC to close an enquiry and issue a closure notice. Once this happens, and the taxpayer appeals, the matter is removed from HMRC’s control and put into the hands of an independent tribunal.

Following registration with the tribunal, it is usual, in the more complex cases, for bespoke directions to be sought from the tribunal in order to ensure effective and speedy case management. There are effective sanctions should HMRC fail to comply with issued directions. Negotiations can continue with HMRC with a view to seeing if a mutually acceptable settlement can be reached. In practice, this dual approach can be very effective in curtailing long running enquiries and persuading HMRC to come to the negotiating table.

It has often been said that death and taxes are the only certainties in life. With public debt soaring, and tax disputes on the rise, dealing with the taxman requires a well thought out and effectively implemented strategy if a successful result is to be secured.

Why might this happen?

X plc is a public listed company with a mix of institutional and private investors. The audit committee, in response to recent changes in company law and the greater potential liability that non-executive directors are under, are taking a greater interest than previously in the company’s tax strategy. The executives on the board are keenly aware of the need to maximise the bottom line. The investor and shareholders want to see their board being proactive in these difficult economic times. Every avenue needs to be explored and all parties know that tax is one of the major business costs of any large company. Against this background, the audit committee and the investors are asking the executives: “What are you doing about HMRC?”

Jonathan Levy is the head of, and Adam Craggs is a solicitor in, Reynolds Porter Chamberlain’s Tax Disputes Group.