The tax avoidance cycle

WHEN HMRC claimed victory over the Eclipse 35 film partnership in the courts this week, it was supposedly indicative of a wider trend.

The thinking is that in the good times, when the man on the street has more money in his wallet, the general consensus among the populous – and the authorities – is that the rich can plan their affairs as they wish, provided it is lawful.

When the economy reaches the point much like today’s, avoidance becomes culturally unpalatable, and the government swings into action. And so the cycle goes.

The Eclipse 35 case was a strange one. It involved Disney, Manchester United manager Sir Alex Ferguson, former England boss Sven-Göran Eriksson, former Newcastle United player Nolberto Solano, as well as various hedge fund and private equity managers. The partnership borrowed £790m from Barclays, and its 289 members then topped it off with £50m of their own; about £173,000 individually. Just over £500m of that cash was then paid to Disney as investments in the films Enchanted and Underdog.

Some £293m was then paid back to Barclays for a decade’s worth of interest payments on its original loan, licensing the rights to the films back to Disney, at a rate of return of £1.02bn for 20 years.

Had the deal been successful, the 289 investors in the scheme would have each been in line for approximately £400,000 in tax reliefs on their £173,000 investment, while realising approximately £117m of tax reliefs for the whole partnership. This was based on the principle that interest on loans is eligible for such tax breaks provided it is used for the purposes of trade by the borrower.

Of course, HMRC was having none of it, and took the case to a tribunal, which ruled in its favour.

Advisers were far from surprised given the determination to eliminate such schemes, and its use of these wins to build momentum in its fight against practices deemed near to the knuckle.

“It’s clear that the government is intent on cracking down on tax avoidance schemes once and for all”, says Menzies’ tax partner, Dave Truman.

“HMRC is starting to win cases in terms of the general purpose of the scheme and is increasingly using these wins to pressurise clients with outstanding claims into withdrawing them.”

In doing this publically, the government has done an impressive job of making tax avoidance socially unacceptable, or “morally repugnant” as George Osborne described it. As such, it is understandably pursuing as many cases as possible in order to maximise its tax take, which at the time of writing, has dropped significantly.

But tax avoidance and the subsequent government clamp-downs operate in a cycle, mirroring the economic climate.

Avoidance, though, is something open to a lot of interpretation.

The case of Sir Philip Green – recently highlighted by John Humphrys on BBC Radio Four’s Today programme, and something the BBC subsequently had to apologise for – illustrates just that.

Green was employed as a government adviser and in 2002 sold ownership of Arcadia to his wife, domiciled in Monaco, and therefore was not liable for tax in the Britain.

“It’s perfectly within the scope of tax legislation to do that” says Louise Somerset of the Royal Bank of Canada. “It is a fact that if you are not resident in the UK and you receive dividends from a UK company, that you are not liable to UK tax.

“What the Revenue has done very cleverly over the last ten years is to help change the attitude of the public towards tax avoidance. Ten years ago, avoiding one’s liability to tax was seen as perfectly acceptable, I think people feel much more morally obliged to not do things like that.

According to Somerset, the cycle has gone something like this: In the 1970s, it was an aggressive time for tax avoidance, with high tax rates encouraging those with the wherewithal to do it. In the early ‘80s there were cases which were significantly in favour of HMRC. As a result, it became more difficult to successfully mitigate your tax. During the late ‘90s, the courts increasingly found in favour of the taxpayer in a number of significant tax cases, but the tide is now turning back towards the HMRC.

Rulings in these cases are very much dependent on interpretation of the legislation and the prevalent attitudes at the time. Where five years ago, HMRC may have lost its case against Eclipse 35, it is now able to block such schemes thanks, in part, to a change in attitude.

It will be interesting to see how far the government manages to take its battle against avoidance, and how long the measures last. That is the true litmus test.

Image credit: Shutterstock

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