Paying the price of regulation

Stockbroker Brian Shepherd spent more than #200,000 on lawyers defending his business from claims by the Stock Exchange that he abused its rules.

Those legal costs can now be offset against his tax after his victory in the Court of Appeal.

But in the light of McKnight v Shepherd tax investigators are asking themselves if a visit from the Inland Revenue or Department of Trade & Industry falls into the same category as a visit from the regulator.

At first glance, the case appeared to offer a glimmer of hope to campaigners who have been demanding the costs of Revenue special investigations under self-assessment be classed as business expenses.

According to leading tax lawyers, it is almost certain that the legal costs accumulated during an investigation by any of the professional institutes can be offset against tax. The rule should apply whether it is the English ICA, the Law Society or the proposed new and enlarged Securities and Investments Board which is doing the investigating.

DTI investigations should also fall into this category. After all, its investigations flow from its responsibility as a regulator of the industrial and commercial sector.

But the Revenue is another matter. At issue is the nature of the investigation and the motive for mounting a defence against accusations lodged by an investigator.

The motive of a taxpayer must be to stop their business being materially affected by an investigation. Previous court cases have been overidden when the courts decided that taxpayers were hell bent on protecting their personal reputation rather than their business.

As one of the special commissioners concluded in 1995: ‘The sole object to be served by the legal costs was to avoid the destruction of the taxpayer’s business. The fact that his personal reputation was inevitably involved also does not make the preservation of his reputation a purpose.’

And the outcome of the investigation is also irrelevant. Shepherd was found guilty on several counts by the Stock Exchange. But, as far as the court was concerned, his motive was the important issue not the judgement.

A taxpayer could establish a satisfactory motive when faced by a visit from the Revenue. But the nature of the visit is likely to undermine their case.

Charlie Hall, head of tax investigations at Grant Thornton, argues Revenue visits usually focus on a dispute over the level of tax payable. ‘Arguably, tax has nothing to do with your business because it is paid after business is completed and profits calculated,’ he said.

The regulators also come armed with the ability to strip members of their licence to trade. This threat justifies almost any amount of spending on solicitors and barristers.

Professionals, in particular, can safely argue that without a licence, their business suffers. The smaller the firm they work for, the stronger the argument.

Howard Scott, head of tax at BDO Stoy Hayward, agrees with Hall that tax investigations are effectively ring-fenced from the business. ‘The law is clear. An investigation of tax matters is only concerned with the assessment of tax liability, and not the ability of the business to function.’

However Hugh McKay, the specialist tax barrister who defended Shepherd, claimed special circumstances could arise where the outcome of a Revenue investigation would ruin the business. It is possible, he said, that legal costs could be deductible in computing the profits of the trade under case 1 or 2 of Schedule D.

Hope, then, remains that Shepherd’s landmark victory could force a Revenue climbdown. But, for the moment, regulated professionals can take comfort from the ruling, while their clients will have to wait and see.