TAXATION - The whole truth

In Regina versus W and Another (The Times, 24 March 1998) the CourtTwo senior counsel who took part in the case explain what the ruling really means. of Appeal (Criminal Division) decided a prosecution for tax fraud can proceed even though the defendants agreed a financial settlement, including penalties, in respect of the same matters with the Inland Revenue. This ruling, which has yet to be fully reported, led to very considerable comment and concern among the accountancy profession and a statement to the House of Commons by the Attorney General on 8 April 1998.

The pending criminal trial

The defendants W and C are being prosecuted by the Crown Prosecution Service (CPS) in respect of an alleged fraud concerning two companies, xyz plc and abc Ltd. Following a police investigation, which commenced in 1993, W and C were charged in 1995, inter alia, with an allegation of conspiracy to account falsely (contrary to S.1(1) Criminal Law Act 1977).

The particulars of this allegation are that W and C ‘dishonestly conspired with each other, with a view to gain for themselves and/or with intent to cause loss to another or others, to falsify documents required for an accounting purpose which supported bogus transactions in the accounts of xyz plc, namely invoices from abc Ltd, in respect of services provided to the said xyz plc when no such service to the value of the said invoices had been performed.’

The prosecution case concerning the allegation of false accounting has been put in various ways. After the settlement with the Inland Revenue, the case was stated to be as follows:

‘The Prosecution say there were two obvious motives. The first one was to reduce the profitability of the company that paid out the money, thereby reducing the amount of corporation tax which the company would have to pay. In the second place, since the money was going into bank accounts which they controlled, it in effect represented an increase in their income which the Revenue would not know about, with the consequence that they would escape paying income tax on that money …

‘The only purpose in such a scheme must have been to cause a loss to the Revenue in the sense of depriving them of corporation tax on xyz plc’s profits or of income tax by concealing what in effect were large payments by xyz plc to (W and C).’

The amounts alleged to have been paid in respect of such false invoices were approximately #3m.

The Inland Revenue investigation

The Revenue began an investigation into the affairs of the two companies and the defendants in 1992. The investigation was conducted by Special Compliance Office (SCO). Investigations conducted by SCO are commenced in a number of ways:

Under code of practice 8 (COP 8) (cases other than suspected serious fraud);

Under code of practice 9 (COP 9) (cases of suspected serious fraud);

Following a formal caution under the Police and Criminal Evidence Act 1984 (PACE);

‘Neutrally’ whereby none of the above procedures is followed. This usually means that the Revenue is looking for a prosecution but does not have sufficient evidence to require a PACE caution.

In this case SCO adopted a ‘neutral’ opening to its investigation.

In June 1997, almost two years after the CPS had instituted criminal proceedings, SCO reached a financial settlement with the companies which resulted in payment of #1,311,605 in taxes, interest and penalties. The settlement included tax on amounts paid by xyz plc to (or for the benefit of) abc Ltd under the allegedly false invoices. Those companies were controlled and beneficially owned by one or other or both of the defendants, who funded the settlements.

Throughout, the Revenue at all material times and in particular at the date of the acceptance of the settlement was well aware of the police investigation and the pending criminal proceedings. The CPS was aware of the settlement, but nevertheless sought to proceed with the prosecution of the false accounting allegations and, as noted above, clearly stated that those allegations concerned the fraudulent evasion of tax.

The appeal

At a preparatory hearing in the Crown Court in January 1998, the defence applied for an order declaring that the Crown was not entitled to proceed with the indictment. The judge rejected the application and refused leave to appeal. The defendants therefore appealed, summarising the question of law as follows:

‘If the Crown through the Inland Revenue has elected not to prosecute for tax evasion but instead to accept tax, penalties and interest, is the Crown through the CPS nonetheless empowered and entitled to ignore that election and to prosecute in respect of that tax evasion?’

The application for leave to appeal was heard in the Court of Appeal by Lord Justice Rose, Mr Justice Hidden and Mr Justice Penry-Davey. Controversially, they held that they had no jurisdiction to entertain an appeal at the present stage as the order which was being appealed was not a matter within the four purposes of a preparatory hearing as defined by section 7 Criminal Justice Act 1987.

Despite their ruling, their Lordships went on to express their views on the merits of the case. They held there was no inconsistency in the Crown’s position if the CPS prosecuted in circumstances where the Revenue had decided not to. If there had been jurisdiction, their Lordships would have refused leave to appeal against the judge’s ruling.

In so holding, the Court of Appeal implicitly rejected the proposition that a settlement which is binding on the Revenue as an agency of the Crown (and which as a matter of policy operates to bar criminal proceedings against the settling taxpayer by the Revenue) is also binding on any other arm of the Crown. W and C relied upon the duties imposed on the Revenue by the Inland Revenue Regulation Act 1890 and the Taxes Management Act 1970 and in particular relied upon the longstanding powers to compound proceedings and the statements of policy to the effect that settlement is the alternative to prosecution (see ex parte Allen (1997) STC 1141 at 1152g R v Barker (1941) 2 KB 381 and the statements of successive chancellors; the last such statement being made on 18 October 1990). Their Lordships’ attention was also drawn to section 105 Taxes Management Act 1970, and the applicants submitted that it is a necessary implication of section 105 that a pecuniary settlement precludes prosecution.

Further, the Court of Appeal was taken to Robertson v Minister of Pensions (1949) 1 KB 227 and Town Investments Ltd and other v Department of the Environment (1978) AC 359 HL. In the former case, Lord Denning held that ‘the department … is but an agent of the Crown, it binds the Crown also, and as the Crown is bound, so are the other departments for they are also but agents of the Crown’. In the latter case, Lord Simon of Glaisdale referred to ‘the fundamental constitutional doctrine that the Crown in the United Kingdom is one and indivisible’. It is not immediately obvious to the layman that the principle of the indivisibility of the Crown would not apply in the present case.

The Court of Appeal held that the statutory duty of the CPS to take over and conduct criminal proceedings is free standing and unconfined. The Court appears to have attached importance to the fact that at the time of the settlement with the Revenue the taxpayer did not contemplate the termination of criminal proceedings against him. The distinction between a settlement in contemplation of compounding proceedings and a settlement to compromise tax liabilities is emphasised in the statement made by the Attorney General.

‘Neutral’ investigations

This procedure represents something of a dinosaur from the past and is used comparatively rarely in SCO investigations. The origin of the procedure goes back to a 1911 equivalent of a modern-day practice direction, known as the Judges’ Rules. Until the introduction of the relevant provisions of PACE, Judges’ Rules provided the judiciary’s view of the procedures appropriate to the cautioning of suspects in a criminal investigation. Suffice to say that the Rules were somewhat less stringent than those imposed by PACE, and certainly the Rules could lead to a caution being administered at a far later stage than is required under PACE.

The procedure is intended for use where the Revenue suspects a criminal fraud but lacks either firm evidence or wishes to preserve its freedom to prosecute following investigation.

Consequently, warning bells should sound if it is learned that SCO does not intend to proceed under COP 8 or COP 9.

The ‘neutral’ procedure is not without risk for SCO since it requires critical judgement as to when it is appropriate to caution a suspect following the requirements of PACE. This can be a highly subjective judgement which is therefore capable of being criticised in subsequent proceedings.

Should the investigator make an error of judgement in this regard, this could result in vital evidence being excluded following section 78 of PACE.

Information gateways

The Revenue has traditionally maintained tight control over departmental confidentiality. Revenue officials were subject to the Official Secrets Act 1911 and in more recent times to the disclosure of information provisions in Finance Act 1989 section 182.

The following statement is made regarding confidentiality in both COP 8 and COP 9:

‘You have a right to a high degree of confidentiality. We will not give information about your affairs to people you haven’t authorised to receive it, other than in the very limited circumstances allowed by law (such as at Appeal Commissioners’ hearings).

‘We may have to ask other people or organisations for information relevant to our enquiries. We will always do what we can to avoid their knowing that we want the information in connection with a tax investigation, or embarrassing you in any way. But, it is not always possible to prevent them drawing their own conclusions.’

The Code of Practice seems clear. The statutory exceptions to this general rule relate to exchanges of information with other fiscal departments such as Customs & Excise and the contributions agency. SCO investigators are generally not permitted to make disclosures of other confidential information to third parties such as the police or CPS unless the Revenue has requested the police to investigate a suspected offence which is not directly related to tax.

A change in the law to permit the exchange of information between the Revenue and the police is under active consideration. There is no suggestion in the present case that the Revenue disclosed any information concerning the settlement.

Inland Revenue pecuniary settlements

The Revenue can institute criminal proceedings for tax offences. It may alternatively use a civil process to recover tax, interest and penalties.

The Revenue will normally try to negotiate a financial (contractual) settlement, whereby it agrees not to take proceedings against the tax-payer in return for a sum representing tax, interest and penalties. Criminal proceedings are rare and contract settlements are used in the overwhelming number of cases. Where a monetary settlement is concluded, the Revenue would not institute criminal proceeding in respect of offences which have been dealt with by the imposition of financial penalties (unless the disclosures made were subsequently found to be untrue).

The Revenue’s policy was set out in a reply to a Parliamentary Question on 18 October 1990 known as the ‘Hansard statement’.

It reads as follows:

‘The practice of the Board of Inland Revenue in cases of tax fraud is as follows:

1 The Board may accept a money settlement instead of instituting criminal proceedings in respect of fraud alleged to have been committed by a taxpayer.

2 They can give no undertaking that they will accept a money settlement and refrain from instituting criminal proceedings even if the case is one in which the taxpayer has made full confession and has given full facilities for investigation of the facts. They reserve to themselves full discretion in all cases as to the course they pursue.

3 But in considering whether to accept a money settlement or to institute criminal proceedings it is their practice to be influenced by the fact that the taxpayer has made a full confession and has given full facilities for investigation into his affairs and for examination of such books, papers, documents or information as the Board may consider necessary.’

On its own, the statement offers no guarantees and therefore gives the taxpayer little comfort. It is familiar in the circumstances of an SCO investigation under COP 9 (Suspected Serious Fraud) where the statement is formally drawn to the attention of the taxpayer. However, it is an accurate statement of Revenue practice in all investigations whether or not it is ‘given’. The real differences between those investigations where ‘Hansard’ is offered, and those where it is not, lie in the practice of the Revenue in those circumstances. ‘Hansard’ is given in COP 9 cases and experience shows that a correct and complete disclosure in such cases does not lead to an Revenue prosecution. The taxpayer cannot assume the same will apply where SCO uses the ‘neutral’ opening but such differences need not detain us here because we know that the Revenue did in W and C decide to pursue a financial settlement having rejected the idea of prosecution before the CPS prosecuted the defendants.

The financial settlement is represented by a contract between the taxpayer and the Revenue. It normally takes the form of a letter to the Board of Inland Revenue from the taxpayer offering to pay a sum in respect of tax, interest and penalties ‘in consideration of no proceedings being taken against me.’ Once the offer is accepted, the Revenue is bound by it and cannot start criminal proceedings (unless the taxpayer’s disclosure on which the settlement is predicated is shown to be materially incorrect or incomplete).

Revenue staff are instructed not to give any undertakings to the effect that a pecuniary settlement will be accepted. Provided that instruction is observed, section 105 Taxes Management Act 1970 ensures that disclosures made by the taxpayer in the course of an investigation are not inadmissible in criminal (or other) proceedings. Section 105 reads as follows:

1 Statements made or documents produced by or on behalf of a person shall not be inadmissible in any such proceedings as are mentioned in subsection 2 below by reason only that it has been drawn to his attention that;

(a) pecuniary settlements may be accepted instead of a penalty being determined, or proceedings being instituted, in relation to any tax, and

(b) though no undertaking can be given as to whether or not the Board will accept such a settlement in the case of any particular person, it is the practice of the Board to be influenced by the fact that a person has made a full confession of any fraudulent conduct to which he has been a party and has given full facilities for investigation, and that he was or may have been induced thereby to make the statements or produce the documents.

2 The proceedings mentioned in subsection 1 above are;

(a) any criminal proceedings against the person in question for any form of fraudulent conduct in connection with or in relation to tax, and

(b) any proceedings against him for the recovery of any tax due from him, and

(c) any proceedings for a penalty or on appeal against the determination of a penalty.

This would be relevant, for example, where a taxpayer submitted a disclosure report which was later found to be materially incomplete and the Revenue decided to prosecute.

Where the Revenue does prosecute, its practice is to leave the courts to impose sentence in respect of tax losses drawn to the attention of the court. Where quantum is considered by the court in sentencing, the Revenue does not seek to impose financial penalties under the civil law.

Conversely, where there is a financial settlement involving tax, interest and penalties, the Revenue is normally precluded from bringing criminal proceedings.

In this case, the Revenue specifically decided not to prosecute, and negotiated a financial settlement with the defendants. Paradoxically, statements and documents provided by the defendants during the course of the tax investigation remain admissible in ‘criminal proceedings … for any form of fraudulent conduct in connection with or in relation to tax’.

An analysis of events in this case indicates that the defendants have settled their tax liabilities with the Revenue and are now facing prosecution by the CPS for the alleged false accounting which lead to the tax losses. In other words, they are being prosecuted for the same substantive offence for which they have already been ‘punished’.

The judge will have an unenviable task if the defendants are convicted.

Should that happen, he will have to decide on the appropriate penalty given that the contractual settlement agreed with the Revenue included an element of financial penalty.

The future

The Court of Appeal may have presented a major potential problem to the Revenue regarding its practice in cases of suspected serious fraud. The Revenue chooses to prosecute only a small number of the most egregious cases. In most cases, its aim is to collect the tax and interest due, together with an appropriate penalty.

The Revenue can do so most efficiently if the taxpayer makes a full disclosure and these cases are worked under COP 9. The incentive is provided, not by the ‘Hansard’ statement itself, but by the Revenue’s practice, which gives taxpayers reasonable expectation that a correct and complete disclosure will avoid a Revenue prosecution. If a prosecution can be mounted by another agency, such as the CPS, that incentive may be worthless. Inevitably, the Revenue’s duty to collect tax becomes much harder without the taxpayer’s co-operation.

We noted above that the W and C case appeared to turn on the fact that the taxpayer did not expect the settlement with the Revenue to terminate the CPS prosecution (even though the taxpayer could not at the date of the settlement have contemplated that the false accounting allegations would solely concern the evasion of those liabilities which were the subject of the settlement).

It would appear to follow that particular care should be taken in effecting any settlement, and ideally the settlement letter should contain express language to the effect that the taxpayer is entering into the settlement to compound any and all criminal proceedings and that the Revenue warrants that following such settlement no criminal proceedings will be brought whether by the Revenue or any other prosecuting authority.

It is, however, doubtful whether the Revenue will be able to commit other prosecuting authorities to a particular course of action, which may defeat the objective.

To put matters into perspective, the case is only likely to affect those errant taxpayers who fall foul, not only of the Revenue but also some other prosecuting authority, such as the CPS, DTI, or SFO. The prospects look bleak for such cases but, fortunately, these are few when compared to the total number of investigations conducted by SCO at any one time. It seems that use of the Hansard procedure itself remains substantially unaffected by the decision.

The authors are: Robert Rhodes QC and Simon Stafford-Michael of 4 Kings Bench Walk, Temple, London, who were counsel for one of the taxpayers in the case and Martyn Bridges, partner in Deloitte & Touche.