‘Aggressive’ tax planning arrangements

‘Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury.’ Judge Learned Hand, Helvering v Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934).

‘I regard tax avoidance schemes of the kind invented and implemented in the present case as no better than attempts to cheat the Revenue.’ Lord Templeman, IRC v Fitzwilliam (1993) 67 TC at 756 (UK).

Attitudes towards the payment, or more specifically non-payment, of tax, do change over time, with the economic backdrop inevitably being a key factor; when times are tough, most would agree that all should pay their ‘fair share’ of taxes.

One might say that the way in which an individual law firm partner manages his or her own tax affairs is no one else’s business. But if that individual was also exposed to a tax evasion scheme, how would the national/legal media have reported it? What if that partner had been a tax partner too? Would it be solely the name of the partner that existing and potential clients would remember, or would the firm also be damaged by association? In a competitive market place, where lawyers are expected to maintain the highest standards of professionalism, can their firms take the risk of allowing partners to expose their reputation in this manner?

To provide some context, it is useful to consider the difference between tax avoidance and evasion. While evasion refers to deliberately hiding income or taxable assets from Her Majesty’s Revenue & Customs (HMRC), avoidance refers to the use of measures to reduce the tax that might otherwise be payable. Avoidance, as a concept, is of course not illegal, and under certain controlled schemes, is positively encouraged through the use of, for example, pensions or Venture Capital Trusts (VCTs). Each of which are designed to legitimately reduce the amount of tax the investor would otherwise pay. 

However, actions taken that have no practical benefit other than to reduce the amount of tax paid sit at the more aggressive end of the tax avoidance spectrum, and are likely to attract the attention of HMRC. As an example, the now infamous Jersey-based K2 tax scheme, allegedly used by a well-known comedian to reportedly pay income tax rates as low as 1%, falls very much into this category.

Arguably schemes that have been designed to deliberately take advantage of unintended consequences in tax legislation to increase net returns, introduce an additional dimension to the risk the investor is taking. This risk may not be appreciated fully by the investor until the scheme fails and, where a tax planning scheme does not produce the financial reward intended because it has been successfully challenged by HMRC, the loss to the investor may be more than simply monetary based. It is for this reason that the lawyers, and indeed law firms themselves, should take heed.

In June last year, when details of the aforementioned comedian’s tax arrangements were exposed by the media, it attracted condemnation from a wide variety of public figures, including David Cameron, who was quoted as describing use of the K2 scheme as ‘morally wrong’. 

While cynics might view this as nothing more than political point-scoring, it could also illustrate the tide of public opinion on the ethical debate that tax avoidance prompts. The government had clearly set out their view; in his March 2012 budget speech, chancellor George Osborne spoke of his disdain for tax evasion and aggressive tax avoidance, describing both as ‘morally repugnant’.

So with the cultural tone clearly set, in July last year, the introduction of the General Anti-Abuse Rule (GAAR) provided HMRC with another tool to tackle, what it terms, ‘abusive tax avoidance’. Covering a range of different taxes, including the three key types of personal taxation (income, capital gains and inheritance taxes) the GAAR is designed to tackle the concept of tax avoidance. This is an important point, as it creates a deliberately grey area; any scheme that creates a ‘tax advantage’ can potentially be challenged, and almost dares taxpayers to play chicken. HMRC’s image may be morphing from the friendly bespectacled, bowler-hatted cartoon character to a magnum-toting Dirty Harry.

So, where does this leave our lawyer, keen to maximise his hard-earned income and gains? Well, in an industry where credibility and reputation are king – proceed with caution. Consult your advisers and challenge their ideas. When analysing potential tax planning opportunities, some of the questions we would demand answers to are:

• What are the costs of the scheme (does the scheme adviser stand to receive substantial fees)?
• What is the likely loss of liquidity?
• What is this scheme promising me above and beyond what I can hope to gain from more mainstream, uncontroversial, tax planning?

As with so much in life, if a scheme looks too good to be true, it probably is. The question lawyers (and their firms) should have at the forefront of their minds is this:

If your (or your firm’s) name was published nationally in connection with the scheme, would you be embarrassed, and would your credibility with your clients be impacted? If the answer is “yes”, then the prudent lawyer would steer well clear.

Edward Nice, chartered financial planner at Saunderson House