09 May 2018

CAPITAL letters - Issue 28

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Profit fragmentation: HMRC’s latest proposals a step too far?

The last two years have seen an avalanche of new measures designed to tackle offshore tax avoidance so it is perhaps no surprise to see another consultation document (Tax Avoidance involving Profit Fragmentation, 10th April 2018) published by HMRC.

What is surprising is not the proposed anti-avoidance rule itself – we are battle weary when it comes to those – but instead the extraordinary advance payment provisions, which seem to pay little heed to taxpayers’ rights.

What’s HMRC’s problem?

Despite the fact that we already have extensive anti-avoidance legislation which targets offshore matters – such as transfer pricing (TP), the diverted profits tax (DPT) and (my personal favourite) the transfer of assets abroad (TOAA) rules – HMRC is still of the opinion that our law needs to be tightened.

Specifically, HMRC is worried about arrangements that effectively divert (or ‘fragment’) profits from UK business activity to offshore entities, thereby leading to lower tax in the UK. It seems these measures are targeted at high earning individuals, such as asset managers, management consultants, entertainers and professionals such as architects. This list is by no means exhaustive.

The proposals:

  1. Targeted legislation will be introduced which will identify ‘alienated profits’ of an UK resident (A) which end up in an entity (Z) which pays ‘significantly less tax’ than in the UK. If A, or someone connected with A, has the ‘power to enjoy’ those profits then they are taxed as if they were received in the UK.

  2. Taxpayers who enter into arrangements that are potentially caught by the new rules will have an obligation to inform HMRC of the fact on or before the deadline for the tax return for the relevant period.

  3. HMRC will have the right to send a charging notice that will demand payment of the alleged underpaid tax within (probably) 30 days.

Comment

HMRC justifies the new legislation on the basis that the current law is inadequate. This appears unconvincing, given the breadth of the existing offshore anti-avoidance rules. Whilst I accept that both the DPT and TP rules do not catch small and medium sized enterprises, the TOAA rules do. It is also particularly unhelpful to introduce another ‘power to enjoy’ concept when the one in the TOAA rules is both extant and extremely widely drawn. This kind of doubling up will only cause confusion amongst taxpayers and their advisors.

It also seems that the author of this consultation has completely forgotten about the GAAR – it is not mentioned once. Given that the GAAR already gives HMRC the power to counteract ‘abusive’ arrangements - if HMRC thinks that profit fragmentation of the kind described in the consultation is abusive then why doesn’t it use its powers under the GAAR? What is the need for yet more overlapping legislation?

The notification requirements are also troublesome as they put the onus on the taxpayer to notify HMRC if a particular arrangement falls within the new rules. But how is the taxpayer, or his/her advisor supposed to know? The rules are likely to be very widely drawn and could potentially catch anyone who trades or provides services offshore.

Finally, and most significantly, the new advance payment provisions give HMRC hitherto unprecedented powers to demand money from the taxpayer. Under the existing accelerated payment notice (APN) provisions, HMRC has at least to show that the taxpayer’s arrangement is substantially the same as one that has been defeated in the courts. No such protection here – all it takes is for HMRC to have ‘reason to believe’ an arrangement is caught, in which case a preliminary notice is sent to the taxpayer. You will then have 30 days to persuade HMRC you are not caught and, if HMRC remains unconvinced, you will then have to make the advance payment, probably within another 30 days.

This means that HMRC acting alone, without the authority of the GAAR advisory panel, a tribunal or a court, will have the power to decide whether an arrangement falls within a very widely drawn anti-avoidance rule and demand payment of the alleged understatement of tax within, effectively, 60 days of notification.

Conclusion

I am not convinced by HMRC’s claim that this new law is necessary. We are already staggering under the weight of existing targeted anti-avoidance rules, not to mention the GAAR.

If enacted, the proposals will drive a coach and horses through the normal file and pay deadlines under our self-assessment regime, thereby undermining the protections in the Taxes Management Act.

Finally, the lack of judicial oversight of HMRC’s powers to demand payment of disputed tax is a worrying erosion of taxpayers’ rights.

These proposals are indeed a step too far and should be scrapped.

 

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