TAX: An Introduction

Contentious Tax – Overview 

Life-cycle of a tax investigation 

Tax investigations are initiated by His Majesty’s Revenue & Customs (HMRC), usually by enquiring into a tax return or by carrying out investigations outside of a return as a result of information received. If HMRC determine that tax is due they will issue an assessment, which can be appealed to a court by the taxpayer if it is not accepted. Tax appeals are first heard at the First-tier Tribunal (FTT), which will determine the facts and issue a judgment. Appeals against the FTT’s judgment are usually restricted to issues of law and heard by increasingly senior courts: the Upper Tribunal, then the Court of Appeal, then finally the Supreme Court if the issues are of general public importance.

The ever-increasing reach of HMRC in a highly complex tax system

Advice and representation by specialist contentious tax lawyers is essential to the successful resolution of tax disputes.

The UK tax system is complex, with the Yellow Tax Handbook and Orange Tax Handbook (the books containing the UK’s direct and indirect tax legislation respectively) running for 22,950 ready-to-tear pages and weighing in at over 12 kg. There are entire chapters focused on tax avoidance, and international and European law both have a marked influence on the statute book.

HMRC have access to more information gathering resources than ever before, including through the Disclosure of Tax Avoidance Schemes (DOTAS) regime, third-party notices, the OECD’s mandatory disclosure rules and country-by-country reporting, financial institution notices, trust registration regimes, and by requiring large businesses to disclose uncertain tax treatment.

With such technical complexity and the extent of information available to HMRC, it has never been easier for taxpayers to find themselves on the wrong side of an investigation.

International cooperation and collective action continues as OECD-led initiatives continue to align taxing principles with current commercial practices. Draft legislation was announced in July 2022 to implement a new multinational top-up tax and introduce additional transfer pricing reporting obligations. Other examples include the interim digital services tax introduced in April 2020 and the introduction in 2021 of HMRC’s Manual on the taxation of crypto assets.

These new and expanding areas of tax law and commercial practice give scope for disputes to arise with HMRC over the interpretation and implementation of new and old legislation alike.

Collecting more tax 

With the cost of COVID-19-related government measures estimated at between £350 billion and £410 billion, the UK government will likely look to HMRC to collect more tax and reduce the estimated £32 billion tax gap (about 5.1% of all tax liabilities) to help balance the public finances. Recent and planned increases to corporate and personal taxes have increased the tax burden to the highest levels since the early 1950s.

Against this backdrop, the fine distinctions between legitimate tax planning, lawful but unacceptable tax avoidance, and unlawful tax evasion – distinctions so beloved by tax professionals – will remain increasingly blurred in the public mind, and will give further encouragement to HMRC to continue to crack down on what is perceived to be unacceptable tax behaviour.

HMRC’s changing approach 

HMRC have become more assertive and tenacious. Tax investigations can be carried out ‘informally’ (even if they have many of the hallmarks of formal investigation). Tax enquiries regularly last years and adopt a regimented pattern guided by internal processes and procedure rather than by the frontline officer “on the ground” assessing actual tax risks. This encourages individual officers to adopt an uncompromising stance to settling enquires – quick to assess where tax is underpaid; slow to accept the taxpayer has got things right. This is enforced by ever more stringent powers, including:

• Enhanced information-gathering powers

• Large penalties for non-compliance, including without fault penalties following Follower Notices or general anti-abuse rule (“GAAR”) notices

• Advanced payment notices requiring tax paid before the resolution of a dispute

• Extended assessment windows for offshore non-compliance

HMRC have invested heavily in training specialist staff. For example, in 2020/21 there were 431 full-time equivalent staff working on international issues involving multinational companies, up from 82 in 2017. Recently we have seen HMRC focus on, amongst other things:

• Residence and domicile status for individuals and small companies – particularly in domicile cases. Long-term residents should expect an enquiry and make sure they are prepared

• Sports players’ image rights and agents’ fees

• Complex offshore trust and corporate structures – how funds flow in and out of the UK

• Transfer Pricing, Diverted Profits Tax, Controlled Foreign Companies and cross-border debt – statistics published by HMRC show a 49% increase to £2.1 billion in the yield from transfer pricing casework in 2020-21

• Private equity and carried interest

• Hedge fund structures – where ownership structures include a “tax haven” and challenging the status of partners as disguised employees

• Crypto assets

• Aggressive avoidance schemes – where HMRC have demonstrated their increasing willingness to use the GAAR and its penalty regime in disputes with taxpayers

• VAT Fraud

• Excise Fraud

What taxpayers should be doing to protect themselves

Taxpayers must give thought to the issues above and ask themselves:

• Do they really understand their UK tax and filing obligations? HMRC expect taxpayers to understand their own affairs; they cannot simply leave the understanding part to the advisers.

• Does their previous planning still work? Proactively updating business and family wealth structures in line with legislation and current interpretations before HMRC investigates can save significant time and professional fee cost, in addition to any tax savings.

• Is using an accountant enough? Increasingly, clients are looking for a legal adviser to work with their accountants, to give a second layer of comfort with the added advantage of legal privilege.

• Are they prepared for a HMRC enquiry? Do they have the contemporaneous records to demonstrate the factual position taken years down the line?

Challenging tax-related measures in investor-state arbitration

The avenues for disputing taxation measures have expanded. The number of cases challenging tax-related measures under international investment agreements has more than doubled, with 114 cases between 2010 and 2021. In general, the types of cases that have arisen relate to the withdrawal of tax incentives, the imposition of capital gains or windfall profit taxes, legislative reforms in the renewable energy sector, or the use of oppressive taxation as a surrogate for the expropriation of assets. The increase means that about 14% of all investor-state claims now concern taxation. Since 2016, at least five tax-related claims have been initiated under Bilateral Investment Treaties entered into by the UK.