The Domino Effect

MALCOLM GUNN FTII, TEP reports a recent Court of Session decision concerning forward tax contracts with the Revenue.

WHEN I PRANGED my company car a while back, I have to admit that it was not a job done by halves. It involved a row of parked cars and the first in the line scored a direct hit. The second got shunted and so did a third, and possibly a fourth, although my memory is trying to blot out details of the exact number. I was surprised that I never got a commission cheque or holiday vouchers from the panel beaters. Equally surprising was that the company duly knocked all the dents out at its expense and still let me carry on driving.

It was a real life version of the domino effect, by which one upset at the head of a queue sets off a train of events leading to multiple collapse. A very recent decision of the Court of Session offers us another example of the domino effect. In fact, it is probably a little difficult to identify the first mishap in the chain of events, but the story gets under way with the Neil Hamilton libel case against Mr Al Fayed. At that court action, Mr Al Fayed apparently gave evidence to indicate that he had access to large sums of cash and had given presents of cash to employees. Heaven knows why, but this sent eyebrows up at the Inland Revenue, who as a result decided to revoke an agreement which it had reached with Mr Fayed. This brought about an application for judicial review of the Revenue's action which the Revenue defended in a manner designed not to cause upset to other similar types of agreement. Unfortunately, the Court of Session decided the case on a much wider basis and by now you will be asking whether the ripples go out even further to upset other deals which the Revenue may enter into in specific cases.

Forward contracts

In my article in Taxation, 17 May 2001 entitled (in view of impending electioneering) 'Vote SRM, Please', I detailed a little known practice of interest to non-domiciliaries with complex overseas financial affairs. The practice was unpublished, and from certain remarks made in the evidence given to the Court of Session, it seems that it was also little known within the Inland Revenue. It was largely operated by the Revenue's Special Compliance Office. When it opened detailed investigations into the affairs of wealthy non-domiciliaries, this often resulted in much obfuscation and general time-consuming hassle that both the Revenue and the taxpayer were happy to enter into a deal to cover future tax liabilities. Part of the evidence included the following extract from an Inland Revenue internal memorandum:

The memorandum went on to state that these contracts were considered to be to the advantage of the Exchequer because they produced tax payments which might otherwise be avoided entirely by operation of the remittance basis rules and also because it avoided extensive work within the Inland Revenue.

I first became aware of the existence of such contracts about two or three years ago, and assumed at the time that I was simply learning about something which was commonly known about, at least by those whose area of tax work centres on non-domiciliaries. It later transpired that the gap here in my education was likewise to be found in many others' as well.

Different varieties

Like all creatures on planet earth, there are many different types of what is basically the same animal. It seems that the forward contract under examination in this case was very much a horse trade with the Revenue and the original agreement was entered into without detailed disclosure of all overseas assets. Other agreements, as discussed in my article of 17 May 2001, have been entered into on the basis of full disclosure of worldwide assets and income with a much more detailed analysis of prospective remittances and prospective tax liabilities. I have noted with interest the discussion of the latter variety by James Kessler in his book 'Taxation of Foreign Domiciliaries' (Key Haven) with a final comment that 'it is likely that publication [of the existence of these contracts] will stop the practice completely. Those who believe that tax should be governed by law will add: quite right too'. As we shall see in a moment, that comment was more prophetic than its author probably realised at the time.

The contract with Mr Al Fayed

The particular contract considered by the Court of Session is set out in detail in its judgment. It covered investment and employment income assessable on the remittance basis and also capital gains from the disposal of foreign assets, subject to a limitation on the latter that the proceeds do not exceed £15 million. The contract also closed off the possibility of the Revenue raising a shadow director charge on the use of company properties under sections 145 and 146, Taxes Act 1988, unless and until a case on that topic went in favour of the Inland Revenue in another similar case. That eventuality has in fact now occurred, as readers will be well aware. The contract contained a clause permitting the Revenue to terminate it if the annual payment (£240,000) due under its terms went unpaid for more than six months from a stated due date, but apart from that it was only to terminate on the death of the taxpayer or his departure from the United Kingdom. During the term of the contract, it was agreed that the taxpayer was to be treated as resident but not domiciled in the United Kingdom for all tax purposes.

Earlier events

Pausing here for a moment, it is relevant to note that there was an earlier line of dominoes which collapsed after Mr Al Fayed gave evidence to the Department of Trade inquiry into the House of Fraser takeover. Following that evidence, the Revenue tore up a previous forward contract and a huge back duty investigation was opened. Giving evidence which is unhelpful to one's tax returns is a habit best avoided.

The investigation was settled by a lump sum payment of about £31 million and after that the above mentioned forward contract was entered into. One cannot help noticing the slight disparity between £31 million and £240,000, which has already brought forth caustic remarks from one barrister who rang me to express trenchant views about those in the Revenue who apparently thought they were operating sensibly.

In the Court of Session

For Mr Al Fayed, it was argued that the Revenue had full powers under its 'care and management' provisions to enter into a forward contract with a taxpayer. The contract in the present case was therefore valid and the decision to revoke it was therefore made in breach of contract, was an abuse of power and was made for an improper purpose, and was one which no reasonable authority should have made. For good measure, a human rights point was also thrown in.

The Revenue's argument was not that it had no power to enter into contracts of this type, but that this specific agreement was ultra vires because it was entered into on the basis of inadequate information and it lacked proper provisions for review or termination on the occurrence of a material change of circumstance. Clearly the Revenue's argument was carefully pitched so as not to spread too many ripples out in the direction of the other forward contracts which it had concluded.

The judgment

The Court of Session was clearly unimpressed with the existence of these deals with non-domiciliaries. It took the view that they are entered into 'on the threat that the other party may avoid any liability to pay United Kingdom tax at all' and so the Revenue steps outside the law completely and does a deal by which it at least gets some tax. This could 'fairly be described' as a premium paid to avoid the process of assessment and to have the opportunity to receive unmonitored foreign remittances in the United Kingdom. The Revenue is not 'in a commercial marketplace operating an extra-statutory system of levying money' and the contract allowed the taxpayers to become 'a privileged group who are not so much taxed by law as untaxed by concession'. These scathing criticisms almost leave us wondering how anybody ever thought they could get away with setting such things up in the first place. Evidently, times have changed since some twenty-five years ago when leading tax counsel at Pump Court Tax Chambers advised that the Revenue would be bound by a forward contract, once it had entered into it.

Despite the carefully pitched argument by counsel for the Revenue, the Court of Session refused to limit its conclusions on the same basis. The finding was:

The Court of Session was also critical of the absence of any mechanism for a review of the agreement, or the termination of it, if there should be a material change of circumstances. For example, the taxpayer's increasing involvement in businesses in this country coupled with his repeated applications for United Kingdom citizenship offered 'the possibility' that he may acquire a domicile of choice in the United Kingdom during the term of the agreement. Suddenly, the taxpayer's domicile status is beginning to look like another line of wobbly dominoes.

The Human Rights Act 1998

The taxpayers had a small measure of success with an argument based on breach of Human Rights; the Court agreed that their rights under the agreement with the Revenue were a possession within the meaning of the Human Rights Act and that the revocation of the agreement deprived them of their possession. Unfortunately this availed them nothing because, if there were a breach of the Human Rights Act, it occurred before it came into force.

Other Revenue deals

Fortunately, one important line of dominoes still stands firm, despite this progressive collapse. Contract settlements with the Revenue are a common feature of tax practice and one might begin to fear that this robust decision of the Court of Session might start making inroads in this area. However, this is not the case. We do of course have the authority of the House of Lords itself in Regina v Commissioners of Inland Revenue ex parte National Federation of Self Employed [1981] STC 260 to the effect that the Revenue can enter into special arrangements under its care and management provisions. It does not have to extract the last penny of tax from everybody. The Court will only interfere where discretion has been exercised unreasonably or illegally. It is up to the Revenue to make a judgment as to how it should best use its resources in collecting tax known to be due and this includes entering into settlements which involve an element of compromise on the part of both the taxpayer and the Revenue. Settlements of past liabilities by this method remain within the Revenue's powers.

Where next?

This application for judicial review will probably be the last we shall hear about forward contracts with the Revenue. One imagines that the costs of an appeal by the applicants to the House of Lords would not be a worry, but the chances of success look very slim indeed. The courts have never liked the Revenue operating on an extra-statutory basis and the circumstances here offer no moral encouragement for their Lordships to go against their natural inclinations. Even if the applicants were to succeed, my guess is that the most they would achieve would be a continuation of their 1997 agreement until its expiry date in 2003. There seems little hope that the Revenue would enter into further fixed sum agreements.

It is perhaps not absolutely certain yet that all the dominoes in this little corner of tax have been completed flattened. Some of the earliest types of forward contracts operated by the taxpayer making full declaration of all remittances to the United Kingdom and bearing tax on them at a sort of composite rate, commonly one half the basic rate. This was on the basis that the remittances were a blend of taxable and non-taxable elements. The main criticisms made by the Court of Session were directed at the fixed payments due under the agreement, making it a sort of insurance policy against the Revenue making intrusive enquiries. There could perhaps have been the slimmest of chances that the Revenue might have continued the alternative type of forward contract involving a sort of composite rate. However, all such matters will now be swept up in the forthcoming wholesale review of the remittance basis. I believe that this marks the end of the road for extra-statutory deals.

As forward contracts have been held to be ultra vires, it remains to be seen if the others too will now collapse. Initial indications are that the Revenue does not intend to withdraw them, but on the authority of the Court of Session they are unenforceable and offer no protection. Indeed, the past could be re-opened back six years.

There would then be quite a number of aggrieved non-domiciliaries following this decision. But at least Neil Hamilton must now be a slightly happier man.

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