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GILES GOODFELLOW, barrister at Pump Court Tax Chambers, discusses the House of Lords decision in the Morgan Grenfell case.
GILES GOODFELLOW, barrister at Pump Court Tax Chambers, discusses the House of Lords decision in the Morgan Grenfell case.
'THE FOUNDATION OF this rule [prohibiting the disclosure of confidential discussions] is not difficult to discover. It is not … on account of any particular importance which the law attributes to the business of legal professors or any particular disposition to afford them protection. But it is out of regard to the interests of justice which cannot be upholden and to the administration of justice which cannot go on without the aid of men skilled in jurisprudence … If the privilege did not exist at all every one would be thrown upon his own legal resources; deprived of all professional assistance, a man would not venture to consult any skilful person, or would only dare to tell his counsellor half his case ..'
This was the justification for legal professional privilege given by Lord Brougham Lord Chancellor almost 170 years ago in Greenough v Gaskell. The overriding public interest in the promotion of candour between lawyer and client by ensuring the absolute confidentiality of those communications was endorsed recently by the House of Lords in R v Derby Magistrates ex parte B [1996] 1 AC 487.
In Regina (on the application of Morgan Grenfell) v A Special Commissioner [2002] STC 786 three important issues fell to be decided:
n Whether there was a common law right to rely upon the legal professional privilege status of a document as implied exception to an otherwise authorised request for relevant information which was made outside judicial or quasi judicial proceedings.
n If there were such a right at common law, had Parliament, when giving the Revenue its standard information gathering power under section 20, Taxes Management Act 1970 intended substantially to abrogate that right in relation to legal professional privilege material in the possession or power of the taxpayer?
n If Parliament had indeed intended to restrict the taxpayer's right to keep confidential legal professional privilege material, was the nature of the provision compatible with the taxpayer's rights under Article 8 of the Convention for the Protection of Human Rights and Fundamental Freedoms?
The decision is one of fundamental importance to taxpayers and their advisers, since if the Inland Revenue's contentions had been upheld, legal professional privilege material would have been immune from disclosure only where expressly preserved. These express preservations were so limited and so easily circumvented, that in practice no taxpayer could be confident that what he told his lawyer would remain confidential.
The facts
Morgan Grenfell carried on trade as a merchant bank. As a means of providing finance in a tax efficient manner to one of its clients, the Tesco group, it acquired for premiums long headleases of supermarkets from the property holding company within the group. The headleases of supermarkets were subject to underleases in favour of a trading company within the group. The trading company continued to occupy the supermarkets for the purposes of its trade. Rack rents were reserved under the underleases.
The rents under the headleases were nominal for the first five years, unless the rents under the underleases increased - in which case there was a corresponding increase in the rents payable under the headleases. After five years, rack rents were payable under the headleases.
The amounts of the premiums payable under the headleases were equal to the discounted value of the rents payable under the underleases for the first five years. The discount rate was equivalent to the standard interest rate, which Morgan Grenfell would have charged for an amortising commercial loan. At the end of each accounting period, it was obliged, as a matter of correct commercial accounting, to write down the book value of the headleases by the amount by which those assets had declined in value.
Before entering the transaction, Morgan Grenfell took the view that headleases would be current assets of its banking trade. It obtained advice from counsel on whether it would be entitled to claim the write down as an expense in its Schedule D, Case I computation. If it could, the tax treatment of the transaction in Morgan Grenfell's hands would not be materially different from that of a normal amortising loan and would be in line with the commercial accounting treatment of the transaction.
By contrast, in the hands of the property holding company, the premiums would be capital receipts. Due to indexation or the availability of allowable losses, the part disposals of the supermarkets in return for the gains would not give rise to any or any appreciable corporation tax liability. The trading company would be able to claim a deduction for the rent paid under the underleases of supermarkets it was using for its trade. In broad economic terms, the Tesco group would have obtained a tax deduction for the full cost of repaying the monies the property holding company had raised by granting the headleases. If the trading company had taken out a normal loan, it would not have been able to obtain a tax deduction for the cost of repaying the principal of the loan.
Procedural background
In about 1997, the Inland Revenue Special Compliance Office launched an investigation into the tax treatment of these transactions. The Revenue wanted to satisfy itself that the headleases were not capital assets of Morgan Grenfell's trade. The bank co-operated fully with this investigation, complying with all of the Revenue's requests for voluminous amounts of information. It became clear that the Revenue wanted to see documentary records of communications between Morgan Grenfell and its legal advisers. On principle, Morgan Grenfell objected to a request for disclosure of material which it had been advised was covered by legal professional privilege.
The Revenue claimed to be entitled to obtain the material from Morgan Grenfell pursuant to a section 20(1) notice. Following the service of the precursor notice under section 20B(1), Morgan Grenfell sent directly to the Special Commissioners written representations (including a written opinion from leading and junior counsel) why section 20(1) could not require the disclosure of legal professional privilege material. It also requested an opportunity to attend any hearing before the Special Commissioner at which an Inspector sought consent to the issue of a section 20(1) notice.
Preliminary decision
The Special Commissioner dealt with these two issues by means of a preliminary decision. He decided that:
n the legal professional privilege status of documents was no bar to those documents being obtained under a section 20(1) notice;
n a Special or General Commissioner from whom an Inspector sought consent to the issue of a section 20(1) notice had no jurisdiction to permit the recipient of the notice to attend the hearing even if it could be considered that such attendance would be helpful to the decision whether consent should be given.
Although the preliminary decision was published and attracted widespread comment, until such time as the Inspector applied for consent and did issue a notice under section 20(1), there was no decision under the section 20 code which Morgan Grenfell could challenge.
Consent hearing
Eventually, after six months, the Inspector applied for consent. Following the ex parte hearing in September 1999, the same Special Commissioner gave his consent to the issue of the notice without giving any reasons. From the summary of reasons (which the Inspector was obliged to provide under section 20(8E) following the issue of the notice), it appeared that at the consent hearing, the Inspector had justified the notice seeking the disclosure of legal professional privilege material on the grounds that, in the course of their confidential communications, Morgan Grenfell's executives and their lawyers might have revealed whether they truly perceived the headleases to be current assets of the trade and evidence of such perception might be relevant to the underlying tax treatment.
At the hearing, the Inspector had also relied on material not previously raised with Morgan Grenfell for its comments, including material relating to a completely different transaction that was never implemented.
Judicial review
Morgan Grenfell launched judicial review proceedings challenging:
n the power to require disclosure of legal professional privilege material under section 20(1);
n the reasonableness of the Inspector's view that such material was potentially relevant to the underlying tax treatment;
n the Special Commissioner's consent to the issue of the notice which he could not give unless he was satisfied that in 'all the circumstances the Inspector was justified in proceeding under [section 20]';
n the correctness of the Special Commissioner's decision that he had no jurisdiction to allow the attendance of the recipient of the notice at the consent hearing.
Ambit of section 20(1)
Section 20(1) authorises an Inspector to require a person to deliver to him:
'… such documents as are in the person's possession or power and as (in the Inspector's reasonable opinion) contain, or may contain, information relevant to -
'(i) any tax liability to which the person is or may be subject, or
'(ii) the amount of such liability, …'
The general meaning of the words used was wide enough to authorise the disclosure of legal professional privilege material. The only express limit on the documents that could be required was based on the reasonableness of the Inspector's opinion of the relevance or potential relevance of information contained in such document rather than the type of document or information sought. There was no express saving for legal professional privilege material in the possession or power of the taxpayer.
1976 mini-code
The section 20(1) power had been enacted along with other information gathering provisions by Schedule 6 to the Finance Act 1976. These core provisions remained materially unchanged at the time of the issue of the section 20(1) notice in September 1999. It was at least arguable to describe these Schedule 6 provisions as constituting 'a mini-code' which provided some form of legitimate guide to Parliament's intention in enacting section 20(1). The relevant parts of this mini-code were:
n Section 20(3) which contains an equivalent power by which the Inspector can by notice require the disclosure by certain persons of documents potentially relevant to the tax liabilities of another person (the so called 'third party notice').
n Section 20B(2) provided that notices under section 20(1) or 20(3) did not oblige the recipient of the notices to deliver documents relating to the conduct of any pending appeal by the taxpayer.
n Section 20B(8) provided that a third party notice under section 20(3) did not '... oblige a barrister, advocate or a solicitor to deliver or make available, without his client's consent, any document with respect to which a claim to professional privilege could be maintained …'.
n Section 20C(1) gave a circuit judge power, if he was satisfied that there were reasonable grounds for suspecting any form of fraud in connection with tax had been or was about to be committed, to issue a warrant authorising Revenue officers to enter and search premises.
n Section 20C(3) authorised the removal of any items found there which the Revenue officer had reasonable cause to believe might be required as evidence in relation to such offence subject to the proviso that the section did not '… authorise the seizure and removal of documents in the possession of a barrister, advocate or solicitor with respect to which a claim to professional privilege could be maintained …'.
n Where a 'tax accountant' (which was widely defined so as to be capable of including a lawyer who assisted in the preparation of a tax return) had been convicted of an offence in relation to tax or made subject to a section 99 penalty, section 20A permitted an Inspector by notice to require disclosure of a document which in the Inspector's reasonable opinion might be relevant to the tax liability of any client of that tax accountant. The saving in section 20B(8) also applied to such a notice.
Coherent code or tangled web?
Anyone who has had the misfortune to grapple with the Revenue's investigation powers under sections 20 to 20D, Taxes Management Act 1970 will appreciate that they are now a series of loosely connected provisions of prima facie wide and overlapping ambit. These provisions are made subject to a variety of saving provisions that lack any clear coherent theme. The current state of the legislation is the result of series of amendments and additions made by various Finance Acts since 1976.
The piecemeal nature of these changes makes it more difficult than ever to ascertain the purpose of Parliament. But, unless one clearly identifies what provisions were being enacted at any particular time, a later amendment could easily found a misleading inference concerning the intended ambit of the provision that Parliament was originally enacting.
Two examples will suffice. Finance Act 1989 introduced express exceptions from section 20(1) and third party notices for a taxpayer's personal records and for journalistic material; see section 20(8C). Secondly, the Finance Act 2000 amended section 20C so as to contain an express exclusion from the search and seizure powers for legal professional privilege material irrespective of the person by whom the material was held.
If such express savings both in relation to other categories of confidential material covered by a section 20(1) notice and in relation to legal professional privilege material liable to be seized under a section 20C warrant had been enacted at the same time as and as part of a single code along with the section 20(1) power (which contained no such express saving in relation to legal professional privilege material in the possession or power of the taxpayer), the inference that Parliament intended to preserve legal professional privilege only to the extent specified in the statutory provisions would have been infinitely stronger.
Common ground
The following matters were common ground before all the courts:
n Legal professional privilege was a fundamental right at common law.
n As a matter of parliamentary sovereignty, Parliament could abrogate or limit that right by statute.
n However, such an abrogation or limitation was not to be deduced from the use of ambiguous or general words in the statute. If fundamental rights were to be overridden, the legislation had to do so either expressly or by necessary implication. A 'necessary implication' was one which was 'truly compelling'.
This important common law principle of reading down the prima meaning of statutory provisions so as to be consistent with fundamental rights could be traced back to decisions of the courts in the 16th century (see Stradling v Morgan (1560) 1 Pl 199). However, the principle had been given both new life and a new name (the so called 'principle of legality') by the speeches of Lord Steyn and Lord Hoffmann in R v Home Secretary ex parte Simms [2000] 2 AC 115 at page 131. As Lord Hoffmann recognised in Simms, the principle applied to read down general words, even in the absence of an ambiguity, because there was a danger that the full impact of general words on fundamental rights could be overlooked in the rough and tumble of the legislative process. The consequences of the provision must be sufficiently clear that the proponent of the Bill has to face the political cost of legislating contrary to fundamental rights.
n Although the section 20 notice had been issued before the coming into force of the Human Rights Act 1998, the courts should determine the validity of the notice on the basis that the Human Rights Act applied. In other words, the courts were under a duty to construe the United Kingdom legislation in a manner consistent with convention rights if at all possible. If such a construction were not possible and a convention right would be abrogated, the courts could make a declaration of incompatibility.
This was a sensible concession by the Revenue, because if it had taken penalty proceedings to enforce the notice, Morgan Grenfell would have been entitled to rely upon the provisions of the Human Rights Act, the difference being that the proceedings would be instituted by a state organisation; see section 22(4), Human Rights Act.
Lower courts
One would have thought that both the nature of fundamental right involved and the principle of legality gave Morgan Grenfell more than a head start in winning both the sympathy and support of the courts. It did not have to establish an implied exception for legal professional privilege. The Revenue had to show a truly compelling implication that legal professional privilege had been overridden.
Nevertheless, both the Divisional Court and the Court of Appeal unanimously held that there was a necessary implication that Parliament had intended to protect legal professional privilege material in the hands of the lawyer and not the client. The common theme to the reasoning of both courts was that the express protection for such material in the hands of the lawyer by section 20B(8), was inconsistent with Parliament taking the view that there was a residual right at common law to withhold documents on the grounds of privilege. If there had been such a right, the express saving would have been unnecessary. In a surprising application of the principle of legality, the Court of Appeal explained the failure by the draftsman expressly to override legal professional privilege in all other circumstances as based in a wish to avoid parliamentary trouble. One would have thought it was precisely this type of erosion of fundamental rights by parliamentary sleight of hand that the principle of legality was designed to prevent.
House of Lords
Not all aspects of the decisions in the Lower Courts were appealed by Morgan Grenfell. The only issues were whether there was implied abrogation of the right to withhold legal professional privilege and, if so, whether that abrogation was compatible with Article 8 of the Convention. After a two day hearing, the House of Lords unanimously allowed Morgan Grenfell's appeal. There was no necessary implication that the fundamental right to lawyer-client confidentiality had been overridden. The leading speech was delivered by Lord Hoffmann with whom all the other Law Lords agreed. Lord Hobhouse delivered a concurring speech, with which Lord Hope also agreed.
The House of Lords took an altogether more rigorous approach in limiting the statutory material to which the Court should have regard in deciding whether an override of legal professional privilege was necessarily implied. The validity of the notice depended on the ambit of section 20(1) which had been enacted in 1976. No suggestion had been made that the meaning of the words had been changed by later amendments. Accordingly, regard should be paid only to the other provisions enacted at the same time in ascertaining the meaning of section 20(1).
Lord Hoffmann rejected the Revenue's reliance upon the legislative scheme of the information provisions. It was argued that the more invasive the power, the more stringent the substantive and procedural safeguards. Consequently, the ambit of a particular power was part of the carefully crafted legislative scheme for dealing with tax avoidance. But the House of Lords considered that these provisions did not expressly mention legal professional privilege, and were no more than the normal statutory safeguards which are imposed to prevent any executive power being abused.
Similarly, section 20B(2) shed no light on the protection given to legal professional privilege because it was concerned with protecting information covered by litigation privilege. This was a separate type of privileged communication enjoyed by any party to proceedings which was not limited to documents relating to the obtaining of legal advice, e.g. communications made by the taxpayer who was conducting his own appeal could qualify for litigation privilege.
Lord Hoffmann acknowledged the force of the Revenue's argument based on section 20B(8), but rejected it for the following reasons. First, there was no rational purpose behind the preservation of legal professional privilege material in the possession or power of the lawyer and not the client. If the Revenue's argument was correct, the disclosure of relevant information contained in legal professional privilege material held by the lawyer alone would depend upon happenstance: did the client have a contractual right to call for that type of document from his lawyer, or was the lawyer entitled to exercise a lien over that material for unpaid fees? Secondly, the purpose of section 20B(8) was not to resolve a conflict of interest for the lawyer between his duty to his client and his duty to obey a notice requiring disclosure. Such conflict could just as easily have been resolved by making no exception for legal professional privilege material held by lawyers. Thirdly, the language of section 20B(8) pointed against the client being unable to assert the privilege in relation to documents in his own possession or power. Why make the disclosure of legal professional privilege held by the lawyer subject to the consent of the client, if the client had no equivalent right in relation to legal professional privilege material in his own possession or power?
Purpose of section 20B(8)
Lord Hoffmann accepted Morgan Grenfell's explanation that its purpose was to resolve any doubt in the mind of the lawyer that it was still his duty not to disclose legal professional privilege material without his client's consent. In 1976, there was remarkably little English authority on the extent to which legal professional privilege material should be immune from disclosure outside judicial or quasi-judicial proceedings.
The decision of the Court of Appeal in Parry-Jones v Law Society [1969] 1 Ch 1 suggested that outside judicial or quasi-judicial proceedings, a lawyer's duty to withhold legal professional privilege material depended solely upon an implied contractual duty of confidence. Such a duty would not be implied in the face of a duly authorised order to disclose. Lord Hoffmann considered that while the result reached by the Court of Appeal might be correct, the reasoning was too broadly expressed. He agreed with the New Zealand Court of Appeal decision Commissioner of Inland Revenue v West-Walker [1954] NZLR 191 that the public policy behind the protection of legal professional privilege (promotion of candour through absolute confidentiality) required the same degree of protection to be given to the client's confidences outside judicial or quasi-judicial proceedings. Similarly, Lord Hoffmann considered that the reasoning of the Court of Appeal in R v Commissioners of Inland Revenue ex parte Taylor (No 2) [1990] STC 379 was too broad, although the result was again justifiable.
Lord Hoffmann was able to uphold the results in both Parry-Jones and Taylor (No 2) because he considered that privilege of the client had not been infringed or only to a minimal extent. Both cases concerned orders served on a lawyer to disclose documents held by the lawyer which might be relevant for the purpose of investigating the lawyer's own affairs (in Parry-Jones' case, his professional conduct, in Taylor's, his tax affairs). Such documents might contain material covered by legal professional privilege. It was conceded that the investigating body could not use the document for any other purpose, e.g. investigating the client. In those circumstances, Lord Hoffmann considered that the privilege of the client would not have been infringed.
Consequences
The first question is whether the Revenue will seek to reverse the decision by legislation. Such a reaction would no doubt be characterised as unsporting, but also as unlikely and unnecessary. The House of Lords acknowledged that the case law of the European Court showed that legal professional privilege was a fundamental human right which was to be overridden only in exceptional circumstances. The House of Lords doubted that the collection of taxes could provide the necessary justification for interfering with such a fundamental right. In particular, the numerous anti-avoidance provisions which depend upon a taxpayer's subjective purpose would still be operable. The tax tribunal and the courts could draw the necessary inferences concerning the purpose behind a transaction without needing access to a taxpayer's confidential communications with his lawyers.
If the Revenue's construction of section 20(1) had been accepted, legal professional privilege would have been abrogated in most circumstances. While the collection of taxes may be a legitimate aim, justifying some inroad into the confidentiality of a citizen's affairs, it is doubtful whether an across the board abrogation of such an important right as legal professional privilege would be a proportionate response to that legitimate aim. In light of these comments, a future Treasury minister will have difficulty certifying that an amendment is Convention compliant, unless it is much more sharply focused upon particular circumstances where the proper operation of the tax system is dependent upon the disclosure of legal professional privilege material.
One has to wonder whether such an amendment would really be necessary. First, the Revenue has foresworn access to legal professional privilege material when dealing with serious tax offences. Why does it need access to such information when dealing with the standard taxpayer? Secondly, the advantage of securing additional information needs to be balanced against the disadvantage of lawyers giving advice to certain clients on the basis of half the information. If legal professional privilege were overridden, would clients be as forthcoming with their advisers? If they were not, would the Revenue have the resources to pick up the erroneous tax returns filed in accordance with the advice of lawyers acting in ignorance of the full facts?
The second question is what to do about legal professional privilege material already disclosed to the Revenue pursuant to a section 20(1) notice. Such a notice would be ultra vires section 20(1). Unless it could be said that the client had impliedly waived his privilege by surrendering the material, the client would appear to have good grounds for seeking recovery of the material and preventing the Revenue from relying upon such material in any pending tax proceedings. However, the client must take action before the material is tendered in evidence. Once the material has been tendered in evidence, most of the remedies, which are based in the law of confidence, are lost.
Future conduct
Looking to the future, three points should be made: first, lawyers will still not be able to hide behind their client's privilege to prevent enquiries into their own tax affairs. However, they (or, more likely, their clients) will be able to insist that proper steps are taken to ensure that neither the document covered by legal professional privilege, nor the knowledge of the information contained in the document, can be used for any other purpose.
Secondly, when information is being obtained for the purpose of giving a client legal advice on his tax affairs, much more care will have to be taken to ensure that the communications satisfy the common law requirements necessary to qualify as legal professional privilege communications. More of the information gathering process will have to be conducted at the direction and under the supervision of lawyers if those communications are to be privileged.
Thirdly, the House of Lords decision highlights the disparity of treatment between the confidentiality conferred on advice given by firms of lawyers compared with that given by chartered or certified accountants or chartered tax advisers. For the most part, legal professional privilege does not attach at common law to communications between a taxpayer and his tax accountant for the purposes of advising him on the legal effect of actual or contemplated transactions.
This seems to be an anomalous position: the subject matter of the advice is the client's legal rights and obligations. The same public policy argument in favour of promoting candour would seem to apply, particularly since the client is responsible for assessing his own tax liability in an area of undoubted complexity. Both professional accountants and chartered tax advisers are bound by professional ethics and rules of conduct in their dealing with the Revenue.
But because no legal professional privilege attaches to such communications, it will be difficult to read down the scope of a section 20(1) notice on the grounds that it would otherwise invade a fundamental common law right. However, Article 8 may provide some assistance: the compulsory disclosure of bona fide communications between client and tax adviser would be a prima facie breach of the client's right to confidentiality under Article 8.1. Such interference would have to be justified on the grounds that it was in pursuit of a legitimate aim and that it was proportionate to the aim sought to be achieved. Given the need for professional advice, and the role played by professional accountants in advising upon legal questions in the tax field, the absence of any protection for such communications might well be found to be disproportionate.
