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Key points * Magna Carta's 'rule of law' principle and modern human rights. * Discretionary application of 'tax advantage' loss provisions. * Why are partnerships other than film partnerships not targeted for associated companies? * 'HMRC think' in Schedule 24.
'DOES MAGNA CARTA mean nothing to you? Did she die in vain? Brave Hungarian peasant girl who forced King John to sign the pledge at Runnymede and close the boozers at half past ten — is all this to be forgotten?' Since the time of Tony Hancock in Twelve Angry Men much has changed. The licensing laws now allow the boozers to be open all night long in some places, and there are worrying signs that the principles of Magna Carta may be being ignored in the drafting of tax law too.
Article 39 of Magna Carta states that:
'No Freeman shall be taken or imprisoned, or be disseised [dispossessed] of his Freehold, or Liberties, or free Customs, or be outlawed, or exiled, or any other wise destroyed; nor will We not pass upon him, nor deal with him but by lawful judgment of his Peers, or by the Law of the Land'.
It is one of the few articles which still has legal force today, and it is meant to entrench the principle that the powers of the state are not to be exercised capriciously, but only on the basis of impartial laws which apply to all. A similar modern provision is Article 1 of the protocol to the European Charter of Human Rights, which starts:
'No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law.'
It goes on to say that this does not prevent states from 'enforcing such laws' as are necessary to levy taxes, but it does not allow for the arbitrary confiscation of assets.
King John II
Suppose some modern King John wanted to restore the right of the executive to grab whatever it wanted from people it disapproved of, but also wanted to stay within both Magna Carta and human rights law. Could he pass a law which said 'The tax due each year shall be 100% of the income of each taxpayer, such income to be determined by the king as he shall think fit' but then issue guidance that the actual tax collected would be a lot less except for those the king took exception to? Presumably not; the courts would surely conclude that such a law was a blatant attempt to circumvent human rights.
What, then, is the difference between that and a law which says that a loss which arises from arrangements where one of the main purposes is to secure a 'tax advantage' is not allowable, the drafting of which is accompanied by a raft of guidance explaining that in many situations HMRC do not intend to apply it (see 'Caught in the Crossfire' by Emma Chamberlain in last week's issue, Taxation, 19 April 2007, page 428)? The most obvious example she cites, to me anyway, is Example 6 from the HMRC guidance, where an individual sells shares in order to generate a loss that can be offset against another gain, and then repurchases them 31 days later. This, HMRC say, will not be attacked under the new legislation, although it would be if the taxpayer had some arrangement to avoid being subject to the commercial risk of the shares going up in value over the 31 days before repurchase.
As Emma rightly pointed out, what has that got to do with the legislation as drafted? It is clear from the wording of the example that the only reason for selling the shares is to generate the loss. What HMRC are really saying is that they will only enforce the legislation in cases where they think the taxpayer is doing something they don't like. So the legislation is drafted very widely, and then applied only when HMRC want to apply it. What is that but taxation by executive fiat?
Why Wick?
Take another set of provisions — those relating to associated companies and the effect of them on the small company rate thresholds. TA 1988, s 13 requires the thresholds to be divided by the number of associated companies, using s 416 definitions of control. This in turn effectively includes companies controlled by connected persons as defined by s 417, a definition which includes business partners.
Late last year letters started to be sent out from Wick asking the partners in film partnerships to give details of the companies they controlled. HMRC then proposed to tell the individual partners the number of companies with which they were associated through the film partnership.
Now there is a certain schadenfreude involved in watching those who had created some of the more esoteric versions of film schemes, which depended on careful reading of the legislation, being called to account by a similarly literal interpretation. But if the law requires the companies controlled by partners to be taken into account in arriving at the small company thresholds, it should apply in the case of all partnerships. We therefore asked HMRC some time ago whether they had applied a similar approach to partnerships of accountants and solicitors, and were told that they had 'no plans' to do so. We asked why they had no such plans, but at the time of writing we had received no reply. If we receive one, we will publish it.
HMRC thinks
Finally we come to Schedule 24 in the latest Finance Bill. It is the schedule which will impose the new penalty regime, not just for direct taxes but for VAT and NIC as well. The maximum penalty rises from 30% for a 'careless inaccuracy' to 70% for a 'deliberate but not concealed' inaccuracy and to 100% for a 'deliberate and concealed' inaccuracy.
However, many other tests in the schedule are not given in objective language at all. Paragraph 3(2), for example, says that if 'HMRC thinks' that an error (which was not careless at the time it was made) was later discovered by the taxpayer, who does not then take reasonable steps to inform HMRC about it, that will be treated as a careless error. Paragraph 10 is all about reductions for disclosure, and every subparagraph starts with the phrase 'If HMRC thinks' that a particular disclosure has been made.
The Explanatory Notes claim that this is just modern drafting practice, and that 'to think that something is the case requires a best judgment'. The amount of the penalty is also subject to appeal, with the tribunal being able to confirm or dismiss the penalty — although in some cases, such as the decision not to suspend a penalty, only if they believe that HMRC's decision is 'flawed'.
But why is judgment the test at all? The test for paragraph 3(2), like all the others, can quite easily be recast in objective terms — if an innocent error is discovered by the taxpayer and he does not take reasonable steps to inform HMRC about it, it shall be treated as a careless error. I hope that the Finance Bill Committee takes the opportunity to do so.
