HMRC: STRENGTHENING THE TAX AVOIDANCE DISCLOSURE REGIMES FOR INDIRECT TAXES AND INHERITANCE TAX The Law Society's response July 2016

HMRC: STRENGTHENING THE TAX AVOIDANCE DISCLOSURE REGIMES FOR INDIRECT TAXES AND INHERITANCE TAX The Law Society's response July 2016 2016 The Law Society. All rights reserved. 1

1. The Law Society is the professional body for solicitors in England and Wales, representing over 160,000 registered legal practitioners ("the Society"). The Society represents the profession to parliament, government and regulatory bodies and has a public interest in the reform of the law. This response has been prepared by the Society s tax committee who are formed of practitioners with relevant expertise and experience in this field. 2. The Law Society welcomes the opportunity to respond to the Consultation Document published on 20 April 2016 by HMRC: 'Strengthening the Tax Avoidance Disclosure Regimes for Indirect Taxes and Inheritance Tax'. 3. VADR disclosure of avoidance schemes - Background 3.1. As an opening remark, in our response to the July 2014 consultation Strengthening the Tax Avoidance Disclosure Regimes, the Law Society suggested that as a precursor to any reform of VADR, HMRC should set out the basis upon which any revisions were considered to comply with EU law. Putting intervening events concerning the application of EU law to one side, the Law Society still considers that this is an area that has not yet been properly addressed, and we would welcome an opportunity to understand HMRC s position in this area. 3.2. Without repeating in full our responses to the July 2014 consultation, our principal concern remains that the VADR regime must comply with (now) Article 273 of the Principal VAT Directive, which we understand is the provision under which HM Customs & Excise (as it then was) considered it had vires to introduce VADR. 3.3. Under this Article, Member States may only impose obligations which they deem necessary to ensure the proper collection of VAT and to prevent evasion. In the case of Léa Jorion, née Jeunehomme, and Société anonyme d'étude et de gestion immobilière 'EGI' v Belgian State (joined cases 123/87 and 330/87), Advocate- General Slynn noted that in relation to the predecessor provision to Article 273 The requirements laid down must not, however, go beyond what is reasonably necessary for the purposes of verification and fiscal control. If a Member State wishes in particular areas to go further then it must have recourse to Article 27of the Sixth Directive. Although that case related to the right to deduct, the comment applies generally in respect of what is now Article 273. 3.4. It is not clear, therefore, that the vires exists for VADR to encompass legitimate and lawful planning arrangements, and doubts were certainly raised at the time that VADR was introduced. Nor is it clear that a promoter based regime, as opposed to a user based regime, is permitted given that this would involve parties other than the taxable person involved in a relevant transaction, which we recall formed part of the original determination to structure VADR as a user discloses model unlike DOTAS. 3.5. The premise behind HMRC s suggested amendments to VADR is that the current regime has, at least in part, failed to keep pace with developments in VAT 2

planning. It would be helpful to understand what empirical evidence HMRC has that this is the case, as opposed to there being a lower incidence of VAT avoidance through marketed arrangements than is the case in relation to direct taxes. 3.6. Subject to these general comments, we set out below our specific responses to the questions, which we would be happy to discuss with HMRC. 4. Questions on VADR. 4.1. Q1 Do you agree that reforming VADR in this way would provide a clearer and more timely picture of the nature and extent of avoidance? We are not clear that the evidence suggests reforms to VADR in the manner proposed by HMRC (assuming that it has the vires to introduce such reforms) would necessarily provide a clearer and more timely picture of VAT avoidance. 4.2. Q2 If you disagree, what suggestions do you have for reforming VADR so that it provides HMRC with a clear and timely picture of the nature and extent of avoidance? See our comments above. In particular, HMRC may wish to clarify whether the focus of VADR should be on marketed arrangements, or whether it also expects to receive disclosures of more bespoke arrangements, which would be a much more onerous obligation for both promoters and users. Some form of grandfathering should also be considered in respect of arrangements that are within the scope of old VADR and which users may already have disclosed, without potential future promoters being aware of such disclosure. 4.3. Q3 To what extent do you think the DOTAS rules on who is a promoter and 15circumstances when a scheme user has to disclose an avoidance scheme would be effective in a revised indirect tax disclosure regime? If there is a desire to move forward with the reforms, then having similar rules that apply both for the purposes of DOTAS and VADR would be superficially attractive, although we note that the same issues that arise under DOTAS in identifying a promoter would then apply equally in the VAT arena. 4.4. Q4 To what extent would the DOTAS benefit test be a clearer and more objective test for disclosure of indirect tax avoidance schemes? There have always been issues with a number of the listed schemes, given the breadth of the definitions used, and therefore movement away from this approach would be helpful. In addition, we can see that making use of the concept of a benefit would remove some of the subjective analysis that can otherwise be required. This comment, however, should be considered in light of the Law Society s other comments on the VADR proposals. 3

4.5. Q5 To what extent would removal of turnover thresholds ensure HMRC is more fully sighted on VAT avoidance? The Law Society suggests that the turnover thresholds should be maintained at their current levels until the effect of any changes to the VADR regime have had the opportunity to bed down. 4.6. Q6 To what extent should a revised indirect tax disclosure regime place reporting obligations on VAT non-taxable persons? Q7. How should users of VAT avoidance schemes who are not registered for VAT, and who receive a scheme reference number from the promoter, be required to notify HMRC when they use such schemes? We question whether non-taxable persons will be in a position to comply with the VADR rules, to the extent they do not otherwise have VAT obligations. To the extent notification was required by HMRC, it would be appropriate to create a form to allow notification to be made by non-taxable persons of the use of a disclosed arrangement in as straightforward a manner as possible. 4.7. Q8 Should the indirect tax disclosure regime adopt the DOTAS definition of tax advantage for VAT or should it retain the current definition, suitably adapted to cover non-taxable persons? The Law Society does not consider that the DOTAS definition of tax advantage would be appropriate for VAT purposes, given the very different nature of VAT. The current definition should therefore be retained, although there may be a need to recast the definition to take account of subsequent case law, for example suggesting that deferral of irrecoverable VAT is permissible in circumstances where no absolute saving is intended. 4.8. Q9 Do you believe that penalties for failure to comply with obligations under the indirect tax disclosure scheme should be the same as those applied under DOTAS? If not, please explain your reasons and explain what penalty structure would be more appropriate. If the decision is taken to remodel the VADR regime based on the DOTAS regime, we agree that the penalties should be similarly reformed. 4.9. Q10 Which DOTAS hallmarks do you believe are suitable for an indirect tax disclosure regime? Would these hallmarks require any modification to work effectively for VAT arrangements, and if so how should they be modified? Q11. Which of the current VADR hallmarks should be retained in a reformed regime? What further hallmarks or features of schemes should be added? The Law Society considers that the four hallmarks summarised in paragraph 2.32 of the consultation document would be appropriate in the context of any wider changes to VADR. We would, however, be concerned about the suggested VAT specific hallmark involving offshore transactions and connected persons there 4

are many normal commercial intra-group transactions that involve such factors, and it would be inappropriate to craft a hallmark that would need to be considered in every such circumstance. 4.10. Q12 Do you see any reason why gambling duties and IPT should not be brought within the scope of VADR, revised as proposed in this consultation? Q13 Do you agree that indirect taxes should be included within the scope of the proposed revised VADR? What further changes would be required to include these regimes? Q14. Which hallmarks do you believe are suitable for VAT and for IPT and gambling duties? Would these hallmarks require any modification to work effectively for arrangements in these taxes, and if so how should they be modified? Q15. Would these generic hallmarks also be suitable for other indirect taxes? If not, what changes do you believe would be needed to make them effective? Q16. What further hallmarks are required to ensure avoidance risks specific to these taxes are properly addressed? Q17. Do you agree that the DOTAS definition of tax advantage is appropriate for indirect taxes other than VAT? If so, does it need to be modified for any of the taxes? The Law Society does not consider that it is automatically the case that any remodelled VADR regime should apply to other indirect taxes, in the absence of evidence that the complexity of dealing with such a regime and the compliance burdens incurred as a result are justified by the level of avoidance of such taxes through the use of promoted schemes. It is not clear from the Con Doc whether this is the case, although there is some comment about HMRC having evidence of avoidance. We suggest that if HMRC wishes to move forward with introducing VADR like rules to other indirect taxes, a phased approach should be taken, with the focus being initially upon VAT, and then only upon those taxes where HMRC has specific evidence that avoidance is occurring through the use of promoted schemes that present material risks to the Exchequer. This will have the related benefit of enabling proposed changes (if implemented) to the VADR regime to bed down in respect of VAT, so that potential promoters and users of schemes concerning other indirect taxes will be able to learn from their experience in dealing with any future disclosure regime relating to those other taxes. 5. DOTAS & Inheritance Tax ('IHT') Background 5.1. The Law Society recognises that since 2014 the government wanted to extend the application of DOTAS more generally to IHT and, in particular, to extend the scope beyond the 2011 Regulations which apply simply to the relevant property trust 'entry charge'. The government is proposing a much wider IHT-specific hallmark and the Society appreciates that the Government has amended the July 2015 draft regulations to remove the most objectionable provision, which it has acknowledged made the rules far too wide. 5

5.2. The Society, however, continues to be concerned that the amended draft regulations are still too wide and uncertain. It should be recognised that DOTAS rules have already been extended from their original narrow scope to all types of IHT charges by extending the Confidentiality and Premium Fee hallmarks to the whole of IHT with effect from February this year. This has now brought IHT more generally within the DOTAS rules alongside the other main taxes such as income tax and capital gains tax. The need for, and scope of, a further IHT-specific hallmark should be carefully considered against this background. 5.3. The Condoc makes clear that the proposed strengthening of the DOTAS rules is aimed at tackling the "small minority" of taxpayers who "try to sidestep their liabilities through the use of tax avoidance schemes." We believe that, in their current form, the draft regulations will have a much wider impact and are not sufficiently targeted at the "small minority" of tax avoiders. They have the potential to place unreasonable and unnecessary burdens on the majority of compliant taxpayers by creating uncertainty as to whether a disclosure should be made. 5.4. The potentially wide scope of the hallmark arises from several aspects in the draft regulations which we consider further below. For example, the rules are not specifically related to tax avoidance but instead focus primarily on obtaining a tax advantage, which usually has very little to do with tax avoidance. The main thrust of the disclosure requirement then hinges simply on what might be considered to be "contrived or abnormal" arrangements/steps, with no other filters, grandfathering or meaningful exceptions to properly target the rules at the sort of arrangements that would provide the Government with useful information on IHT avoidance. 5.5. The Society is not aware that there is widespread avoidance of IHT and so, now that existing hallmarks have been extended to the whole of IHT, it is not clear why IHT has been singled out for a further disclosure rule that does not apply across the rest of the tax system. There is no equivalent requirement to disclose income tax or capital gains tax arrangements simply because they could be seen to be contrived or abnormal. This means the IHT disclosure rules could potentially be wider than they are for any other tax. We cannot see the rationale for that approach. 6. Comments on the technical detail of the current draft regulations 6.1. The Society is not convinced that such a generalised disclosure rule for all IHT planning is the right approach. In our view it would be more appropriate to identify and target particular areas of avoidance that are of concern. This would be more consistent with the other hallmarks which are much more prescribed. 6.2. It is difficult to understand the sort of areas that are of concern to HMRC and, in turn, it is far from clear what sort of arrangements would be notifiable. The one area that the consultation document mentions in several places is reservation of benefit and attempts to circumvent those provisions, (presumably only if the preowned assets tax does not apply as the reservation of benefit rules already have 6

their own targeted anti-avoidance rules?). If that is an area of particular concern, the disclosure rules should focus on that, rather than require disclosure of any IHT planning that may in some way be contrived or abnormal. 6.3. Other categories of notifiable IHT avoidance might include schemes to avoid all relevant property trust charges, not simply the entry charge; IHT avoidance using EBTs; purchases of excluded property trust interests etc. 6.4. It is unacceptable, in the Society's view, to introduce a very wide and uncertain rule backed up with non-binding guidance which only contains "high level" examples (para 4.13 of the consultation document). Many of the provided examples of the sort of arrangements that would not be caught by the rule are so simple that they do not offer any insight into what would need to be disclosed and may serve to suggest that anything slightly out of the ordinary could be categorised as avoidance for the purposes of DOTAS. 6.5. The guidance will offer little assistance and may create confusion and blurring of the lines if it states, as per the Condoc, that the rule is not intended to catch "nonabusive" arrangements. The DOTAS rules aim to uncover avoidance which is much wider than abuse (viz the GAAR with its double reasonableness test and other indicators/filters). In fact the draft hallmark is not explicitly aimed at avoidance but is predicated on obtaining a tax advantage which is wider still. Either way, it is not entirely clear what the true aim of the rule is in the context of IHT. In our view the regulations should be drafted in a way that makes them more closely aligned with abusive avoidance than merely obtaining a tax advantage in a contrived or abnormal way. There should be a higher bar for disclosure if it is only intended to uncover abusive avoidance. 6.6. Turning more specifically to the detail of the draft IHT hallmark, the informed observer test is consistent with some of the other DOTAS hallmarks but is a relatively new and untested concept that could be particularly difficult for individual taxpayers to interpret. It can be difficult enough for professional advisers to gauge what may be considered to be contrived or abnormal. Given that so much inheritance tax advice is given by lawyers who will be covered by legal professional privilege, the disclosure requirement will fall on scheme users and they may find it even harder to determine what an independent person with knowledge of tax legislation would regard as contrived or abnormal. 6.7. Condition 1 - as noted above, the rules start from the premise that a purpose of the arrangements is to enable a person to obtain a tax advantage. A tax advantage is defined extremely widely and has a particularly broad meaning in the context of IHT. Normal succession planning and a desire for individuals to provide for their families could have little to do with tax planning let alone tax avoidance but may nevertheless result in an IHT advantage. 6.8. It should also, perhaps, be appreciated that an IHT advantage gained by one person will often shift the IHT burden to someone else or to a trust where the assets will remain in scope for IHT. Most IHT planning does not place assets 7

outside the reach of tax completely or indefinitely. Equally, obtaining an IHT advantage may come at the price of other tax charges. 6.9. Condition 2 - the only real filter that turns a tax advantage into avoidance is that the arrangements are either themselves "contrived or abnormal" (condition 2(a)); or involve one or more contrived or abnormal steps without which a tax advantage could not be obtained (condition 2(b)). We think the words "without which a tax advantage could not be obtained" should be added to limb (a) and in both cases condition 2 should be limited to arrangements or steps that are contrived or abnormal in relation to the relevant tax provisions so that there is a clear link to planning that deliberately aims to sidestep the tax rules in question. 6.10. More fundamentally, the main problem with Condition 2, is that the words "contrived or abnormal" are very broad and uncertain terms in their own right and may have different meanings in different contexts. It is assumed that these terms have been taken from the GAAR where they also lack any definition. The GAAR guidance (which is all we have to assist in discerning the meaning) only contains three short paragraphs on the meaning of these words and it concludes that they "will be applied in their normal sense". But the word "contrived" can have different meanings: it can simply mean obviously planned or brought about, or calculated in an underhand or artificial way. Similarly the word abnormal can simply mean unusual without any underhand connotation. The DOTAS test is an 'either or' test and therefore something that is simply unusual will be disclosable. 6.11. There are many instances in the GAAR examples of action which could be characterised as contrived or abnormal and yet the arrangements are not regarded as abusive because the other GAAR tests are not satisfied. If the contrived or abnormal test is the only filter for DOTAS, there will be a much greater disclosure requirement, potentially covering quite inoffensive arrangements and offering little assistance to HMRC in obtaining information on unacceptable avoidance techniques. 6.12. If a broad rule is to remain, there ought to be additional filters and exceptions (see further below) but moreover a grandfathering provision should be retained to keep the rules in proportion to the burden it will place on both taxpayers and HMRC. The Society believes this has been a sensible provision in the 2011 IHT DOTAS regulations to avoid excessive and unnecessary burdens on taxpayers to make disclosures within the tight timeframe required under DOTAS (and with all the associated consequences of APNs and identification as tax avoiders) simply to provide information which is already in the public domain and well known to HMRC. 6.13. Excepted arrangements.- it is not clear why the Schedule is limited to insurance industry schemes which have been singled out for special exemption from the rules. IHT is something that tends to be planned for on a more bespoke basis arising from personal circumstances on the back of individual succession planning. 6.14. The implication of such a narrow and specific set of exceptions is that arrangements based on similar principles must be disclosed. For instance it 8

seems strange that the discounted gift scheme which is based on a carve-out concept is specifically excepted but other planning which relies on a carve-out of interests is not excluded from disclosure. 7. Questions on IHT 7.1. Q18: Do the revised Conditions 1 (tax advantage and a main purpose) and 2 (contrived or abnormal arrangements) target the hallmark appropriately and ensure that ordinary tax planning arrangements are not caught, whilst ensuring that IHT avoidance is disclosed? No, for the reasons stated above. Whilst the hallmark excludes very straightforward tax planning, that is not something remotely associated with avoidance in any event. The hallmark will not ensure that only avoidance is disclosed and will be difficult for taxpayers to know where the line is drawn and to apply the rules in practice. 7.2. Q19: Does the Schedule now cover the types of arrangements which could meet Conditions 1 and 2 but which should not be disclosed? Should other types of arrangements be included? The Law Society would prefer a more targeted test to obviate the need for a long list of exceptions but if the rule is to remain in such a generalised form, there should be additional exceptions along the lines of all the current 'white list' of arrangements that are not expected to be disclosed under the 2011 Regulations. As the hallmarks are widely defined, the Law Society is believes that there should be an exemption for wills because it is not clear that wills are automatically outside the scope of the disclosure requirement. We welcome the opportunity to assist further in collaboration with HMRC on this issue should the opportunity arise and meanwhile we thank you for considering our comments. Officer's Name Officer's Title Officer's Email address : Renee Turner : Policy Advisor : Renee.Turner@LawSociety.org.uk Officer's Telephone number : 020 7320 5782 9