27 APRIL 2004

Mr David Ramsden, Mr David Hartnett, Mr Chris Tailby, Mr David Hubbard and Mr Peter Hopkins

  Q80  Lord Barnett: I have one or two questions for the Inland Revenue. The examples you have given are almost on the borderline of evasion as well as avoidance. I do not know how far you would say they are attempts to evade rather than avoid tax. It is a thin line at times.

  Mr Hartnett: If I may, I think it was a Chancellor of your time, if I am not being too bold here, who said that the difference was the thickness of a prison wall.

  Q81  Lord Barnett: It was my fault, was it?

  Mr Hartnett: I was not suggesting that it was. Essentially these are not evasion because, in our examination, we have not found dishonesty. What we have found is exploitation of asymmetries in different parts of the law brought together and used in a way which certainly the Inland Revenue and I imagine Parliament never intended, but no evidence of dishonesty in the matters I have mentioned.

  Q82  Lord Barnett: I take the point you have been making about disclosure and transparency and so on, and you have given us some examples of particular schemes. In section 290(1) we are told that "notifiable arrangements" means any arrangements which fall within any description prescribed by the Treasury by regulations. How, as an accountant putting forward a scheme of tax avoidance perfectly properly and perfectly legally and honestly, would you know whether the scheme fits, when the regulation has not yet been put before Parliament?

  Mr Hartnett: There are three things I would like to say if I may. The first is this. We have talked extensively to the accountancy profession, the legal profession, business and others about the filters that I mentioned earlier on and it has been a hugely valuable process because we have been able to ease some concerns. Some we have failed to ease so far but we have been able to listen very closely to what has been said to us in helping us design the filters that I mentioned. The second thing I want to say is that the governance arrangements, the risk management in accountancy and law firms mean when we may end up litigating schemes with them, and indeed their own indemnity concerns mean, that they will have a very good record of anything they put together. We are not attempting here through this legislation to expose every package of arrangements and the government has limited the proposals to financial products and employment products because those are the areas in which we see most difficulty. What the larger firms of accountants are saying to us is that they reckon they can put in place systems now (and some have already done so) to make sure that when they have to make a disclosure back to the 18 March they can do so with relative ease. All we are asking for here is a simple plain English description of what has been done and a reference to the statute. We are not asking for the blueprint or the great design or anything else. We work those things out for ourselves.

  Q83  Lord Barnett: I am no longer a senior partner in a practice, but usually these very large schemes involving, in one case you mentioned, a billion pounds would largely be done by the kinds of firms that Mr Tailby was a partner in rather than the modest-sized firm I was a senior partner in. Let us say a partner put forward a scheme that was not proposed to you and, therefore, not disclosed. What risk would the partner in question be at? Would he be liable to prosecution?

  Mr Hartnett: Not unless he was dishonest.

  Q84  Lord Barnett: Would he be charged with anything if he did not disclose it because he did not think it was necessary?

  Mr Hartnett: If, after Royal Assent of the Finance Bill, the provisions here are largely in the shape they are in now, there will be a penalty imposed by the Special Commissioners Tribunal of up to £5,000 for non-disclosure, but the Inland Revenue has already committed to the main accountancy and legal bodies as opposed to individual firms that we will not be pursuing penalties against people who have made mistakes in relation to non-disclosure or who have not disclosed through lack of understanding. What we will do is vigorously seek penalties if it is quite clear that non-disclosure was deliberate and we have given that assurance.

  Q85  Lord Sheppard of Didgemere: It has always surprised me—and this is not sarcasm; this is factual—that, given the high level of intelligence and IQs and high degrees and all that in the Treasury, the legal profession as much as the accounting profession have managed to come up with minute gaps sometimes in the legislation, and other things have gone for a long time, like the pre-owned assets situation. One could have debated the morality of that as well as the legality of it for some years now. What are you doing, quite apart from even the most defensive mechanism against disclosure, to uncover these things? Have you got a bunch of guys who are trying to out-think these things? and are you going to be more effective now?

  Mr Ramsden: Perhaps, Lord Sheppard, Dave Hartnett could give you the perspective from Revenue and then Chris Tailby could say something about Customs' administrative procedures in this area.

  Mr Hartnett: The first thing I want to say is that we are at a bit of a disadvantage in that we are not working in commerce or business, or conducting commerce and business, and are always in a position of having to react to new financial products. Were we designers, which clearly we are not, it would be that much easier. However, we are in the throes of significantly changing our ways. We are going to set up something we are calling at the minute—and I am sure we will get a much buzzier badge for it—an avoidance intelligence group. They will receive information on disclosures but the other thing this group are going to start doing is provide objective proofing, if I can put it that way, of the legislation in a way that we have normally left to the teams that design the legislation because we think that by handling the disclosures as well they will be that much better equipped to do exactly the sort of thing that you are describing.

  Mr Tailby: In Customs we have an anti-avoidance team and a core part of that is our anti-avoidance advisers, our triple-As, and these are people—and we have about eight of them—who were senior managers in the major firms of accountants. We have recruited them at a market rate to join us and they are invaluable in that they know where to look for schemes. Particularly in dealing with your question, Lord Sheppard, they proof legislation that we are proposing; they will go through that and make sure that there are no loopholes on the face of it. They are particularly valuable in performing that task and of course they provide significant technical input when we are challenging the schemes.

  Lord Wakeham: It is many years, like Joel, since I practised as an accountant, but—

  Lord Barnett: I did not know you were an accountant.

  Lord Sheppard of Didgemere: I am also an accountant, so that is why I tackle the lawyers.

  Q86  Lord Wakeham: I just want to be sure I understand the difference. I am totally in favour of what you are seeking to do in this issue. In the old days, as I recall, and maybe it is up to now, when you had decided that something was wrong, there was an announcement made and you were not, because it was not retrospective legislation, able to go back to any transactions that had occurred before the date of the announcement. But you were bolstered up over the years by, I think, the Ramsay decision in the House of Lords, which enabled you to attack things which basically you are still attacking under this legislation. Under the new system you get notified of a scheme which is being marketed. You then have the job of considering whether that is an acceptable scheme or not. At what date does the effectiveness of the measures you now have become apparent? Will it go right back to the schemes at the beginning? Or will it be when you make a decision? That is the first part of the question. The second part is—when you are considering a scheme that is being put forward under this system, will you take outside advice from the industry or the professions as to whether this thing is, as they would normally be presented to you, a genuinely "commercial, logical business transaction"?

  Mr Hartnett: Ramsay, McGuckian, Westmoreland and other cases have seen the approach which started with Craven & White and Ramsay and all that ebb and flow as between taxpayer and the Revenue authorities. There are cases coming which tax advisers and indeed the tax departments are very interested in. That is a fairly fluid thing. In terms of timing, one of the cases I mentioned to you, the swaps case, we saw on a particular day. Within a week we understood it and were able to advise the government how it could act against it if it wanted to. Treasury ministers issued a press release on a day and said that in the Finance Bill that would be coming they would legislate back to that day to outlaw the scheme.

  Q87  Chairman: They would legislate—?

  Mr Hartnett: They would legislate in the next Finance Bill with the measure backdated to the date of their announcement that they were going to legislate. Let me put a pretend date on it. They made their announcement I think on 10 September 2002 that in the Finance Bill 2003 they would bring forward legislation which would be effective from 10 September 2002, so that everyone was on notice as to what they were going to do.

  Q88  Lord Wakeham: And everybody accepted that as reasonable?

  Mr Hartnett: Yes.

  Q89  Lord Sheppard of Didgemere: But any corporation that had gone in for the scheme before that you could not catch up with?

  Mr Hartnett: On that occasion the government decided that they would go back to that date. Our legal advice as Revenue departments is that it is possible to introduce in the right circumstances, with a particular caveat around it, legislation which is truly retrospective, if I can put it that way, back to the time when the scheme was introduced, but that is a decision for government and not for us.

  Q90  Lord Sheppard of Didgemere: Can I understand how that will now work?

  Mr Hartnett: It will not change. Nothing in this measure changes the way of dealing with schemes once we start analysing them.

  Q91  Lord Sheldon: But you do seem to be rather careful about full consultation in advance because you feel that this might lead to avoidance measures taken. There are a number of consultations which could have been taken which were not taken because, quite understandably, this is one of the problems that you have to face. How does what you are doing deal with that particular one?

  Mr Hartnett: That is rather like the third of Lord Wakeham's questions, if I can answer that and see if it helps. Stock lending, and many of the committee will know more about stock lending perhaps than we do, is a frequent occurrence. In advising the Government in 2001 how to deal with the stock lending scheme we felt that it was very important that we did not give advice that ignored seriously important elements as to how stock lending worked in the market place. We did two things. We found an adviser in London that we knew and trusted and talked to them about the approach that we were going to take and so got some assurance about the London markets, and I think we became clients of a firm in New York. We may have got someone we knew well and trusted there and wanted to make sure that there was nothing that happened on the New York markets in relation to stock lending which would impact adversely on the UK if we gave government the advice that we did. It is a judgment call every time, because the financial industry is very important to us, to make sure that we do not create knowledge of what advice we may be about to give government because I am afraid there are advisers out there who will try and forestall on a very substantial scale if we do that.

  Q92  Lord Freeman: It might be helpful to the committee if you could explain the practical differences between this transparency disclosure as opposed to anti-avoidance legislation.

  Mr Hartnett: Let me have a go. Anti-avoidance legislation as introduced now is dependent on the Customs and the Inland Revenue discovering something that is avoidance. Whilst things have improved through us getting a better understanding of business and working closer with business and their advisers on some issues, it may be helpful if I give a feel for the time frame in a not untypical case. A taxpayer or company submits its tax return up to nine months after the end of the year or accounting period. We then have in broad terms a year to examine it. For a large enterprise, unless it says,—and very few do this—"We have done the following avoidance scheme"—there is a bit of a needle in a haystack chase that goes on from that stage. We have to have made our initial inquiries within a year. Quite often those are broad inquiries while we are still thinking about it and getting more information. It might be another year or two before we expose the package that that particular taxpayer has used. What this arrangement does is bring the package to our attention very much earlier than we get to see it at the moment, enabling us to provide advice to Treasury ministers very much earlier and in appropriate circumstances I imagine the government would then be able to act very much earlier than it can now.

  Q93  Lord Blackwell: Can I go back to a point Lord Barnett raised about how in practice it will be possible to define what constitutes a scheme or arrangement which needs to be notified versus general advice? It seems to me that this is the core of this. The examples you gave are very clear at one end of the spectrum. On the other hand, any tax adviser sitting down with a client is going to end up giving a set of advice about how to organise their tax arrangements, taking advantage in many cases of legitimate benefits and incentives that are there or at least that are intended for companies to take advantage of. I realise the regulation has not been published, but how do you conceive that you can create a practical definition where that person giving advice is clear that what he is doing is a scheme as opposed to simply tailoring some advice in the light of the circumstances of that company, in a way that does not get you flooded with everyone notifying you of every single piece of advice they give just to make sure?

  Mr Hartnett: Perhaps I can use the financial products filter arrangement to demonstrate how we are going to do that. A financial product scheme that is going to be notified to us has to have the potential to avoid income tax, corporation tax or capital gains tax; not any other taxes, just those three. The tax benefits of the scheme plus the economic benefits of the arrangement have to be greater than the economic cost but over a two-year period. If it was over a much longer period ordinary savings products might come in, and that filter will take out a lot of arrangements. Then the scheme to be a financial product has to involve one of the following: a loan, which, to use the terminology I used earlier, is not a plain vanilla loan, a share which is not an ordinary share,—and a lot of shares are not ordinary shares—a derivative contract such as an option, future or swap and a contract which is accounted for under UK generally accepted accounting practice as a financial arrangement, a finance lease, rent factoring and so on. We are not attempting to define tax avoidance here. We are attempting to produce a filter which brings out particular things. We are hopeful soon that we can release a draft of our guidance on these measures and that guidance and, subject to ministerial agreement, the regulations that we are going to produce are going to exempt a number of things from disclosure. The sort of thing which will be exempted is again simple use of exemptions and reliefs and the like available through the tax code. That is our general approach. You ask about swamping, there are three sorts of disclosure we might get. The first is straightforward disclosure from people who understand the new rules. The second is disclosure from people who are cautious and want to err on the right side of disclosing, and we are hoping that there will not be a third sort but the Internal Revenue Service, the US service, saw this, an attempt to put a lot of what I will call chaff into the system to slow it up or bring it down or whatever are the right words I should be using here. We are prepared for all three.

  Q94  Chairman: Can I ask a couple of commonsense questions, speaking as someone who does not understand any of this? When I first heard of the gilt strips scheme, it seemed to me to be an obvious racket and, going back to Lord Barnett's point and your joke about prison walls, I was amazed to be told that that was legal, because it seemed to me to involve a kind of artificiality in terms of losses which, if it was not illegal, ought to be illegal. The swaps one seems to be even more like that. I used to teach a bit of financial economics, and I am amazed that that could even get into the game, let alone anything else. What you are arguing at the moment on disclosure is that these things may well be legal but it gives you a chance at least to act. Am I right in interpreting that in that way?

  Mr Hartnett: Yes, you are.

  Q95  Chairman: Going back to yours, Chris, on the administration fake, that was clearly illegal surely. They were charging for a service they did not give. That is at least what it sounded like to me. They were saying, "We were doing this for administration", and you were saying, "No, you were not doing anything?"

  Mr Tailby: The argument for Debenhams, and I would not want to argue their case too strongly, would be that they had put in a chain of contracts between the Debenhams retail company, the top company, their own in-house company, the Debenhams card handling company, and the company which did the real work, so effectively the card handling company is sub-contracting that work down to the company that is doing the real work, so they are inserting that company into the supply chain if you like and relying on that argument. We say that does not actually work and indeed there is quite a body of case law which is building up which supports us on that. They would argue that as a matter of contract they have put these contracts in place and therefore it worked and therefore it was legal. The interesting point is that we have won in the tribunal. I hope we will win in the High Court. Tribunal decisions do not bind other companies, or indeed other tribunals, but of course the High Court does, so the question then is, if we get a result in the High Court what does that do for all the other retailers who are still doing it? If the High Court have said, "This does not work", the question is, could you then run an argument that if you continue to do that that would be evasion? That is a fight that we have yet to come.

  Q96  Chairman: But it does answer my other last little question, and I swear I had a piece of paper only the other day which had the 2.5 per cent on it. I take it the answer is that the first decision does not bind anybody else, so it is still going on?

  Mr Tailby: That is right.

  Q97  Lord Wakeham: Presumably though, if they had actually had a totally outside party to run their credit card operation for them and charged the 2.5 per cent, that would be all right and this is what they tried to replicate inside? Is that the artificiality of it?

  Mr Tailby: What they had before was, yes, they had an outside credit card handling company but they supplied their services to Debenhams, so although the supply was exempt that did not really help Debenhams because of course they have to account for VAT on 100 per cent of the purchase price.

  Q98  Lord Sheppard of Didgemere: We do not have time to discuss this, and in one case it is sub judice so we cannot. But some of the issues you tackle get into the fact that it is not a perfect fit; it is a 99 per cent fit between, say, US tax law and our own law, and people will go to the one per cent, and I realise you have got regulations on transfer pricing. In that sense the European courts will get involved, as happened in the Marks & Spencer case which is still ongoing?

  Mr Tailby: That is right and indeed any legislative change, and this was a significant factor in the work that we did on disclosure, is governed by European law and we have to work within that. Sometimes you get situations where the national laws of countries do not exactly fit with each other in terms of the directive so yes, you can get lacunae but we do try and work to keep those down.

  Q99  Lord Barnett: Is there any conflict between European law and VAT?

  Mr Tailby: The short answer is no, there is not, because we have taken lots of advice on this. We went to leading counsel on VAT, EU Community-wide counsel on the Community issues and even Human Rights Act counsel to make sure that we had covered that, so we are very confident on that.