Tax Professionals Under Attack -- I

CHRISTOPHER CANT, barrister, discusses the developments in law regarding professional negligence and tax advisers.

Tax advisers, along with all professionals, have to be constantly aware of the possibility of claims for professional negligence. The very complexity of the subject and the never ending volume of information heightens such need. This has been emphasised by recent developments in the law applicable to limitations of actions and it is these developments which have led to this article. This aspect is therefore the main subject of this first instalment.

Although it is perhaps a little unusual to start with limitation of actions, there have been important developments in this area in the last few years which will have a significant effect on the number of claims for negligence brought against professionals, including tax advisers, and possibly in turn have an effect on the cost of professional indemnity.

Traditional approach

The position used to be relatively simple and advantageous from the point of view of the professional. A claim for breach of contract or in tort needed to be brought within six years of the breach. This was well illustrated by Forster v Outred and Co [1982] 1 NMR 86. That case concerned a claim against a firm of solicitors in respect of a mortgage that had been entered into by a mother to secure the repayment of a loan made by a company to her son. The solicitors had acted for the mother. The allegation was that she had not been fully advised prior to entering into the mortgage. There was delay in pursuing the claim and an application to strike out for want of prosecution was made. A second protective writ was issued.

The question was whether that second claim would be statute-barred. This in turn depended on whether the cause of action accrued when the mortgage was executed or when the demand for payment was made. It was held that the second claim against the solicitors was statute-barred. The loss occurred when the mortgage was executed and the liability hereunder incurred. It did not matter that the client was unaware of the problem at that time or for some time in the future.

There have been a number of developments in the last few years which mean that there is no longer such certainty as regards the determination of the statutory period for the purposes of limitation. The courts have developed a number of different approaches which have the effect of postponing the expiry of the limitation period. This has resulted in an increase in the number of preliminary issues heard in professional negligence cases on the question whether or not the claim is statute-barred and thus whether it should not, therefore, go to trial. This has been further encouraged by the introduction of the new Civil Procedure Rules.

Occurrence of loss

One development has been to treat the cause of action as accruing at a later date. A cause of action has been defined as being all the facts which are essential to establishing the claim. In the context of a claim for breach of contract all that is needed is a breach of contract. This is in contrast to a claim in tort. A claim in tort based on negligence requires not just a negligent act but also loss as an essential ingredient in the cause of action. Until loss is suffered, there is no cause of action. If the loss is treated as occurring at a later date, then this means that the cause of action will also accrue at a later date and in turn the expiry of the limitation period will occur at a later date.

This is an important distinction, because a claim based on negligence against a professional adviser may be pursued in either contract or tort if the claimant is the client (Henderson v Merrett [1995] 2 AC 145). If the claim is made by a third party, then it will inevitably be in tort alone.

A case of property subsidence

An illustration of the effect that this can have is provided by the Court of Appeal decision in Havenledge Limited v Graeme John and Partners [2000] PNLR 804. This decision arose from a hearing of a preliminary issue as to whether or not a claim against the firm had become statute-barred. The claimant purchased a property intending to convert it into a nursing home. The purchase was in 1987 and the conversion works were completed by April 1988 when the home opened. The property suffered subsidence damage which required extensive repair work by the end of 1990. A writ was issued in February 1996.

The basis of the claim against the solicitors was that the claimant purchasers should have been advised prior to purchase to obtain an engineer's report which would have revealed that British Coal had plans for workings in two seams near the property over the subsequent five years.

The defendants inevitably took the argument that the claim was started more than six years after the cause of action had accrued. This was on the basis that it had accrued when the property was purchased in 1987. The Court of Appeal rejected this argument and held that the claim was not statute-barred. This was on the basis that actual loss was not suffered until the cracks appeared and the investment in the home was lost which was in1990.

The mere entry into a transaction which has the potential to cause loss in the future may not start time running. Something more may be necessary to establish loss and, until that occurs, the limitation period will not have started. This type of transaction is to be contrasted with one in which the loss has been incurred but not known until some time in the future whether actual loss will be suffered. This may be a difficult distinction to draw in practice.

Late election for tax purposes

This type of point has most often arisen in the context of buildings which have suffered physical damage subsequent to a transaction or completion of work. However, it may arise in the context of tax advice. An example of a set of facts which could give rise to such an argument are to be found in Cotterell v Leeds Day (13 June 2000), although the point was not actually argued.

In that case a deed of variation had been executed by a widow in which she transferred her deceased husband's half share in their home to their daughter but the solicitors acting failed to notify the Capital Taxes Office within six months (September 1990). In consequence the variation took effect for the purposes of inheritance tax as a potentially exempt transfer by the widow rather than being deemed to be a transfer by the deceased husband under section 141, Inheritance Tax Act 1984.

The widow was informed fairly quickly after the mistake was appreciated. Everyone waited to see what happened. The widow died within the seven-year period so that the potentially exempt transfer failed and thus there was an inheritance tax bill related to the half share which would not have arisen had the assignment been properly notified to the Capital Taxes Office. Subsequently a claim was started (November 1998) which was more than six years from the last date at which notification could have been given to the Capital Taxes Office. The limitation point was taken but failed on the grounds of estoppel.

An interesting argument would have been that until the widow died there had been no loss and that it was only on her death that a loss was suffered and the cause of action accrued. If she had survived the seven-year period, then the potentially exempt transfer would not have failed and there would have been no loss suffered. There must have been good grounds for the claimant succeeding on that ground as well. The point was raised by the court when application for leave was sought and it was the stated reason for leave to appeal being given. At the appeal hearing it was not argued and reliance was placed only on the estoppel argument which succeeded.

Concealment

A separate and far reaching development is the recent extension in the manner in which section 32, Limitation Act 1980 is applied. This section provides that, if there has been 'deliberate concealment' of the right of action, the limitation period is suspended until the claimant has discovered the concealment or could have done so with reasonable diligence.

It is expressly provided by subsection (2) that deliberate commission of a breach of duty in circumstances in which it is unlikely to be discovered for some time amounts to deliberate concealment of the facts involved in that breach of duty.

Until recently, little attention has been given to this section in professional negligence cases. The generally held view had been that for it to operate the defendant had to have wrongfully concealed the facts so that there was an element of impropriety. Lord Browne-Wilkinson had stated that the underlying rationale of section 32 was that defendants should not be entitled 'to benefit from their own alleged unconscionable behaviour by deliberately concealing the facts relevant to the plaintiff's cause of action' (Sheldon v Outhwaite [1996] 1 AC 102 at page 145H). This is no longer applied by the courts. In particular this section has been applied to professional negligence claims to extend the period in which the claim can be made even though there has been no deliberate concealment and no unconscionable conduct on the part of the professional being sued.

In a number of cases it has been held recently that in order for this section to operate it is sufficient that:

(i) the breach is deliberate in the sense that the act is knowingly and intentionally one whether or not it was appreciated that it constituted a breach; and

(ii) the circumstances are such that the claimant is unlikely to discover such breach for some time.

What does not need to be proved is any attempt on the part of the defendant to conceal from the claimant any information which would otherwise alert the claimant to the problem or the possibility of a claim. It is virtually certain that any alleged negligence on the part of a professional will be a deliberate breach.

Applying the time limit

The Court of Appeal decision in Brocklesby v Armitage and Guest [1999] Lloyd's Rep PN 888 or [2000] PNLR 33 is a good example of the application of this section to a professional negligence case. Again this was the hearing of a preliminary issue. In 1989 various transactions were carried out by which it was intended that the claimant would transfer his interest in a property and would be released from his obligations to a building society. The solicitors acting for him carried out the transfer of the interest but failed to obtain his release from the building society obligations.

In 1992 the building society sued the claimant. The claim against the solicitors was commenced in June 1997 which was more than six years from the carrying out of the transaction. It was held that the claim was not statute-barred because time did not begin to run until mid-1992 when the claimant was informed by the building society that he had not been released from his obligations. The solicitors had intentionally carried out the transaction and the circumstances were such that the claimant was not likely to discover the failure to obtain the release.

This new approach has been applied in the context of tax advice. Yet again the case concerned the hearing of a preliminary issue as to whether the claim was statute-barred. Liverpool Roman Catholic Archdiocese Trustees Incorporated v Goldberg (30 June 2000 reported [2001] PNLR 503) concerned a claim in respect of tax advice given in November 1989 in respect of profits made by the charity from the sale of drinks. The defendant was asked to advise whether there was a need to restructure the activities carried on by the charity. In March 1992 the charity became aware that the Inland Revenue was seeking to tax the profits. Assessments were raised in February 1993 and a reorganisation took place in October 1993. The dispute with the Revenue was settled in late 1996 under which penalties and interest was paid. A writ was issued in September 1997. Negligence was strenuously denied. This was more than six years after the initial advice.

It was held by Mr Justice Laddie that the claim was not statute-barred. The concealment did not have to relate to facts. It was enough that the concealment related to the legal consequences which flowed from the facts. Nor did the concealment have to be dishonourable, which it clearly was not in that case.

There has recently been an attempt to argue that the decision in Brocklesby v Armitage did not bind the Court of Appeal because a number of authorities were not cited to the Court of Appeal in the earlier case. This attempt failed in Cave v Robinson Jarvis and Rolf [2001] 1 EWCA CIV 245. The Court of Appeal indicated that leave to appeal to the House of Lords would have been given but for an agreement between the parties which meant that they no longer had an interest in the outcome. However, the House of Lords refused leave to appeal in Brocklesby v Armitage without even a hearing. There is a strong view amongst some that the decision is wrong but it may well be that the position on section 32 will be governed for some time by the Court of Appeal decision in Brocklesby v Armitage. One oddity with regard to the application of section 32 is that once the discovery has been made, there is then a six-year period in which to bring a claim running from the discovery.

It appears that the overriding fifteen year period specified in section 14B, Limitation Act 1980 will probably not apply to a case in which section 32 applies. The fifteen year period was introduced as a long stop so that there was finality, but the significance of this long stop will be greatly reduced by the new approach to concealment. A cause of action for professional negligence only discovered after the expiry of the fifteen-year period will still be capable of being pursued and there will be a six-year limitation period running from the discovery. Similarly, if the discovery is made within six years of the expiry of the fifteen-year period, the limitation period will run pass the long stop date.

These provisions relating to concealment operate quite separately from section 14A, Limitation Act 1980. That section applies to claims for negligence (but not for breach of contract). It provides that the limitation period will be six years from the accrual of the cause of action or three years from the date on which the claimant had the knowledge of the facts on which the claim is based. It is preferable from the claimant's point of view for section 32 to apply.

Estoppel

As mentioned above, the operation of the limitation period may also be defeated by the application of the doctrine of estoppel. This is not a recent development but it has been applied recently in the context of tax advice. It was this argument which succeeded in the Court of Appeal decision in Cotterell v Leeds Day, supra. In that case a deed of variation had not been notified in time. The Court of Appeal accepted that the solicitors who had failed to notify the Capital Taxes Office had led the widow to believe that there would be compensation if the widow died within seven years. It found that this had been represented by the solicitors and acted upon. The effect of the estoppel was to preclude the solicitors from relying on the Limitation Act.

It will be apparent from the above that there is now far greater scope to avoid the full impact of the limitation periods in a claim for professional negligence. In particular, there may be many professional negligence cases in which section 32, Limitation Act 1980 can be relied upon by the claimant. This will be particularly so if transactions have been carried out without any notification to the Revenue and some years later the Revenue raises an assessment.

The consequence of this must be to increase the number of professional negligence cases brought and to make it more difficult to assess the risks in the field of professional indemnity. It will certainly not be safe to take out run-off cover for six years only. There will be no date by reference to which a line can be finally drawn and by which it can be known for certain that there no longer can be a successful claim.

A further practical problem is the period during which firms should retain documents. It is no longer safe to assume that six years is sufficient in the majority of cases and even the fifteen year period is not guaranteed to suffice.

The retainer

In the light of these developments it is worth considering some recent cases in the area when examining the ingredients of a negligence claim. In this week's instalment I shall examine matters relating to the retainer for the work carried out. Further aspects will be considered in the second part of the article, to be published next week.

In any case which concerns a claim against a professional for loss due to alleged defective tax advice, the starting point will be the scope of the retainer. What has the client retained the professional to carry out? This will determine the nature of the responsibilities taken on by the professional and also affect the definition of the duty of care undertaken by the professional. In deciding this issue, the court will be influenced by the nature of the practice of the professional and the objectives of the client.

As regards tax advice, there are two separate issues which arise in the context of the retainer. First, does the retainer include the giving of tax advice? Second, if it does, is the responsibility limited to the giving of advice on the fiscal consequences of the proposed transaction, or does it go further and impose a responsibility to give advice as to how potential tax liabilities may be mitigated or avoided?

On the first issue, if the giving of tax advice is within the normal scope of the particular work being undertaken by the professional, then it will be regarded as part of that professional's retainer unless it has been clearly excluded and the possibility of instructing another professional to advise on tax has been considered with the client.

Failure to give tax advice

In Hurlingham Estates Limited v Wilde and Partners [1997] STC 627 a solicitor was held liable for failing to warn the client of a liability to tax under section 34, Taxes Act 1988 (treatment of premium as income) arising from transactions involving a management buy-out and the transfer of a lease for a premium. It was considered by Mr Justice Lightman that it would be expected that a commercial conveyancing solicitor would deal with the fiscal consequences of assignments of leases and in particular the concealed trap in section 34. In consequence it would be within the solicitor's retainer unless it has been expressly excluded, with advice that the client should consider going to a professional who was able to give tax advice.

In this case the defence was that it was agreed that tax advice would not be given. However, there were no attendance notes and nothing recorded in writing to suggest that there had been such an exclusion of liability. The judge did not accept that there had been such a limitation. It emphasises the importance of keeping attendance notes and sending a full letter to the client setting out the terms of the retainer. The solicitor was held liable for the tax on the premium which could have been avoided by restructuring the transaction. The test applied by the judge was whether he should reasonably have appreciated that tax advice was needed and that the client was exposed to risk by entering the transactions.

More general tax advice

The retainer will not only decide whether responsibility for tax matters lies with the professional but it will also decide the extent to which the professional is concerned with tax advice. In particular it will determine whether the professional is expected just to advise on the tax consequences of the proposed transactions or is to go further and advise on steps that may be taken to avoid such tax. It may be that the retainer is limited to the carrying out of the normal work involved in the case and does not include the giving of advice regarding the avoidance of tax. This issue arose in Cancer Research Campaign v Ernest Brown and Co [1997] STC 1425. The claim was against a firm of solicitors retained to carry out the administration of an estate. The deceased was entitled to the residuary estate of her brother's estate who had died eighteen months earlier. The allegation was that they had failed to advise that there should be a variation of the dispositions of the brother's estate so as to reduce the inheritance tax bill in respect of that estate.

Mr Justice Harman considered that the retainer covering the carrying out of the probate work did not extend to specialist advice regarding the avoidance of tax through the use of variations. This went beyond the normal scope of the probate work undertaken. For the claim to be well founded, he considered that the testator should have given instructions to confer a greater benefit on the beneficiaries. The absence of such instructions limited the scope of the retainer.

He further did not consider that it was right to assume that ordinary people would necessarily want to avoid tax and was not persuaded that even if told about the possibility of a variation of the brother's estate, the solicitors would have been instructed to proceed with the variation. This last point goes as to causation and establishing that if there has been negligence it has caused loss.

Apart from determining whether or not the professional is responsible for the giving of tax advice and whether this includes advice on tax avoidance, the scope of the retainer will have an important influence on defining the precise duties undertaken by the professional.

General criticisms of advice given

This is illustrated by Wedderburn v Grant Thornton (14 May 1999, unreported). This case concerned a sale of shares in a company. The vendor of the shares wanted to reduce the potential tax liability on the proceeds of sale. following advice from her accountants, she settled on the use of a scrip dividend which had the effect of reducing the tax rate from 40 per cent to 25 per cent on the sale proceeds. Despite this reduction of the tax bill, it was alleged that the accountants had been negligent in not advising the client to take a significant part of the proceeds in loan notes so that she could either retire abroad later or apply the monies in such a way as to take advantage of the reinvestment relief.

The judge, Mr Justice Rattee, found that the client had certain clear objectives which included:

(a) a wish to stay in this country;

(b) a desire to reduce her tax liability but also to achieve certainty;

(c) a wish to avoid a challenge from the Inland Revenue; and finally

(d) she wanted a speedy resolution of the sale as she feared a change of government and an increase in taxes.

The judge's findings on her objectives were important as they set limits on the retainer of the firm. The judge held that the accountants owed a duty to the client to give her proper advice as to such means of mitigating her tax position as were consistent with the client's objectives. Thus those objectives played a crucial role in determining the nature of the duty undertaken by the accountants. The judge found that the accountant had carried out this duty properly and successfully. Not surprisingly the claim failed.

The one criticism made in his judgment by the judge was the paucity of written record. The evidence of the accountant as to the advice given was accepted but it would have been an easier task for the trial judge if the advice had been recorded in writing.

This decision illustrates the importance of determining precisely what the professional is being asked to undertake as this will set the limits on the duty accepted. It is a vital first step. It is equally important that this should be recorded in writing to avoid future disputes.

Christopher Cant is a member of Chancery chambers, 9 Stone Buildings, London WC2. The second part of this article, to be published in next week's issue, will examine the standard of care and the impact of limitation clauses in retainers.

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