Data Protection And The Taxman

What assistance to the taxpayer will the Data Protection Act 1998 provide? ALAN PINK investigates.

SOMETHING WHICH IS almost unprecedented in the history of the relationship between the taxpayer and the Revenue has taken place. A new information power has been given to the taxpayer by the newly effective Data Protection Act 1998.

The Data Protection Act 1998 is large and complex, and it would not therefore be surprising to find that widespread misunderstandings exist about its scope. One of our clients confidently informed us of the fact that the Revenue is now obliged in all circumstances to let us see the files that it holds on us personally. This could revolutionise the way we deal with the Revenue, if it were true.

Part of the purpose of this article is to pour a little cold water on such rumours, while not entirely extinguishing hope that the new Act may prove a useful tool in the hands of the tax-paying public. The article confines itself to the question of how the Data Protection Act might affect the way in which taxpayers and their representatives deal with the Revenue in practice, and does not attempt to give any kind of overview of the Act. It is inevitably no more than an expression of personal opinion. Statutory references are to the Data Protection Act 1998 except where otherwise indicated.

Data Protection Act 1998

The Data Protection Act 1998 supersedes the Data Protection Act 1984, and there are a number of important differences between the new law and the old. Although the Act was passed in July 1998 and commenced with effect from 1 March 2000, the most important effective date for this subject is 24 October 2001, when most of the transitional reliefs for data held since 1998 came to an end.

One salient feature of the new Act, which has been reasonably well publicised, is that it relates not just to computerised data, but also to data held in manual form. Within the scope of the Act is any information which is part of a 'relevant filing system', which means any set of information relating to individuals which is structured, either by reference to individuals or by reference to criteria relating to individuals, in such a way that specific information relating to a particular individual is readily accessible. This will clearly apply to taxpayer records held by the Revenue.

Power to the people

The Act creates new rights in favour of individuals where information relating to them is held electronically or on a relevant filing system, including:

section 7, which entitles the taxpayer to require the 'data controller' (that is, the person who controls the use of files) to communicate the information to him;

section 10, the 'damage or distress veto', which gives the individual the power to require the data controller to cease processing data concerning himself where this would cause unwarranted damage or distress;

section 42, which entitles any person to request the Data Protection Commissioner to make an assessment of whether or not personal data is being processed in accordance with the provisions of the Act.

On the face of it, the second of these, the damage or distress veto, would appear to be a potent weapon against the Revenue. However, it seems that there will be very few cases of such distress being 'unwarranted' in this respect, and the Revenue department concerned would need to be stepping fairly significantly out of line for an application under section 10 to be upheld.

This article therefore concentrates largely on the power given to individuals under section 7, which is effectively a power to require the Revenue to show the individual his file, or at least communicate to the individual the substance of what is recorded in that file.

Right of access

On payment of a fee, which has been set by regulations at a maximum of £10, an individual is entitled:

to be informed by any 'data controller' whether personal data of which that individual is the data subject are being processed by or on behalf of that data controller;

if that is the case, to be given by the data controller a description of the personal data, the purposes for which they are being processed, and the recipients or classes of recipients to whom they are or may be disclosed;

to have communicated to him in an intelligible form the personal data and their source, as far as the data controller is aware of this;

to have explained to him the logic of any computerised decision making affecting him.

The data controller has 40 days after receiving the request, the fee, and, if necessary, a form of identification, in order to comply with the request. Under subsection (9) the individual is given the right to apply to the court for an order that the data controller comply with the request, where the data controller has failed to do so.

The Act does not apply to companies, nor to estates in administration, because of the definition of 'personal data' as including only living individuals.

The power to apply to the court is subject to an interesting restriction, contained in section 15(2). The court can ask for the information to be made available for its own inspection, but shall not require the information to be disclosed to the applicant. If this were not the case, it would be easy for an applicant effectively to force disclosure by taking court proceedings.

Data protection principles

The eight data protection principles, as they are called, are contained in Schedule 1 to the Act. These are:

personal data must be processed 'fairly and lawfully';

personal data can only be obtained or processed for specified and lawful purposes;

data must be adequate, relevant and not excessive;

data must be accurate and up to date;

data must not be kept for longer than is necessary;

data must be processed in accordance with the Act;

precautions must be taken against unauthorised use or accidental loss or destruction of data;

data must not be transferred outside the European Economic Area unless the country of destination has an adequate level of protection for the rights and freedoms of individuals in relation to the processing of personal data.

Escape routes

So much for the rights of the individual under the new Act; but does this mean, as our client thought, that the Revenue has to throw open all its files to the public?

The answer, inevitably, is no. Depending on the circumstances, the Revenue is provided with four specific reasons for refusing a section 7 application.

The first possible escape route is in subsection (4), where the data controller is unable to comply with the request without disclosing information relating to another individual who can be identified from that information, unless that other individual consents, or it is reasonable in all the circumstances to comply with the request without his consent. Note that this protection relates only to other individuals and not, for example, to companies. It is not a defence under section 7(4), therefore, for the Revenue to say that information relating to a company (for example, the individual's employer) would be disclosed. Furthermore, the data controller is not excused from communicating so much of the information as can be communicated without disclosing the identity of the other individual concerned, whether by the omission of names or other identifying particulars or otherwise.

This seems, therefore, in most circumstances to be a very weak defence against disclosure.

A far more potent defensive weapon in the Revenue's armoury, will be the exemption contained in section 29. This provides, inter alia, that data processed for the purpose of the assessment or collection of any tax or duty or of any imposition of a similar nature are exempt from section 7 to the extent that the application of section 7 would be likely to prejudice such assessment or collection.

Thirdly, in some circumstances the Revenue may be able to rely on paragraph 7 of Schedule 7, which exempts data consisting of records of the intentions of the data controller in relation to any negotiations with the individual concerned.

Finally, it is believed that, in practice, organisations other than the Revenue, (banks, for example) are relying heavily on the 'disproportionate effort' defence. This is derived from section 7(2), which provides that the obligation to provide details of the information about the individual which is held on file must be complied with by sending copies of the file 'unless the supply of such a copy is not possible or would involve disproportionate effort'. While one can understand a bank might find this a potent defence against having to provide, say, several years' worth of copy statements for a customer, it is perhaps questionable whether the exemption will be able to be relied on by the Revenue to anything like the same extent, in the case of manual files held by them, where the papers of interest to the taxpayer will tend to lie fairly readily to hand and where individual items of information may be of considerable financial importance.

Tax investigations

In most cases there will be no need to make a formal application under section 7 in order to obtain information from the Revenue's files. The Revenue in practice will always disclose to the individual or his duly appointed agent the relevant information which it holds on file, for example copies of tax returns and accounts and past claims and elections, because there is no reason why the Revenue should withhold this information from the taxpayer.

An exception to this general rule is in the context of tax investigations. Very often an investigation will open with the Inspector indicating that he holds information which suggests that the tax return may be incorrect. The purpose of this vague and unspecific statement is to ensure that the taxpayer 'comes clean' on any errors or omissions of which he is aware, which may or may not coincide with the information which the Inspector says he has on file. It would completely draw the teeth of any such investigation if the taxpayer were entitled at that time to see what the information was.

The section 29 exemption will, in most cases, enable the Inspector to avoid disclosing his file at this stage. If the Inspector has received reliable information which contradicts the tax return, and which the taxpayer has not separately disclosed, it is likely that any court would consider the 'premature' disclosure of this information to the taxpayer as likely to prejudice the due collection and assessment of tax.

What about situations, however, where the Inspector is going on a 'fishing expedition', or has even claimed to have information discrediting the tax return when in fact he has not? Fortunately, such situations are rare in practice, but they are not completely unknown.

Suppose, again, that the information is provided by a malicious informer, to the extent that the Inspector ought to take it with a pinch of salt? The court's attitude in cases of this type is more difficult to predict. Where large sums of money are involved, it may well be worth entering into the procedure of a formal application, backed up by court action in the event of a refusal.

As a point of strategy if an investigation is being unnecessarily prolonged for any reason, an application under section 7, might, if nothing else, concentrate the Revenue's mind on dealing with the relevant issues.

Although there are as many possible real life situations as there are tax investigations, the common thread linking the situations where a section 7 application may be to the taxpayer's advantage is where there is any kind of irregularity or inadequacy in the Revenue's handling of the investigation.

Penalty negotiations

It is common practice for the Inspector, where an investigation is nearing a contractual settlement, to consider, and discuss with his superiors, the level of tax-geared penalty which should be charged. This discussion apparently often takes written form. Will it be possible for the taxpayer, before shaking hands on the final deal, to ask to see the Revenue's notes, which potentially display the Inspector's negotiating hand before he plays it?

In my view this is a prime example of the Revenue's third escape route contained in paragraph 7 of Schedule 7, where negotiations are taking place with the individual who is the subject of the file. There is little hope that the Revenue could be made to part with its files at such a prejudicial time.

Requests at other times

Generally speaking, because the Revenue will disclose information freely to the taxpayer, it would seem that section 7 requests other than in the course of tax investigations will be rare. There may, nevertheless, be a number of situations where it may be useful for a taxpayer or his accountant to have sight of the Revenue's files.

One such situation might be where it was felt that a previous accountant or other adviser has been negligent, and a catch-all review of the Revenue's files might possibly be useful for gathering information for a claim to be made.

A second situation might be where the taxpayer feels he has grounds for a complaint about some aspect of the Revenue's handling of his affairs. There may well be remarks on file, for example, to indicate that an Inspector was approaching his job in a spirit of personal animus directed towards the taxpayer. Fortunately, again, such situations are rare, although not unheard of (see, for example, the Special Commissioners' decision in Farthings Steak House SpC91).

Arguably, a section 7 application should precede any substantive hearing of an appeal before the General or Special Commissioners. There may certainly be remarks on file concerning the strength or otherwise of the Revenue's case which could be extremely prejudicial in the taxpayer's favour. This should not be open to the defence under section 29 that the disclosure would be likely to prejudice the assessment or collection of tax, because the idea of a Commissioners' hearing is to arrive at the correct assessable amount, so any truthful information which might influence that, should not be regarded as being against public policy. As yet the law is completely undeveloped in this area, however.

A review of the Revenue's files could also be a useful way of obtaining background information on a client's affairs which is not so readily available elsewhere. The Revenue file will normally contain details of any rollover claims applying to assets which the client holds, together with other types of information which the client may have forgotten. It may not be possible, in advance of actually seeing the Revenue files, to know what specific questions to ask.

Exchange of information

It is understood that Revenue Special Compliance Office has a department devoted to the exchange of information relating to taxpayers' affairs with the tax authorities of other countries. This is believed to be a growth area for the Revenue, contrasting with the past situation where there was very little actual liaison between countries.

The Data Protection Act may provide some protection in this area. The eighth data protection principle, quoted above, is to the effect that personal data must not be transferred to any country outside the European Economic Area unless that country has a level of protection which presumably has to be similar to that within Europe. Personal data includes data relating to an individual's financial and tax affairs, and the section 29 exemption does not provide any protection from the eighth data protection principle.

The Revenue's views on the application of the eighth data protection principle to the international exchange of information are urgently required, particularly in relation to which countries in its view provide an adequate degree of data protection and which do not.

The Revenue's approach

I invited the Revenue to give its views on the impact of the new Act on tax affairs, but there was no response. In my view, a statement of practice or an article in the Tax Bulletin is urgently needed, both to give the Revenue's general views and to answer the following specific questions:

In what circumstances will the Revenue consider the section 29 exemption to apply?

How will it deal in practice with the first escape route mentioned, where it is difficult to provide the information to a taxpayer without identifying someone else?

What will the Revenue's approach be to the exchange of information with other countries in the light of the Data Protection Act?

A powerful weapon?

Whilst the Data Protection Act does not seem to tip the balance in the taxpayer's favour as much as some might have hoped, it could well be a powerful weapon in the taxpayer's hands where there has been any inadequacy in the Revenue's approach to tax investigations. Another, perhaps unpredicted, by-product of the Act is the question mark it puts on the freedom with which the Revenue exchanges information with other countries.

Alan Pink FCA, ATII is a tax consultant partner with the Ashdown Hurrey Group, and provides specialist advisory services to solicitors and accountants. He can be contacted on 01424 730300 or by email: alanp@ashdownhurrey.co.uk.

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