Catch 42

The consequences for an employee whose employer fails to pay over the
pay-as-you-earn tax can be inequitable. JULIAN STAFFORD LLB, ACA, ATII explains.
IF SOMEONE WERE to tell you that there is a provision in the tax legislation
which gives the Inland Revenue carte blanche to assess a taxpayer on whatever
figure it thinks fit with (effectively) no right of appeal, you might be
sceptical, incredulous, outraged or any other adjective you care to mention.
But such a power does exist, buried deep in the Income Tax (Employments)
Regulations 1993. There is something inherently dull about Statutory
Instruments, perhaps because of the assumption that, if the subject matter were
interesting or important, it would be included in primary not secondary
legislation.
Well, read on, because Regulation 42(3) and Regulation 101(6) have, in the
writer's view, broad implications in the areas of human rights, the appeal
system, natural justice and Inland Revenue prerogative.
Background
Regulation 42(3) allows the Revenue to pursue taxpayers who operate limited
companies and who receive salary from the company, which purports to be net of
tax, but where the company never pays over the pay-as-you-earn to the Collector
of Taxes. Often, in reality, the company goes into liquidation shortly
thereafter. In these circumstances, the Revenue never gets the pay-as-you-earn
tax, but the taxpayer puts the P60/P45 figures on his self-assessment return,
claiming credit for the tax which has been deducted by the employer, but not
paid over. Regulation 42(3) counteracts this by stating:
'If it appears to the Board that the amount specified in Regulation 40(2) or
41(2) which the employer is liable to pay to the Collector exceeds the amount
actually deducted by him from emoluments paid during the relevant income tax
period, and the Board are of the opinion that an employee has received his
emoluments knowing that the employer has wilfully failed to deduct the amount
of tax which he was liable to deduct under these Regulations from those
emoluments, they may direct that the amount which they consider to constitute
the excess “the excess amount” shall be recovered from the employee, and,
where the Board so direct, the employer shall not be liable to pay the excess
amount to the collector.'
In practice, the Revenue does not collect the tax under Regulation 42(3), but it
refuses to allow the deduction in the taxpayer's self-assessment calculation, so
the gross salary which the taxpayer has put on the self-assessment return is
treated as income which has not been subject to deduction of tax.
The first point to note is that there is no right of appeal to either the
General or Special Commissioners. If the Revenue issues a direction, the
taxpayer has to pay. The second point to note is that there used to be a right
of appeal. Regulation 42(5) previously gave the General Commissioners power to
determine whether the amount of the direction was reasonable. Regulation 42(5)
was repealed by amendment regulations in 1995 (SI 1995/447). The press release
issued at the time makes fairly chilling reading. The preamble states that the
aim of the regulations was 'to simplify and improve the collection of income tax
under the pay-as-you-earn system'. The amendments:
give the Revenue power to estimate the amount of tax unpaid;
remove the need to refer to the General Commissioners disputes about such
amounts;
remove the need for the Collector to make a payment demand prior to issuing a
notice;
remove the need for the Collector to certify any debt which remains unpaid
when a notice has expired.
Rather disingenuously, the notes in the press release continue:
'The Inland Revenue has identified a number of operational changes needed for
collection procedures and the amendments announced today are necessary to
allow those changes.'
The removal of the right to appeal therefore appears to have been a conscious
act by the Revenue to enable it to get its money quicker unchallenged.
Readers may be thinking 'Well, that is not a problem. It is just like section
28C(1A), Taxes Management Act 1970, which allows the Revenue to determine tax
due if a taxpayer does not send in his return. There is no right of appeal there
either. It all gets sorted out under section 28C(3) when the return is
submitted, as the tax is adjusted to the assessed amount'.
But there is no comparable provision here.
Readers may argue that all that has happened is that the forum for disputing the
direction has changed. So, instead of appearing before the Commissioners to
argue over Regulation 42(3), the affected taxpayer appears before them to appeal
under section 31, Taxes Management Act 1970, against the Revenue amendment to
the self assessment return, in which it will have assessed the gross salary, but
not given any deduction for the tax 'deducted' at source under pay-as-you-earn.
This is where catch 42 comes into play. The taxpayer is perfectly entitled to
appeal against a Revenue amendment, but if the matter comes before the
Commissioners, the Revenue will argue that the Commissioners have no basis for
disturbing the amendment because Regulation 101(6) states quite clearly:
'Where a direction is made by the collector under Regulation 42(2), or by the
Board under Regulation 42(3) or 49(5), in relation to the employee and in
respect of one or more income tax periods falling within the year:
'the employee shall not be entitled to include the amount of tax which is
the subject of the direction in calculating the amount of tax referred to in
paragraph 4(a);
'if the direction follows the making of the assessment, the amount (if any)
shown in the notice of assessment as a deduction from, or credit against,
the tax payable under the assessment shall be taken as reduced by the amount
of tax which is the subject of the direction.'
Paragraph 4(a) referred to above deals with tax which an employer is liable for
as a deduction from employee's emoluments. So in layman's terms, a taxpayer is
not entitled to claim credit for any tax which is the subject of a direction.
Effectively, the Commissioners could not adjust or reverse the denial of tax
credit, as this would be completely contrary to a legislative provision. If they
did so, the Revenue would ask for a case stated for the High Court on the basis
that the Commissioners had erred in law, and would undoubtedly be successful on
appeal.
Human Rights Act
It might be assumed that this is a case where the Human Rights Act 1998 will
come to the taxpayer's rescue. Again, as with all matters relating to taxation,
things are not that simple.
The general purpose of the Human Rights Act 1998 is to give further effect in
domestic law to the rights and freedoms guaranteed under the convention, to
which the United Kingdom has been a signatory for many years. The main
consequences of the Act are as follows:
All public authorities, including courts and tribunals, must act in a way
which is compatible with convention rights (see below).
All primary and secondary legislation will have to be read and given effect
to, in a way which is, so far as is possible, compatible with conventional
rights.
Where it is not possible to read the legislation as compatible with
conventional rights, the tribunal will have to apply the legislation.
The first thing to note is that the Act is only potentially of help in relation
to 'convention rights'. These are the rights contained in the main convention
and subsequent protocols. There are not that many which relate to taxation
matters. The two main items are Article 6 of the Convention and Article 1 of the
first Protocol.
Article 6 reads as follows:
'In the determination of his civil rights and obligations, or of any criminal
charge against him, everyone is entitled to a fair and public hearing …'
It will be seen that the Article is only relevant if the matter before a
tribunal refers to civil rights and obligations or a criminal charge.
Unfortunately, the convention was drafted by various countries with legal
systems which recognise different divisions within the area of the law. It is
not therefore clear whether it really applies to tax matters at all. In relation
to civil rights and obligations, it appears that a case will only be successful
where the subject matter of the dispute is taxation, but the action is brought
to deal with a wider question, such as damages or enforcing a claim of some
sort. See for example Editions Periscope v France [1992] 14 EHRR 597, where a
taxpayer claimed compensation from the French tax authorities, for damage
suffered because they would not grant a tax relief to the company.
Criminal charge has a similar etymological problem. From a number of decided
cases, it appears that prosecutions for tax evasion would certainly be within
the ambit of the article. Fines for correct returns probably are, but fixed
penalty fines are probably not, unless they are meant to be a deterrent and
punitive. So, in the current situation, it is difficult to see how the facts
could come within Article 6.
Article 1 in the first Protocol reads as follows:
'No-one should be deprived of his possessions except in the public interest
and subject to the conditions provided for by law …'
The second paragraph qualifies this by saying:
'The preceding division shall not, however, in any way impair the right of the
estate to enforce such laws as it deems necessary to control the use of
property in accordance with the general interest, or to secure the payment of
taxes or other contributions or penalties …'
It appears that tax would only come within this Article if the payment of tax
amounted to a form of confiscation rather than routine revenue gathering. The
Revenue authorities are given significant latitude to gather tax and, for
example, a windfall tax is not deemed to be confiscatory in nature.
If either Article did apply, there would be a great deal more flexibility for
the General Commissioners. The main action they could take would be under
section 3, Human Rights Act 1998, which would enable them to read the
legislation in a way that was compatible with convention rights. There are two
ways of doing this. Firstly one can adopt the process of 'reading down', which
involves choosing one interpretation out of two or more interpretations which
the tribunal considers most compatible with human rights. The second and more
radical approach is to 'read in' wording, i.e. to insert words which are not in
the legislation to make it compatible with human rights. 'Reading down' might
involve choosing the interpretation that the inability to get credit for tax
subject to a direction is implicitly trumped by the overriding power of the
General Commissioners to decide, under section 50, Taxes Management Act 1970,
whether a taxpayer has been overcharged by an assessment. 'Reading in' might
involve putting back the wording of Regulation 42(5) to reinstate the right of
appeal.
Judicial review
The rules of the Supreme Court 11965 provide, with effect from 11 January 1978,
for applications for judicial review on the illegality of an action or inaction
by persons or bodies exercising governmental powers.
Lord Templeman, in R v Commissioners of Inland Revenue, ex parte Preston, said
that judicial review is available where a decision-making authority exceeds its
powers, commits an error of law, commits a breach of natural justice, breaches a
decision which no reasonable tribunal could have reached or abuses its powers.
In this case, the breach of natural justice would probably be the main focus of
the review, on the basis that a right of appeal is fundamental in any fair legal
system.
The main problem here is one of cost. Realistically, in most cases where
Regulation 42 directions are made, the cost of applying for judicial review will
probably exceed the amount of tax at issue. Most taxpayers will be reluctant to
go for a 'double or nothing' strategy in this case.
Avoiding the trap
Regulation 42(3) relates to the employee 'knowing that the employer has failed
to deduct the … tax'.
Note it does not say 'paid over' the tax. So an employee who receives a lump sum
where there is no evidence that pay-as-you-earn has been operated would be
vulnerable.
However, if an employer has registered a pay-as-you-earn scheme with the Revenue
and has issued monthly payslips to the employee, and has sent monthly
information to the Revenue indicating the amount of pay-as-you-earn due for that
month, there would be clear evidence that the employer had 'deducted' the tax,
even if it had not been paid over and used instead as unofficial working capital
for the business. In this situation, the problem is less likely to arise, as the
Revenue collection machinery would swing swiftly into action to recover any
unpaid pay-as-you-earn. Annual salary paid in arrears would be more of a grey
area, particularly if the net pay exhausted the available cash in the company.
It therefore seems essential to keep as much evidence as possible to prove that
tax has been deducted.
Conclusion
On a practical note, it is the writer's experience that the Revenue does not act
under Regulation 42(3), unless there is clear evidence of a 'smoking gun', and
it doubtless continues to be frustrated by wily taxpayers who can outrun the
Revenue collection system. But, ultimately, we all need clear, simple and fair
legislation to operate within, and there is no real place for executive
prerogative in a modern society.
Julian Stafford is a chartered accountant and tax adviser based in Cambridge.

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