Comment

Comment

MIKE TRUMAN asks whether the fight over legal professional privilege should be abandoned quite so easily.

'Actually, as Winston well knew, it was only four years since Oceania had been at war with Eastasia and in alliance with Eurasia. But this was a piece of furtive knowledge which he happened to possess because his memory was not satisfactorily under control. Oceania was at war with Eurasia: therefore Oceania had always been at war with Eurasia.' (1984, George Orwell)

Back in May we published two articles by Simon McKie on the new tax avoidance disclosure rules, entitled 'Big Brother Forces a Confidence' (Taxation, 13 May 2004, page 162 and Taxation, 20 May 2004, page 193), in which he raised several problems with the proposed régime. Many of those issues have been addressed in a piecemeal way by successive patches to the regulations, but one of the most intransigent was the issue of legal professional privilege.

War of words

On 20 September, the legal profession was at war with the Inland Revenue, as the Law Society issued guidance saying that legal professional privilege (LPP) prevented lawyers from making the disclosures required by the regulations. Accountants were in an uneasy alliance with the Inland Revenue — they would have preferred not to have the legislation at all, but if it was to be applied it must provide a level playing field for accountants and lawyers alike. Links from the ICAEW's library website pointed towards the Law Society's guidance, available on its own site. The Law Society was saying that a test case might be required to establish the limits of LPP, pitting its view that privilege extended to details of how the scheme worked against the Inland Revenue's view that it only extended to the advice that was given and not to the basic facts of the scheme.

A few weeks later, and everything has changed. A letter from Clifford Chance (Taxation, 4 November, page 120) confirms that in their view LPP does not now prevent the disclosure of schemes, and that there is now a level playing field. An article from Freshfields in Tax Journal (Issue 764, 8 November, page 5) makes much the same assertion. The Law Society is not at war with the Inland Revenue. The Law Society was never at war with the Inland Revenue. The guidance issued so prominently in September is no longer available when you search the Law Society website; it has been withdrawn for updating. The links from the ICAEW library website have been removed. Fortunately, because its memory is not satisfactorily under control, Google still retains the furtive knowledge of times past. A search will still (at the time of writing) locate the original Law Society guidance buried in the bowels of its server, and looking at the cached version of the ICAEW's library page will show the links that used to exist.

There is not, of course, a conspiracy to hide the fact that views have changed. There does, however, seem to be a concerted effort from the 'Magic Circle' of leading law firms to claim that the change to the rules announced by the Inland Revenue on 6 October has solved the problem of privilege — but has it?

Changing places

The disclosure rules are set out in FA 2004, ss 314 - 319. S 316 says that the rules will not require the disclosure of any information that is subject to privilege. The Inland Revenue's view was that this did not prevent the disclosure of the facts of the scheme that had been entered into, as this was not legal advice it was simply a factual account.

The Law Society disagreed. Its memorandum said that:

The Inland Revenue's response on 6 October was to put the burden of disclosure on the client rather than the solicitor. Lawyers who are unable to comply with the requirement to disclose because of LPP are removed from the definition of promoter, and are not therefore liable to make disclosure. However, in such situations an obligation is placed on the client to disclose within the same five-day time limit that normally applies for promoters.

The Law Society says that it believes its lobbying has achieved the desired effect. It has removed the requirement for lawyers to 'snoop' on their clients which, as the representative body for solicitors, was its main aim. This is all very well, but what about the clients, and the underlying importance of legal professional privilege?

Legal professional privilege

LPP is a common-law concept, developed by the courts rather than by statute. Lord Hoffmann, in R (on the application of Morgan Grenfell & Co) v Special Commissioner of Income Tax [2002] STC 786 says that it is a 'fundamental human right'. The reason for it was set out in R v Derby Magistrates Court, ex parte B [1996] AC 487:

Ruritanian investment trusts

So let's consider a hypothetical example. Imagine that a client comes to his solicitor in December and says 'I want to sell my investments within the next year but I will have a large CGT charge if I do, what can I do to reduce it?' The solicitor tells him about a tax loophole he has recently discovered relating to Ruritanian investment trusts. Under Article 14 of the double taxation agreement with Ruritania, it is possible to exchange UK company shares for shares in a Ruritanian investment trust as a share-for-share exchange without a CGT charge. Then, provided the investment trusts are held for at least six months, the same article in the double taxation agreement prevents any liability to CGT arising in the UK. The client thinks this is a very attractive proposition, and the solicitor arranges for the client's investment portfolio to be switched into a Ruritanian investment trust, with the intention that it is to be sold shortly after the six-month limit expires.

Prior to the introduction of the tax avoidance disclosure rules, the exchange would have been reported on the return for the current year, with the eventual disposal either not being reportable at all, or reported the following year as a nil gain.

As initially proposed, the Inland Revenue's argument was that the solicitor could be required to give the details of the scheme without breaching legal professional privilege, because that was only disclosing the facts of the transaction and not the advice received. The Law Society's original guidance disagreed:

Ruritanian disclosures

The validity of this argument can be seen by drafting a disclosure for the Ruritanian Investment Trust Scheme. The disclosures required by the Tax Avoidance Scheme (Prescribed Information) Regulations 2004 have to enable the Inspector to understand how the scheme works, and include:

So the Ruritanian Investment Trust disclosure would look like the example shown overleaf. The report clearly allows a reader to infer legal advice which has been given to the client by the lawyer — transfer your investments into a Ruritanian investment trust and you won't have to pay UK tax on the gains when you sell more than six months later. That advice, as the Law Society rightly says, is part of a privileged communication between client and lawyer.

Client obligation

So how is this changed by putting the obligation onto the client and not the lawyer? The article from Freshfields in Monday's Tax Journal, referred to above, puts it this way, in the context of a scheme which a client is asking a lawyer to comment on:

So far as it goes, this is clearly correct. If I go to a lawyer and tell him or her that I have sold my business and I want advice on the tax implications, privilege will prevent the lawyer from having to disclose the fact that I have sold my business, but I cannot rely on privilege to avoid reporting that to the Inland Revenue on my tax return in due course. If a provision was included in a Finance Act to say that all sales of business assets were to be reported to the Inland Revenue within five days, I would have to comply with it.

Still the same

However, the disclosure which the client has to make is exactly the same as the one which the lawyer would have had to make under the original provisions. So the client who enters into the Ruritanian Investment Trust Scheme will have to make the disclosure set out in the example within five days of the exchange of the UK investments. The disclosures tell the Revenue far more than simply the fact that the exchange has been made. They explain something about the future intentions of the client — to hold onto the investments and then sell them six months later. This may not actually happen. The sale might take place sooner because of a pressing need for funds, or later because the client decides that the Ruritanians are actually rather good at investment management.

The disclosures also detail the legal advice that the client has received, advice which clearly falls within the definition of legal privilege, as the Law Society was originally quick to point out. The fact that the client is making the disclosure means that (as with the disclosure by the solicitor) the Inland Revenue is on notice that advice has been sought.

Finally, the reality in most cases will be that clients will not make the disclosures themselves, they will authorise the solicitor to do so, and it seems that the information which was protected by privilege according to the original Law Society's guidance is now to be disclosed to the Inland Revenue in exactly the same format and by the same person.

Level playing field

In the past, the courts have been zealous in their protection of privilege, and of ingenious attempts to get round it. They have not, for example, allowed the fact that documents are in the hands of the client rather than the lawyer to make any difference. In the Morgan Grenfell case, Lord Hoffmann quoted with approval the opinion of the Advocate General, Sir Gordon Slynn, in the European Court of Justice case AM & S Europe Ltd v EC Commission [1983] QB 878:

Why surrender?

So why give in? Counsel's advice has obviously been taken, but it seems inconceivable that there was felt to be no doubt about the issue when the authorities are so strong. A House of Lords judgment in a case on privilege, Three Rivers, is expected imminently (and may be released after this article is written but before it is published). It is possible that this may have limited the application of LPP significantly, and that the leading law firms have a good idea about what will be said.

There is certainly a desire to make the system work. The flawed nature of the disclosure rules and their introduction has been chronicled several times in Taxation, and there is a feeling that without co-operation and compromise from the professions they will simply be unworkable. The general principle of reining in overly-aggressive tax planning is one that is broadly conceded.

But the importance attached to LPP can scarcely be understated. In the case of R v Derby Magistrates Court mentioned above, the question was whether a man on trial for murder could introduce evidence about the instructions given to his solicitor by a witness in the case who had originally been charged with the murder himself. It was held that the overriding importance of LPP meant that it could not be restricted even in a case such as this. Questions of efficient tax administration pale into insignificance by comparison.

The new régime of client disclosure gets solicitors off the hook; they are no longer on a collision course with the Inland Revenue over the application of legal professional privilege in cases of tax avoidance. It is good for lawyers, it is good for accountants (who now have a tolerably level playing field), it is good for the Inland Revenue.

But is it good for the administration of justice? I am not so sure that it is.

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