It's a fair cop

RICHARD CURTIS refuses to go quietly when considering tax and criminal activities.

AL CAPONE SUPPOSEDLY said: 'The income tax law is a lot of bunk. The government can't collect legal taxes from illegal money'. This came to mind on seeing the ' Loose End ' from Peter Vaines ('Crime pays...', Taxation , 24 February 2005, p503) — reporting that a bank robber in Holland had been allowed to deduct the cost of the gun from the restitution that he had to make — and made me wonder what were the tax implications of such activities in the UK.

The general opinion seems to be that thieves, etc. are not subject to income tax as they are not carrying on a trade; but the more I thought about this, the more annoyed I became. Can this be right? Revenue press releases seem to say on a regular basis that everyone should be paying their 'fair share' of the nation's tax liability, yet, if this opinion about thieves and burglars is correct, we have a section of society who are living off the hard-earned efforts of the rest of us and, to cap it all, are apparently not paying tax! It is as though they are living in their own little tax haven — a latter-day Sherwood Forest perhaps?

The Revenue's view

I decided to consult my Tolley's Income Tax , which seemed to confirm the point.

'Crime, e.g. burglary, is not trading, but the profits of a commercial business are assessable notwithstanding the business may be carried on in an unlawful way, e.g. "bootlegging".'

In response to my enquiries, the Inland Revenue referred me to the Business Income Manual at BIM22010, 'Trade: Exceptions and alternatives: Illegal activities: Activities not amounting to a trade', which reads as follows.

'The courts have not set out to define those criminal activities that do not amount to a trade.

'However in Lindsay, Woodward and Hiscox v CIR [1932] 18 TC 43, at page 56, Lord Sands thought that housebreaking was not a trade. Lord Denning, in J P Harrison (Watford) Ltd v Griffiths [1962] 40 TC 281, at page 299, thought the same about the operations of a gang of burglars.

'In neither case was the point directly at issue. There is little supporting reasoning, the view being expressed as if it was self-evident. However, it is probable that the meaning of trade would not extend to operations intended to deprive the lawful owner of property, contrary to law and against his will, of the use and enjoyment of that property.'

Now I can see that one could argue that breaking and entering and making off with someone's property may not be a trade, but what about a subsequent sale? What happens when a burglar takes my DVD player along to his local 'fence' or car boot sale and converts that into cash? Is this starting to look like a trade?

The 'rap sheet'

The annual profits or gains arising from trades and professions are subject to income tax under TA 1988, s 18 . Then, TA 1988, s 832 goes on to define 'trade' — rather circuitously — as including 'every trade, manufacture, adventure or concern in the nature of a trade'. And in the same way that criminals can be identified by their record (or the bag marked 'swag' and the jemmy), trades can also be identified by their distinguishing features or 'badges'.

Space constrains me from a detailed examination of the 'badges of a trade' and these are reasonably well known. The Revenue's Business Income Manual includes a summary at BIM20205 and it seems to me that if one takes a dispassionate view, many criminal activities will exhibit such badges. Perhaps this is unsurprising; the report, Recovering the Proceeds of Crime , which preceded the Proceeds of Crime Act 2002, stated that 'most crime is committed for profit — about 70% of recorded crime is acquisitive'.

A 'load of bunk'?

So if many criminal activities exhibit the badges of trade, why are we not hearing of the Revenue taking steps to assess and recover tax from criminal activities? Was Al Capone right? Following a further request, the Revenue provided some more information regarding its view.

'The existence of a trade is the key determining factor in whether any activities are taxable in whole or in part. A criminal activity that involves the provision of goods or services to a customer in a commercial manner is taxable. This would include a receiver of stolen goods, sales of counterfeit goods, alcohol or people smuggling, drug production and dealing in drugs, money laundering, etc.

'On the other hand crimes such as simple burglary, confidence trickery or "advance fee fraud" do not invite the provision of goods or services to customers so are not trades and appear not to be taxable. Legal precedence points to the proceeds not being legally the income of the criminal, but remaining the property of the victim.'

In support, the Revenue refers to a New Zealand Court of Appeal case, A Taxpayer v CIR (1997) 18 NZTC 13,350, which, the Revenue states, 'held that stolen money was incapable of being or becoming assessable income'.

Having now read transcripts of the judgments in this case, I am not totally convinced that this rather broad view is quite what the case is saying.

The case concerned an employee who embezzled NZ$2.23 million from his employers for his own futures trading transactions; 'like many embezzlers he intended to restore the stolen funds' and — surprisingly perhaps — he did in fact repay NZ$1.2 million before absconding.

The judges stressed that it had to be shown that the misappropriations had the character of 'income derived', a phrase that figures in New Zealand tax law, but not in, for example, TA 1988, s 18 . The judgments also attempt to distinguish the case from an Ontario Supreme Court judgment ( R v Poynton [1972] CTC 411), which held that embezzled monies were taxable. The New Zealand case justifies this distinction on the basis that the Canadians are following US principles (the James approach (366 US 213 [1961])) which make less of the distinction between income and capital.

The New Zealand judgment also states that 'taxation issues should not be decided on the basis of the so-called economic substance or reality of the transaction, or of the circumstances in which the taxpayer is involved'. Interesting, but does this really hold up in the light of FRS 5, 'Substance of transactions', to which the Revenue refers in its Business Income Manual at BIM31050. 'The principle in FRS5 is that economic substance takes precedence over legal form'.

Again reflecting the Revenue's comments above on the ownership of the stolen assets, the view of the New Zealand court was that '[the] money was, from the moment it was stolen, held in trust by the taxpayer for his employer'; it could not therefore have been income. It occurs to me that if trust came into such cases at all, they would never have come to court in the first place! This altruistic approach also seems completely at odds with the 'economic substance'.

Frankly, the idea that my DVD player is simply being 'held in trust' and that I will be receiving it back again one day, seems quite ludicrous.

In reality, is this the best case for the Revenue to use as justification for it not to be involved in taxing such illegal activities. The thefts — if that is what they really were in the New Zealand case — took place over a relatively short period and it seems to have been accepted that there was an intention (partly complied with) to repay. It may be enlightening to review some of the legal decisions relating to illegal trading.

A case review

Whether they were in business with Mr Capone we do not know, but the Revenue did refer to Lindsay, Woodward and Hiscox v CIR 18 TC 43, where the appellants were involved in the illegal export of rye whisky to the US during Prohibition and claimed that, as illegal profits, they should not be charged to tax. The Court of Session first noted that the fact that the trade involved contractually unenforceable illegal acts did not, of itself, mean that the trading operations were beyond assessment to income tax. Lord President Clyde did opine that 'it is plain enough, I think, that the profits of crime could not be assessable to income tax as the profits of a trade', although there seemed to be an expression of doubt as he added: 'If — to take an example — the mode of living followed by an individual consisted in nothing — or practically nothing — but the commission of the crime of re-selling stolen goods, it might be difficult [my italics] to say that the profits were assessable to income tax as the profits of a "trade"'.

The distinction between such a scenario and Lindsay was that here a commercial article (whisky) was being marketed and the frauds on Customs 'were only incidents of that "trade"'. Lord Sands added that 'crime, such as housebreaking, is not trade, and therefore the proceeds are not caught by tax. It does not follow, however, that there cannot be a business answering to the description of a trade, albeit it is tainted with illegality. Trafficking in drugs, for example, is of the nature of a trade, albeit such trafficking may in the circumstances be illegal'. He added that he followed the views of Lord Haldane in Minister of Finance v Smith [1927] AC 193 (also mentioned by the Revenue) 'that once the character of a business has been ascertained as being of the nature of trade, the person who carries it on cannot found upon elements of illegality to avoid the tax'. Lord Morrison also felt that 'burglary is not a trade or business'; however, he then — perhaps confusingly — added that 'the burglar and the swindler, who carry on a trade or business for profit, are as liable to tax as an honest man, and, in addition, they get their deserts elsewhere'. Needless to say, the appellants were charged to tax.

This case was followed in the same year by Southern v AB and Southern v AB Ltd 18 TC 59. The Commissioners ruled that 'ready money betting' and 'street betting', both of which were totally illegal were therefore not taxable. But the High Court disagreed. Mr Justice Finlay laid much emphasis on the judgment of Mr Justice Rowlatt in Mann v Nash 16 TC 523 involving the unlawful use of fruit machines. The judge felt that the only reason that a burglar 'does not come within the purview of the Income Tax Acts … is because what he does is not the carrying on of a trade within Case I and it is not because, carrying on a trade within Case I, he is taken out by some consideration of morals or anything of that sort. The question always is, I think, a short question of construction: is there a trade?'

The answer here was yes.

Can this decision be reconciled with the comments in JP Harrison (Watford) Ltd v Griffiths 40 TC 281, which turned on whether a dividend-stripping exercise was in the nature of a trade?

In his judgment, Lord Denning, no less, considered what was meant by a trade.

'Take a gang of burglars. Are they engaged in trade or an adventure in the nature of a trade? They have an organisation. They spend money on equipment. They acquire goods by their efforts. They sell the goods. They make a profit. What detail is lacking in their adventure? You may say it lacks legality, but it has been held that legality is not an essential characteristic of a trade. You cannot point to any detail that it lacks. But still it is not a trade, nor an adventure in the nature of a trade. And how does it help to ask the question; if it is not a trade what is it? It is burglary, and that is all there is to say about it.'

This judgment was also referred to by the Revenue, although Lord Denning did dissent on the main issue.

Perhaps the most recent case on illegal trading is CIR v Aken [1988] STC 69 (in the High Court) and [1990] STC 497 (in the Court of Appeal) where the taxpayer, otherwise known as 'Miss Whiplash', contended that as it was illegal for her to do many of the things that a legal business could — e.g. advertise, rent premises, trade from home, employ people, form a partnership or a company — her activities as a prostitute could not be treated as a trade. Both courts dismissed her appeal; 'the Crown does not accept that the illegality of the activities which constitute a trade will prevent it from being a trade within Schedule D'.

The case law conclusion

There appear to be conflicts between and even within judgments, but the majority view seems to be that illegality does not prevent assessment to tax. This does beg the question of whether there is a trade and I wonder whether some confusion has arisen when judges have considered this. Once the stolen goods are sold the Revenue appears to accept that many of the badges of a trade exist and illegality should not prevent tax being charged; although it says that 'the burglar would only be taxable on the "vendor's profit" not the gross booty'. As Recovering the Proceeds of Crime estimated that two-thirds of recorded crimes are motivated by financial gain, it seems to me that there should be a large amount of income being declared or discovery assessments being issued in respect of this (are there?) — even if this is only with regards to those who are convicted, as the Revenue will then have their 'contact details'.

But what about the thief who simply keeps the stolen goods? Some interesting considerations arise.

Let us assume, for sake of argument, that a thief who steals purely for his own use or consumption is not carrying on a trade and that one who steals for resale is. If the latter decides to keep a stolen DVD player for his own use, is that subject to tax on the principle in Sharkey v Werner 36 TC 275 as a withdrawal from trading stock? And, if the former starts to sell a few items, do his 'personal' thefts then fall to be assessed under the same principle?

The professional thief

A professional gambler would be charged to tax on his income and is he trading — providing goods or services — other than perhaps offering someone else the chance to win his money instead? Is this really any different to the professional thief? Would a better argument be that they both have a 'vocation'? Surely the economic substance — that they gain from their particular vocation — is the same, and is it then necessary to show consideration?

Although comparatively rarely referred to, 'vocation' appears prominently in TA 1988, s 18. Whereas my dictionary defines trade as involving the buying or selling of goods or services, vocation seems to be different; 'a particular calling or career' (from the Latin, vocare, 'to call'). And 'profits or gains' cannot simply encompass money, as barter transactions would not then be subject to tax. Once a burglar has made off with my DVD player, he has made a 'gain' and, on conviction, it can no longer be said that he was holding this 'on trust' for me. And given low clear-up rates for burglaries, the likelihood of recovery or restitution, even if the thief is caught, is negligible. So arguments that by taxing the thief the victim will somehow be deprived of restitution seem rather superfluous. If it came to it, presumably the amount of restitution could be allowed as an 'expense' against the income of the trade or vocation, in the same way as our bank robber's gun!

Where's the money?

So, what is really preventing the collection of taxes in respect of profits from purely illegal activities or is the Revenue issuing assessments? Chapter 10 of Recovering the Proceeds of Crime ( www.number-10.gov.uk/su/criminal/recovering/ ) deals with 'Taxing unlawful gains' and does give an example of the Revenue issuing an assessment for £600,000 tax in respect of alcohol smuggling.

The Revenue also now has a responsibility to report criminal activity under the Anti-Terrorism, Crime and Security Act 2001 and since February 2002 has made approximately 33,000 reports to the law-enforcement authorities, covering a wide range of criminal activities, including murder, sexual offences, drugs offences, terrorism, financial offences and violent crime. I have been unable to establish to what extent these resulted in tax liabilities.

It has also been suggested that the problem is assessing an unknown source and the report stated that 'whilst the Revenue can raise a tax assessment against an individual undertaking a trading activity, tax cannot be collected where a source of the income (including criminal activity) cannot be identified.' But is this true? The Revenue's own Enquiry Manual states (at 1900) that where the Inspector is 'unable to attach the capital to a business or professional source, and the taxpayer has failed to produce an argument which you can reasonably accept to explain the capital', then 'you should consider raising discovery assessments … under an appropriate general heading'.

One also wonders whether the Revenue does not actively pursue tax on the profits from illegal activities because it has little incentive to do so. The report notes that — over an eight-year period — the Revenue reduced the cost of collecting each £1 of tax from 2.46p to 1.33p. Presumably drug smugglers and their ilk are unlikely to be the most compliant of taxpayers and there is also the danger of violence and intimidation.

The Assets Recovery Agency

The Proceeds of Crime Act 2002 now allows the Assets Recovery Agency (ARA) to take over the Revenue's role and issue tax assessments. My understanding is that the ARA director needs to show an income stream, rather than an income source and must notify the Inland Revenue of her intention to issue an assessment.

Under this act there is effectively a 'hierarchy' of measures, but if there is insufficient evidence for confiscation or civil recovery, the third weapon is the taxation option, presumably on the basis that if the state cannot recover all of the assets it can at least recover a proportion of their value and I understand that cases are pending in this regard.

Get the cuffs out

The ARA will obviously looking at the 'Mr Bigs' of the criminal world, but surely a general responsibility remains with the Inland Revenue to at least attempt to tax 'career criminals'? Those who have been convicted must surely be a prime target, as must those whose activities have received wide publicity and a tax assessment may act as a significant additional deterrent. And the 'balance of probabilities' burden of proof in a civil case — say to recover tax — is lower than the 'beyond reasonable doubt' of a criminal case.

The Times recently reported that the 'IRA plc' is now the biggest criminal gang in Europe, being involved in smuggling and counterfeit goods in addition to robbery. It would be interesting to know whether the Revenue will be enquiring into the personal tax returns of the members of the IRA's ruling council or issuing discovery assessments on the £28.5 million (less lorry, etc.) stolen, allegedly by the IRA, from the Northern Bank, Belfast.

Despite the 'plc' tag appended by The Times , presumably the ruling council is effectively a partnership, thus making the members jointly and severally liable to income tax on the proceeds of their vocation?

Is it not time that, like the US and Australian authorities, the Inland Revenue took a more active approach in using tax to hit the criminal as well as the business community and prominently publish its work in this regard?

Issue: 4002 / Categories: Comment & Analysis