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Key points
- High Court finds for taxpayer in D'Arcy case.
- Transactions were real but artificial, with no commercial purpose.
- HMRC are attacking advisers who promote such schemes.
- Need to persuade taxpayers that it is not worth entering into them.
HMRC HAVE LOST the case of D'Arcy in the High Court; the judge upholding the decision of the Special Commissioners. I started reading it, got confused and then remembered that I had written an article about it after the Special Commissioners' decision (Taxation, 3 August 2006, page 487) where, after working through the complexities of the transactions and the legislation, I had laid it out in clear and simple prose. So I reread that, and found that six months later I couldn't understand my own article … No matter, because I don't really want to write about the case itself. It is not the mechanics that matter; it is the real world that lies behind them.
Writer's cramp
I came into tax in the late 1970s, as the Ramsay [1981] STC 174 case was working its way through the courts. When I'm lecturing, the way I describe the sort of scheme used in that case is that you walked into the offices of the promoter and said 'I've got a £50,000 capital gain, please can you help me?' You then sat down at a table for three hours signing documents and getting writer's cramp, after which you walked out with a couple of thousand pounds less in your bank account, but a brand new £50,000 capital loss to set against your gain.
During the afternoon, several quite real but entirely artificial things had happened. The shares of a company had been acquired, two large loans had been made to it using borrowed money, the interest rates on them had been varied, one of the loans had been sold for a profit, the other repaid, and shares sold at a loss.
I exaggerate, but only slightly — in Ramsay about half the transactions are carried out on the first day, and most of the rest a week later. The point is that the taxpayer has no interest at all in the substance of the transactions, merely in the end result for tax purposes. This does not mean that the transactions are in any way a sham — if the scheme had suddenly been stopped half way through, there would have been real liabilities and real shareholdings — but it does mean that they have no commercial purpose.
Déjà vu all over again
If you hang around long enough in tax, everything comes round again, and so it seems to have done with these schemes. In essence, Mrs D'Arcy had a large tax liability on her income which she would have preferred not to have, and her tax adviser had a way of getting rid of it. This involved a repo and a sale of £32 million of gilts. Mrs D'Arcy is a very successful recruitment consultant, not a stockbroker, and I feel safe in saying that she was not shorting gilts because she thought the market was about to turn against them. Had she been told that the way to get a tax deduction was to buy and sell yak milk futures, and had been assured that she was not taking any commercial risk, I am sure she would have done so.
Again, six months ago I went through the way in which the judicial tide has retreated from the high water mark of Furniss v Dawson in recent years, which has made schemes like this possible again, although I still wonder whether running a straight circularity argument in this case might have been worthwhile. As I concluded in that article:
'If the scheme had not been stopped, there would only have been two things preventing every taxpayer in the country from completely obliterating their income tax liability. The first would have been the availability of gilts to repo around the ex div date, and the second would have been the costs of the scheme.'
Paper mountain
But of course the scheme was stopped, by ensuring that the manufactured interest deduction can only be offset against the actual interest received. This was introduced by FA 2004, Sch 24. That schedule takes up about a page in the Yellow Handbook. It is a page of legislation which is designed never to be used. The intention is that, having worked out the tax implications of the scheme, and realising that they will prevent any tax advantage being gained, the adviser will not put forward a scheme such as this. The time and effort that is put into drafting the legislation, debating it in Parliament, printing it, and reading it is therefore totally wasted — the net result is that in future nothing will happen.
There is a growing amount of legislation for which this is true. The consultations on managed service companies include eleven pages of draft primary legislation and a further nine pages of draft regulations. So far as I can see, the sole purpose of this legislation is to make managed service companies pointless. So no-one will use them, and as a result the legislation will never actually be applied.
Don't shoot the messenger
HMRC's response to this is generally to blame the firms which provide the tax planning. Dave Hartnett, in evidence to the House of Lords Select Committee on Economic Affairs said that the avoidance industry and its clients were now 'on notice that this huge range of arrangements that they have seen in the past to reduce tax and national insurance liability has reached a stage where a much broader response is needed than has been given in the past'. He said that in the context of the tax avoidance disclosure rules, about which he seemed optimistic. They certainly they have the potential to make an avoidance scheme uneconomic right from the start, on the grounds that it will be closed down before any significant fees can be raised from it.
But HMRC need to be aware that it is not the firms which drive this sort of artificial tax planning — it is the demand from clients. I find it eternally surprising that people who in other areas will want to steer clear from even a hint of impropriety will gladly jump on any method of saving tax. Indeed, a surprisingly large percentage of the general public seem to be prepared to evade, rather than just avoid, their taxes. Tax advisers are given far too little credit by HMRC for their contribution to reducing the 'tax gap' by persuading otherwise gung-ho clients that, no, they really can't claim that their company BMW is a pool car just because it is occasionally borrowed by another employee, and that yes, they really do have to declare the rental income from their villa in Spain.
There is undoubtedly a debate to be had about the role of tax advisers in the context of artificial schemes. The process whereby legislation is amended and re-amended like some ancient Greek palimpsest is ineffective and unedifying. But tax advisers do not create these tax schemes and then persuade reluctant clients to 'just try one' like some evil drug pusher outside the school gates. It is the clients who are driving the industry, and it would be far more effective to persuade them that such schemes are going to be more trouble than they are worth, and to stop continually attacking advisers for devising them in response to demand.
