A hard drive

KEY POINTS

• Harmonisation has given HMRC much greater information powers.
• FA 2008, s 114 extends meaning of document, e.g. in CEMA 1979, s 118B.
• Glenn shows this can extend to HMRC seizing a computer without a warrant.
• Clients need to be told in advance how to react to such a demand.

A sleepy government department no longer, HMRC are very active these days. Since the merger of the Inland Revenue and Customs & Excise in 2005, a plethora of new civil and criminal powers have been introduced to assist HMRC in their endeavours to plug the so called ‘tax gap’.

FA 2007 was the first step in harmonising direct and indirect tax penalties by creating a new cross-duty penalty regime for inaccuracies in the mainstream taxes.

FA 2008 contained new information and inspection powers for the main taxes and further penalty harmonisation for stamp duties, inheritance tax, insurance premium tax and other less common taxes.

FA 2009 then clarified and extended the information and inspection powers, and introduced a new penalty for carelessly or deliberating providing incorrect information in response to an information notice.

It was against this background that the Administrative Court, in R (on the application of Glenn & Co (Essex) Ltd) v HMRC [2010] EWHC 1469 (Admin), was recently asked to consider the legality of HMRC’s actions in removing computers from business premises.

What is a document?

The taxpayer company dealt in excise goods and was registered as a revenue trader. On 4 February 2009, several Revenue officers entered the taxpayer’s business premises, unannounced and without having obtained a warrant.

They stated that the purpose of the operation was to conduct interviews and to inspect business records including computers.

The officers disconnected and removed a computer server and 19 desktop computers to interrogate their hard disks. All but one of the computers were returned the following day and the remaining computer and server was returned on 6 February 2009.

The taxpayer challenged, by way of an application for judicial review, the legality of the officers’ conduct in removing the computers.

In the case of excise goods, HMRC’s powers in relation to inspection, information and search were at the relevant time contained in Customs and Excise Management Act 1979 (‘CEMA 1979’).

The information power was to be found in s 118B. So far as relevant, s 118(5) provided that ‘if it appears to an officer to be necessary to do so, he may, at a reasonable time and for a reasonable period, remove any document produced [by the taxpayer]…’.

This civil power to obtain information is to be distinguished from HMRC’s criminal search power, which was contained in CEMA 1979, s 118C and which could only be exercised pursuant to a warrant authorised by a justice of the peace, who in turn had to be satisfied that there were reasonable grounds for suspecting serious fraud. The meaning of ‘document’ was extended by FA 2008; see FA 2008, s 114.

Put shortly, the taxpayer argued that (notwithstanding the enlarging effect of FA 2008, s 114) CEMA 1979, s 118B did not apply to computers. HMRC submitted that s 118B, read in the light of s 114, enabled Revenue officers to remove computers from the taxpayer’s premises.

Within the scope

Mr Justice Lloyd Jones commented that s 118B permitted ‘a substantial intrusion into the affairs of the persons against whom it may be invoked’ and there is, therefore, a particular need to ensure ‘that the provision is given no wider reading than Parliament must be taken to have intended’.

The judge was of the view that, as a matter of first impression, the words contained in s 114(2) are sufficiently wide to extend the inspection power contained in s 118B to a computer, as a computer is a thing in which information is recorded.

He adopted the description provided by Burnton J in R(oao H) v Commissioners of Inland Revenue [2002] STC 1354:

‘33. The data on the hard disk is stored in magnetic form. Although the data may be regarded for some purposes as contained in separate files, they are all stored on the same physical object, namely the hard disk. Files may be copied to a floppy disk or other storage medium. They may be removed from the hard disk by a ‘cut and paste’ onto another storage device, but this process alters accessibility to the data on the hard disk; which, if not obliterated becomes non-referenced data… Files cannot be removed from the hard disk physically.’

Although there are a number of authorities concerning searches carried out pursuant to a search warrant, i.e. under the criminal code, which are supportive of HMRC’s arguments, Glenn & Co (Essex) Ltd was the first case in which this specific issue had to be decided in the context of FA 2008, s 114(2).

The taxpayer argued that a document was something tangible on which evidence or information is physically recorded.

By contrast, a computer is a piece of machinery comprising a number of features, operated by electricity and having a wide range of functions. The judge did not appear to have much difficulty in dismissing this argument. He said:

‘But in any event, s 114 is clearly intended to ensure that the provisions to which it applies have effect in relation to a category of things which are described in extremely wide terms. In their natural meaning the words of s 114 are entirely appropriate to include a computer because a computer is a thing in which information is recorded.’

Nor was the judge able to accept the taxpayer’s submission that s 114(3) and (5) made a separate provision for computers.

‘However, the mere fact that computers are expressly referred to in these other provisions does not prevent the provision in s 114(2) from extending to a computer. However, Mr Southern [counsel for the taxpayer] then goes on to argue that s 114(3) draws a distinction between a “relevant document” and a “computer… used in connection with a relevant document”. He submits that if “document” means “computer”, this reads “computer… used in connection with a computer”. He submits that the legislation only makes sense on the basis that a computer is not a document. However, this subsection is clearly intended to apply to a computer used in connection with a document. It may be necessary to inspect and check the operation of a computer to find out when a document was written, amended, deleted, received or sent. This provision is intended to address the way in which information has been handled. To my mind there is no incompatibility between this express reference to a computer and a distinct possibility that a computer may fall within the ambit of s 114(2).’

What can be taken?

The taxpayer also argued that s 118B could be exercised only in relation to ‘any documents relating to the goods or services or to the supply, importation or exportation or to the transaction or activity’, and each of the computers removed would have included further documents that did not fall within this description. Therefore, HMRC had no legal power to remove
the entire computer. This argument was again dismissed by the judge:

‘A hard disk is not simply a container of files but is properly regarded as a single object containing a variety of materials ... the fact that the computers inspected may have contained information which did not fall within the category specified in s 118B(1)(b) would not prevent the exercise of the power in relation to that computer provided it contained some information within that category… The information power in s 118B expressly permits, in the case of documents, the making of copies of or extracts from the documents produced and, in certain circumstances, the removal of such documents.’

The judge therefore concluded that the power of inspection does extend to the inspection of a computer.

Taxpayers be warned

Unannounced inspections by HMRC are on the increase. HMRC are making full use of their enhanced powers under FA 2008, Sch 36 to enter business premises and inspect business documents that are on the premises. These powers now apply both to direct and indirect taxes.

Although Glenn & Co (Essex) Ltd concerned different statutory provisions, the reasoning of the judge in that case is equally applicable to inspections carried out by HMRC under Sch 36.

The commercial disruption caused by the removal of computers is clear: such action by HMRC could have a disastrous affect on a taxpayer’s business. Indeed, such a concern was raised by the taxpayer in Glenn, but received short shrift from the judge, who said:

‘The claimant then pointed to the disruption of the claimant’s business which was caused by the removal of the firm’s computers on this occasion and contends that the power of inspection under s 118B cannot have been intended to permit such disruption of the claimant’s business. The difficulty with this submission is that s 118B makes express provision in ss (5) for the removal of documents at a reasonable time and for a reasonable period and ss (7) makes provision requiring copies of documents required for the conduct of the business to be made available. These provisions clearly contemplate some disruption of the business.’

Taxpayers need to be alive to the possibility of an HMRC inspection, which should be on at least seven days’ notice but may be carried out without notice under certain circumstances, and the possibility of computers containing non-relevant information being removed from premises.

Taxpayers need to consider in advance how they will react to such an inspection and may wish to consider whether they should have in place a clear strategy for dealing with such visits.

It is important that taxpayers are aware of their rights in such circumstances, to ensure HMRC do not exceed their powers.

This is particularly important when the material that HMRC wish to inspect may include legally privileged material.

Jonathan Levy is a partner and head of the tax disputes resolution team at Reynolds Porter Chamberlain LLP. Telephone 020 3060 6472 or email.

Issue: 4267 / Categories: Comment & Analysis