The legality of retrospective tax legislation hangs in the balance, as does the likelihood of many contractors having to pay up to hundreds of thousands of pounds in retrospective taxes, interest and penalties.
Contractors affected by Budget Note 66 (BN66), which introduced the clarification of tax legislation known as Section 58(4), are awaiting a crucial vote by MPs to amend the law in this year’s finance bill. Should MPs fail to vote through the change, a dangerous precedent may have been set, which confirms the UK parliament’s power to create retrospective tax legislation, undermining tax certainty for contractors and other taxpayers.
David Colom of contractor accountant DJ Colom explains: “Although it was classed by HMRC and the government of the day as a clarification of existing tax law and not retrospective legislation, introducing Section 58(4) was akin to the government deciding to change the motorway speed limit to 60mph and then charging every driver who drove at 70mph for the last seven years for speeding.”
What is BN66 and Section 58(4)?
According to Colom the government’s objective with BN66 was to tackle specific tax planning schemes offered by Isle of Man-based scheme providers used by contractors and other taxpayers to mitigate their tax liabilities.
“The self-employment-based schemes made use of offshore trusts and double taxation treaties. Although they were highly aggressive tax avoidance schemes and therefore risky, they were perfectly legal prior to the publication of BN66, which introduced Section 58(4),” he says.
“HMRC was aware of the schemes from as early as 2002, and even published an internal briefing confirming it knew the schemes existed and were, at the time, legitimate. This suggests that if HMRC tried to challenge the legality of the schemes, they may have failed. HMRC also stated it intended to introduce specific legislation to tackle the schemes, but it did not.”
Section 58 (4) was intended to close a loophole following the case of Padmore vs IRC.In that case, the taxpayer (Mr Padmore) managed to avoid tax completely on his income through a series of transactions involving a partnership in Jersey.Section 58(4) was itself retrospective and intended to tackle tax avoidance through the use of double taxation treaties and foreign partnership arrangements.
“What Section 58(4) said was not that ‘Padmore’ should apply to relevant tax schemes from March 2008 when BN66 was published, but that it should always have applied,” explains Colom. “And because the schemes were self-employment-based, HMRC therefore came after the individual contractors at the end of the chain for tax assessments, interests and penalties rather than the scheme provider.”
If government can change any law it does not like retrospectively, then we all have a lot to fear
David Colom, D J Colom
The result was that up to three thousand scheme participants received assessments from HMRC for back taxes, interest and penalties backdated seven years, to 2001. Many contractors are facing tax bills of hundreds of thousands of pounds.
Is BN66 and Section 58(4) retrospective, or a clarification?
“There are two schools of thought about whether Section 58(4) constitutes retrospective legislation,” continues Colom. “HMRC and the Treasury’s view is that they said they were going to introduce legislation to tackle what they viewed as abuse, so Section 58(4) is merely retroactive based on an action they took previously, and not retrospective.”
No action was taken because the details of the scheme were revealed only when the Disclosure of Tax Avoidance Scheme (DOTAS) legislation came into force in 2004, although this is inconsistent with HMRC’s knowledge of the schemes as early as 2002.
Furthermore, supporters of BN66 claim that the loophole allowed by the double taxation treaty never actually existed, so there was no loophole to close. The legislation to tackle avoidance using partnerships and double taxation treaties between the UK and Isle of Man has always been there, and from 2008 HMRC was simply enforcing it correctly.
The tax community believes the legislation to be retrospective
“However, the widely held view of the tax community, including the Chartered Institute of Taxation (COIT), the Institute of Chartered Accountants in England and Wales (ICAEW) and the Law Society, is that Section (58(4) is in fact retrospective tax legislation.”
Colom's experience of aggressive tax avoidance schemes is that once HMRC become aware of a new one it usually acts swiftly to close it down with fresh tax legislation sometimes within a matter of weeks of the launch of the scheme.
“Under DOTAS, scheme promoters must register their schemes and exactly how they work or face hefty fines. HMRC is therefore provided with detailed information about every scheme and any loopholes the schemes may exploit. If the scheme was not legal, why did HMRC take no action in 2004 when formally informed of its existence?
“What BN66 and Section 58(4) represent potentially undermines the certainty on which all tax planning and taxpayers depend. The government could decide it does not like specific taxpayer behaviour, legislate against it, and backdate the legislation as far into the past as it likes. Ultimately, although highly aggressive and risky, the schemes BN66 set out to tackle were legal at the time contractors joined them, and most likely would have been closed immediately BN66 was published.”
Recent activity to amend Section 58(4)
Contractors facing HMRC assessments as a result of their participation in the scheme have tried various measures to repeal Section 58(4), but have so far failed. However, last month, eighteen MPs from five political parties wrote to Chancellor George Osborne highlighting the dangers of retrospective tax legislation and requesting that Section 58(4) be amended to take effect from 12th March 2008.
There is an amendment proposed in the 2013 Finance Bill that changes Section 58(4) from reading “always having had effect” to “having effect from 12 March 2008”. MPs are due to vote on adopting the amendment this month.
Despite the current leadership of the Treasury supporting the repeal of Section 58(4) when in opposition, government and HMRC opposition to the amendment is believed to be fierce, so there is no guarantee that the bill will be passed without further changes to remove the amendment.
What the future may hold for those contractors affected
If the amendment fails then this will leave contractors still liable for their tax assessments, potentially pushing many into losing their homes and/or bankruptcy. Colom says: “Because Section 58(4) was introduced in 2008 confirming that the legislation was ‘always having had effect’, HMRC will continue to demand tax, interest and penalties from former scheme participants.
“And although there remain several routes of appeal, because the schemes were self-employment-based and HMRC has targeted each scheme participant individually, it is unlikely that any one individual will stump up the tens of thousands of pounds required to support further appeals.”
However, should MPs vote to include the amendment then HMRC will be required to cancel their assessments, leaving the contractors in the clear.
Colom concludes: “My deep concern is that if the government and HMRC succeed with this instance of retrospective taxation, they will do more of it if they think they can get away with it, particularly in the current anti-avoidance climate.
“This is not only unfair on individuals who simply entered into a perfectly legal transaction at the time, but also serves to undermine the general concept that we are all entitled to certainty under the law - if government can change any law it does not like retrospectively, then we all have a lot to fear.”