Belt tightening

As part of its drive to get to grips with the budget deficit, the coalition government has clearly decided to continue the crackdown begun by their predecessors on so-called 'tax avoidance schemes'.

In June's 'emergency' budget, the coalition signalled its intention to continue the extension of the 'disclosure of tax avoidance scheme regime' (DOTAS) to inheritance tax (IHT) schemes.

The DOTAS regime, introduced in the Finance Act 2004 (FA), currently applies to schemes for the avoidance of income tax, corporation tax, capital gains tax, stamp duty land tax and national insurance contributions. Under the current legislation, a 'scheme' consists of an arrangement or plan falling within certain descriptions, under which a 'tax advantage' may be gained, and obtaining that tax advantage is the main benefit or one of the main benefits of that arrangement. (Note the wording does not require the tax advantage to be the main benefit, but only one of the main benefits.)

In 2009, the Labour government launched a consultation on the proposal to extend the regime to IHT planning. Following the general election, the coalition announced its intention to continue these proposals by launching a consultation of their own in July. The closing date for responses is 20 October 2010.

The Treasury and HM Revenue & Customs readily admit that tax avoidance schemes are devised more quickly than they can keep up with. This is particularly true of IHT schemes because HMRC is often only made aware of the existence of the scheme many years after the scheme has been implemented. The planned extension of the DOTAS regime intends to change this by requiring the 'promoters' (including solicitors) of certain tax avoidance schemes to disclose the details of the scheme, where there is a 'notifiable arrangement' or a 'notifiable proposal'. Where the obligation to notify is triggered, the individual clients (or 'users' as they are described in the legislation) will also need to be disclosed to HMRC. What does this mean for solicitors and their clients?

IHT planning schemes

Since 2006, the creation of most new lifetime trusts has led to an immediate IHT charge of 20 per cent on anything above the settlor's nil-rate band (an entry charge). In addition, such trusts are also subject to ten-yearly anniversary charges on their net asset value at a maximum of six per cent, and exit charges on any payments of capital out of such trusts. This regime is known as the 'relevant property' charging regime, and before 2006 it was applicable only to discretionary trusts.

The focus of the proposed legislation is currently restricted to tax avoidance schemes where 'a main benefit of the arrangement is obtained in relation to a relevant property entry charge'. There is no proposal to extend the DOTAS regime to exit or ten-yearly anniversary charges.

If the scheme falls within this description, the DOTAS regime, contained within the FA 2004 and the Tax Avoidance Schemes (Information) Regulations 2004 (as amended), applies. The regime requires a 'promoter' to provide 'prescribed information' to HMRC within the 'prescribed period'.

Behind the definitions

Section 307 FA 2004 defines a 'promoter' as a person who, in the course of their business, is 'to any extent responsible for the design of the proposed arrangement' or makes the arrangement 'available for implementation by other persons'. Law firms are specifically referred to in the consultation document as falling within this description.

The 'prescribed information' is defined in paragraph 3 of the 2004 regulations, which states that the promoter must disclose:

1. the promoter's name and address;

2. details of the provisions by virtue of which the proposal is notifiable;

3. a summary of the proposal and the name (if any) by which it is known;

4. information explaining each element of the proposed arrangement from which the expected tax advantage arises (including the way in which the arrangement is structured); and

5. the statutory provisions on which that tax advantage is based.

The 'prescribed period' contained within the draft legislation is 12 months from the entry into any transaction forming part of the arrangement.

DOTAS in practice

Once the disclosure has been made, HMRC will provide the promoter with a unique scheme reference number (SRN), which the promoter must provide to the client. The client must then provide this number when completing his annual tax return.

Promoters will also be required to submit returns every quarter setting out the details of clients to whom SRNs have been issued, to enable HMRC to identify those schemes that are not submitting annual returns.

As part of the proposed changes, the penalties for non-compliance with the disclosure regime are also being increased. Previously, the maximum penalty was £5,000 for failure to disclose. The consultation document proposes increasing this to a maximum of £600 per day, with the final amount being decided by a tax tribunal.

The regime not only forewarns HMRC of any new tax avoidance scheme, it also enables them to identify how popular a particular scheme is, what level of benefit may be obtained through it and how long it takes for that benefit to be obtained. All of this is very useful information for a government looking to replenish its coffers.

Although the provisions seem quite drastic, for the now there are a few circumstances when the disclosure regime will not apply.

Only new and innovative schemes '“ the draft legislation contains a 'grandfathering' clause, intended to restrict the regime to schemes that are 'new and innovative'. The regime therefore exempts from disclosure any arrangement that is of the same, or substantially the same, description as arrangements which are already available for implementation, or will be ready for implementation before a certain date (to be decided when the legislation is finalised).

Accordingly, IHT schemes already in place or new schemes in the same form as an existing scheme will not trigger the reporting requirements. Whether the disclosure requirements have a damping effect on the creation of innovative schemes remains tobe seen.

Does not apply to BPR/APR '“ the draft legislation specifically excludes schemes which reduce the entry charge solely because the assets attract business property relief (BPR) or agricultural property relief (APR), they are conditionally exempt as being heritage property, or they are exempt as a transfer into a heritage maintenance fund under section 27 of the Capital Transfer Tax Act 1984.

Legal professional privilege '“ solicitors may be less troubled by the provisions because of the availability of legal professional privilege. Where a solicitor cannot make full disclosure without revealing legally privileged information, section 310 of the FA 2004 exempts a promoter from the need to disclose and shifts the burden to the client.

Practitioners may be concerned about the application of this rule and may consider seeking guidance as to when they can and cannot rely on privilege to avoid the reporting requirements. However, the reality may be that it makes little difference in practice.

If a client is required to disclose when privilege does apply, many clients may decide to waive privilege and instruct their solicitors to make the disclosure on their behalf. Nonetheless solicitors will need to be careful to advise their clients and take instructions accordingly.

Other tax professionals '“ in complex tax planning arrangements, a client is likely to have several advisers who would fall within the 'proposer' definition, in addition to their solicitor (such as accountants and specialist tax advisers). Solicitors may therefore feel that the disclosure should properly be made by one of these.

However, care should be taken to ensure that the disclosure is made to avoid liability. This is true even if the solicitor's sole role in the process has been to introduce the client to the promoter. Under section 312C of the FA 2004 (as amended by the FA 2010), a person whose role is to introduce potential clients to a promoter could be required by HMRC to disclose information about the promoter and the scheme. At the least, solicitors will need to liaise with other advisers to ensure that disclosure is made, and, if more than one adviser is involved, that conflicting reports are not submitted to HMRC.

The impact on you

Remember the legislation is still in draft, and the consultation period has not yet come to an end. However, given that this is the second consultation, in almost identical form, it seems likely the proposals will be adopted. This is supported even further by the recent announcement made by the Chartered Institute of Taxation that the technical feedback it provided in another consultation (on interest harmonisation for corporation tax) was completely ignored. In a letter to HMRC, tax policy director John Whiting wrote: 'If HMRC does not find input useful and constructive, it would be useful to know, so that we can move resources to areas where we can contribute to making good tax law.'

Current thinking indicates the legislation will be introduced in substantially the same form as the draft legislation sometime in early 2011.

If, as seems likely, the regime is implemented, solicitors will be required to explain the disclosure requirements to their clients when advising on tax avoidance schemes within the regime. There will, of course, be clients who decide not to implement a scheme as a result of these new requirements.

However, it is likely that the majority of clients will choose to continue with the scheme regardless. Tax avoidance schemes have obvious benefits and, other than the increased administrative burden at the time the trust is created, there is no immediate financial disadvantage to the client of making a disclosure. For practitioners, however, the administrative burden is greater, and this will need to be factored into the fee estimate given to clients at the outset.

The disadvantage of making the disclosure is the high probability that HMRC will introduce legislation shutting down the most successful tax avoidance schemes as soon as practicable once they have been notified of them, often with 'retroactive' effect on the schemes which will already have been established. Practitioners need only recall the introduction of the pre-owned assets tax rules, and its application to inheritance planning schemes previously set up.

Despite the change in government, and perhaps inevitably in view of the need to tighten the belt, it seems the current climate remains hostile to trusts. A similarly tough approach is expected towards offshore tax planning schemes, with the proposed review of the non-domicile rules, which forms part of the coalition agreement. Recent newspaper articles telling of special tax 'squads' being deployed to crack down on tax evasion (and bracketing such actions with tax avoidance) do nothing to reassure the tax practitioner. For solicitors in the tax planning advisory business, there are tough times ahead.