IT contractors' offshore scheme 'born to avoid tax'

Droves of IT contractors must have used an offshore scheme solely to avoid tax, because a "genuine commercial purpose" to such an arrangement does not exist.

The verdict, issued yesterday by the High Court, effectively cues up HM Revenue & Customs to claw back £100million from UK residents, including 2,000 IT contractors.

Individuals on the scheme, provided by Montpelier, examined by Mr Justice Parker channelled their income through a trust that was not subject to UK income tax.

Their incomes were also not subject to tax in the trust's jurisdiction, the Isle of Man, because the income belonged to them - the scheme users, who were UK residents.

Self-employed IT worker Robert Huitson was one such individual who, despite being told by HMRC of a potential challenge, ducked £85,000 in income tax over 7 years.

A "bandwagon effect" where thousands of other self-employed people joined the scheme, and their variants, for the promised tax saving ensued, the court heard.

These individuals emerged with negligible income tax rates – Huitson lowered his to 3.5 per cent, affording them an unfair competitive advantage over their peers.

" It is one thing to try to compete with, say, an IT consultant who is perhaps more experienced, efficient or skilled", Mr Justice Parker said in his judgement.

"It is entirely a different matter to seek to match a competitor who has the advantage of an effective income tax rate of 3.5 per cent."

In other words, if the schemes were still flourishing, all self-employed people could cut their tax bill to a "tiny fraction" of what it would be otherwise, the judge said.

However in March 2008, the government issued Budget Note 66 (BN66) to introduce anti-avoidance legislation under the 2008 Finance Act, with retrospective effect.

Assessments by HMRC of income tax, assuming no fraud or negligence, are capped to 6 years, so the retrospective effect of BN66 extends no further than 2001-02.

Still, Huitson's lawyer argued that the retrospective move breached his human rights, and in turn the human rights of other scheme users, some of whom face bankruptcy.

In addition, court papers (based on a survey of almost 100 affected users) reveal 57 scheme users are unable to pay their tax demands even if they sell all their assets, and 28 face having to remortgage their family home.

Huitson's lawyer claimed that the tax affairs of the scheme users had been legal, as HMRC took no action until the law was changed, despite knowing about them.

Although Mr Justice Parker accepted "long inaction" from HMRC, he rejected that the retrospective effect of BN66 breached human rights or was disproportionate.

Firstly, he said, the Revenue had warned the users that their tax claims might be challenged, and advised them to pay the income tax which it said was properly due.

Moreover, the judge pointed out that the government has the right to change tax law retrospectively to shut down arrangements that it deems to be artificial.

His judgement states :"HMRC submits – and this did not appear to be seriously disputed by…[Huitson's lawyer] – that such elaborate arrangements would not have been entered into other than for the purpose of tax avoidance. The arrangements had no genuine commercial purpose."

Last night, the judgement drew a mixed reaction from leading tax, accounting and legal experts.

On the one hand, the retrospective clawback arising from BN66 was unprecedented in the history of tax legislation, said John Whiting, of the Chartered Institute of Taxation.

He told CUK: "I think all tax practitioners will worry a bit about this judgement if it is seen as opening the door to retrospection

"[This judgement is] of concern to all because tax systems should aim to give certainty. Retrospection is inherently unfair, creates uncertainty and risks damaging trust in the system."

Seeming to address those taxpayers who will be most concerned – the scheme users – Mr Justice Parker said HMRC intended to take into account their "financial hardship" before pursuing them.

But Simon Dolan, of SJD Accountancy was unconvinced: "Despite the judge's warm words about the Revenue's sympathetic approach to taxpayers suffering financial hardship, I'm sure that going forward the taxman will have no hesitation in approaching them for the tax owed.

"This is obviously a disappointing result for lots of contractors who have been caught out by the promises of the scheme provider, resulting in uncertainty and worse for many of the provider's customers."

However, on the other hand "the judgement highlights the importance for contractors of receiving professional accountancy advice," Dolan said, and ensuring that, as UK taxpayers, they fulfil their tax obligations.

Roger Sinclair of Egos, a legal firm, also expressed "every sympathy" for those taxpayers who stand to "lose a lot" as a result of the High Court's judgement.

But he too agreed that 'BN66 contractors' were always at risk: "I have to say that this case does rather illustrate the dangers of using tax avoidance schemes which rely on artificial arrangements, where the arrangements lack any apparent commercial purpose, beyond the reduction of the tax bill."

According to SJD, the High Court has effectively said that the tax demands the Revenue has made upon scheme users are accurate, lawful and owed.

"What will happen now is that the tax demands will now become payable, up to the point that an appeal to yesterday's ruling overturns them," the firm said.

"[But] this is not taxpayers falling upon hard times, rather HMRC will see it as taxpayers choosing to get involved in a complex, anti-avoidance offshore scheme that, for some, saved hundreds of thousands of pounds".

Given that Huitson's lawyer has indicated that his client will appeal, the chartered accountant Warr & Co says the case is likely to be decided in the Supreme Court, probably towards the end of 2010, or even early next year.

Legal experts say the avenue most often open to those wanting to challenge a High Court judgement is to appeal with leave of the court they are appealing from, or with leave of the court they are appealing to.

But as Mr Justice Parker refused to hear any appeal, it follows that it might be open for Huitson to approach the Court of Appeal and ask for permission to contest the High Court's decision.

Yet a spokesperson for Her Majesty's Treasury signalled to CUK that the right outcome had already been reached.

"The government is pleased with the decision of the High Court," the official said. "Prior to introducing the legislation the government considered very carefully the issues relating to fairness and certainty, and the public interest, and took the view that in the circumstances the legislation was appropriate."

Meanwhile, HMRC would not be drawn on whether there was now a timetable for approaching taxpayers with liabilities under BN66, though such a schedule would likely take account of an appeal process.

Nor was there any word on how actively tax officials would enforce the tax demands, in the light of the judge's expectation that financial hardship for taxpayers would not be ignored.

However, a HMRC spokesman did confirm that BN66 has now been ruled as compatible with the European Convention of Human Rights, adding: "HMRC is serious about tackling those who seek to avoid their tax obligations."