Britain begins another fiscal year this week with the country short on cash, meaning yet another year of the Crown stepping up collection of corporate taxes to help close the gap.
This year, however, the royal tax collector will have a new tool to force companies to disclose possible tax evasion more quickly if they want to stay on the government's good side.
The tool is a process known as Code of Practice 9—or COP9—that Britain's revenue authority, the HMRC, uses to treat tax evasion as a civil matter rather than a criminal one, to avoid the time and cost of a prosecution.
COP9 has been in the HMRC's toolkit for years, but a new version went into effect Jan. 31 that offers businesses immunity from prosecution only if they agree to what's called a Contractual Disclosure Facility (CDF). Under this deal, the company has to admit to fraud immediately, and within 60 days, and then outline details of what happened, including how the fraud was carried out and why it wasn't detected. The company also has to pay any tax due.
If any of the disclosures turn out to be false or incomplete, or the company doesn't comply with any disclosures that HMRC requires after the 60-day deadline, the deal is off and HMRC can prosecute.
The creation of the CDF represents a “considerable hardening” of HMRC's approach to suspected evasion, says law firm Shoosmiths. Previously, companies didn't have to admit fraud; they were offered immunity from prosecution immediately, as long as they did not make any materially false statements or provide false documents with intent to deceive.
Moreover, the 60-day deadline is unlikely to leave a company enough time to get its disclosures ready and to have their accuracy certified, the firm says. The Institute of Chartered Accountants of England and Wales had wanted HMRC to set two deadlines: one to decide whether to admit fraud and one to then get the paperwork ready. The HMRC said no.
What's more, considering Britain's dire fiscal situation, the HMRC has a strong incentive to use COP9 with zeal. The government estimates that large companies underpaid taxes by about £9 billion ($14.4 billion) in 2010, roughly one-fourth of the total personal and business “tax gap” Britain faced that year. And since the country still confronts a sluggish economy and huge deficits today, the HMRC is determined to close that gap between what large companies pay in tax and what the HMRC reckons the letter and sprit of the law requires them to pay.
The small print of COP9 says the company's outline disclosure only needs to be based on “readily available documents.” That might limit the HMRC's ability to prosecute if a company later discovers that its initial disclosures were wrong, according to a bulletin from the law firm Herbert Smith. But that potential buffer is only “a small crumb of comfort,” the firm says.
Putting Teeth Into the Process
The HMRC will no doubt be pleased if its new rules sound harsh; it changed the rules primarily because “people have become less scared of COP9,” says Gary Ashford, national head of tax investigations at accounting firm RSM Tenon and a member of the HMRC's Compliance Reform Forum. A court case in 2005 forced the HMRC to back off its usual prosecution threats, Ashford says. The new COP9 “is designed to put some teeth back into the process.”
“The Lichtenstein Disclosure Facility gives you all the guarantees that you don't get with COP9.”
—Gary Ashford,
National Head of Tax Investigations,
RSM Tenon
If companies discover a tax fraud, COP9 is meant to give them a means of making a protected disclosure to the HMRC—but the bulletin from Herbert Smith urges corporate tax departments to be skeptical about that. “Taxpayers are unlikely to volunteer [a disclosure] if to do so can expose them to prosecution by reason of material omission,” the bulletin says. That's especially true if the fraud is complex, spans many years, or was committed by an agent or third party acting on the company's behalf.
U.S. companies should be particularly careful about making voluntary COP9 disclosures, Ashford says. They can normally use other ways to declare their problems to HMRC. An agreement between Britain and Lichtenstein, for example, offers far better protection from prosecution. “The Lichtenstein Disclosure Facility gives you all the guarantees that you don't get with COP9,” he says—and you don't need assets in Lichtenstein to use it.
CDF OPTIONS
Below is an explanation of the 3 options under the contractual disclosure facility:
Under CDF, you have 3 options:
Owning up to fraud: the CDF route
Deciding not to own up to fraud: the denial route
Not replying to HMRC: the non-cooperation route
If you own up to committing fraud: entering into a CDF contract
If you decide to admit to committing fraud, you need to think about whether using CDF is right for you.
Entering into a CDF contract with HMRC means you are both agreeing that you will stick to the terms and conditions of the contract.
HMRC will:
agree not to criminally investigate and prosecute you over the fraud you tell them about in that CDF contract
You will:
tell HMRC about all the tax you have deliberately evaded, with no exceptions
give HMRC details of all the tax you have evaded within 60 days of being offered the contract
sign a statement to say that you have provided accurate and complete details of the tax fraud
pay all taxes, duties, interest and penalties due
stop any fraud immediately
Entering into this contract to tell HMRC about all the tax and duties you have deliberately evaded is called ‘formal disclosure.' You might see this phrase used in letters and documents sent to you.
Formal disclosure is the only way that you can admit to a tax fraud without HMRC criminally investigating you. If you decide that this is right for you then you need to sign the acceptance letter and complete the outline disclosure form.
If you meet your side of the contract, you will ensure that any penalties are closer to the lower penalty levels.
Deciding not to own up to fraud: the denial route
If you decide that you don't want to admit to tax fraud, you can sign and return the CDF denial letter that HMRC sent you, within the 60 day time limit. Signing the denial letter means that you may still work with HMRC to make sure your taxes are correct and up to date.
If you choose to follow the denial route, HMRC can begin a criminal investigation into your tax affairs at any time, and the letter you have signed can be used in court as evidence to show that you intended to deliberately mislead HMRC.
If you don't reply to HMRC's letter: the non-cooperation route
If HMRC don't hear from you within the 60 days, either to say that you want to accept the offer of a contract, or that you don't want to admit to a fraud, then they will consider that you have chosen not to cooperate. They will then begin either a civil or a criminal investigation into the tax fraud they suspect you've committed. Remember that a criminal investigation and prosecution could result in a criminal record, confiscation of assets or even going to prison.
Source: HMRC.
The good news: While COP9 sounds like a fearsome process, it's aimed at tax evasion rather than tax avoidance—so it's unlikely to be an issue for many large companies, says David Heaton, chairman of the tax faculty at the ICAEW. “In my experience, COP9 is very rarely used with large corporates that have a senior executive in charge of tax, as that type of business is usually extremely careful about and conscious of its tax obligations,” he says. “They may adopt aggressive avoidance schemes that are challenged by HMRC, but they don't go near evasion.”
Nonetheless, large companies remain central to efforts to close the tax gap. “The HMRC is really upping their game in terms of tax compliance,” Ashford says. One of the most significant measures in the pipeline is the creation of a General Anti-Avoidance Rule (GAAR). This empowers the HMRC to counteract abusive tax avoidance arrangements by setting them aside when it calculates tax bills.
The government said earlier this month that it would legislate for a GAAR next year, having received a feasibility report last November from notable tax lawyer Graham Aaronson. Britain needs a GAAR, he concluded, to crack down on “highly abusive contrived and artificial schemes, which are widely regarded as intolerable.”
Aaronson said a GAAR should not be used against “reasonable tax planning,” just against “abnormal business arrangements” aimed at reducing a company's tax bill. To stop the HMRC from interpreting that difference in its favor, Aaronson said an independent panel of mostly non-HMRC experts should advise on whether tax arrangements are justified.
Aaronson did not call for the creation of a system to give taxpayers advance clearance of their transactions, since the HMRC would not have the resources to make it work. Because of this, tax experts are worried about how a GAAR would operate in practice.
“The key question is how in practice taxpayers will know that their transaction is ‘innocent' in the absence of a clearing system,” says law firm Pinsent Masons. If a GAAR is introduced, large companies that report their tax affairs in real time would need a clear deadline by which the HMRC could invoke it, with a quick way for the business to appeal, the firm said. Otherwise, “it is unrealistic that global corporates will find the U.K. tax system workable.”
The government has not said whether it will adopt the full scope of Aaronson's proposals. But it will consult this summer on some form of GAAR, with a view to bringing it into action next year.
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