An offshore thing

In-house lawyers at UK financial institutions may already feel that they have enough on their plate. As well as dealing with pension and endowment selling reviews, customer complaints and new areas of regulation such as mortgage and general insurance, there are many other aspects of the UK financial services regime that are time-consuming and require continuous attention. There are also the obligations imposed by the Proceeds of Crime Act 2002 and the provisions of the new Money Laundering Regulations 2003, which will come into force on 1 March 2004.

If this was not already enough to think about, the recent developments arising out of the Government’s determination to crack down on tax evasion and close loopholes on tax avoidance schemes has created further food for thought. The potential problems for all businesses, but particularly financial institutions with offshore arrangements for private customers, are such that tax compliance can no longer be dealt with outside the remit of the legal department.

In the wake of criticism for failing to hit targets to recover unpaid tax, the tax authorities have in the past year launched an aggressive and far-reaching enforcement campaign. In addition to high-net-worth individuals and owner-managed businesses, multinationals and large corporations are increasingly being targeted by the Inland Revenue’s Special Compliance Office, the unit responsible for investigating cases of suspected tax fraud. According to Sir Nicholas Montagu, the chairman of the board of the Inland Revenue, one in 10 of the UK’s top companies are under investigation for suspected tax evasion.
The Sunday Times reported him saying: “I have extremely expert people in an office specifically dedicated to the affairs of large corporations, and we are ruthless in our pursuit of evasion and of unacceptable avoidance schemes.”

This shift comes against a background in which the traditional distinction between tax avoidance (which in principle is permissible under English law) and tax evasion is becoming increasingly blurred.

Offshore Arrangements Project
The Inland Revenue has decided that a large part of its efforts to counter tax evasion and close loopholes on “unacceptable avoidance” schemes should revolve around tackling the exploitation of offshore arrangements.

Recently, the Inland Revenue released details of its Offshore Arrangements Project, a new initiative directed at recovering billions of pounds of unpaid tax which is believed to be secreted in companies and trusts in offshore tax havens. Sixty-four Inland Revenue inspectors have been designated as offshore consultants to coordinate the identification and investigation of the highest risk cases. A new database, which contains the names of UK and Irish companies and directors and shareholders (including several thousand Channel Island and Isle of Man companies) is understood to have identified 30,000 UK taxpayers for investigation.

The Inland Revenue is looking hard at private client businesses, particularly financial institutions and their customers who make use of offshore discretionary trusts. Its newfound enthusiasm for this derives from a recent matter in which one particular financial institution permitted its UK tax-domiciled private customers to establish offshore discretionary trusts through its Jersey subsidiary, without making the requisite notification to the Inland Revenue under Section 218 of the Inheritance Tax Act 1984. That provision requires anyone concerned in the setting up of an offshore discretionary trust to make notification to the Inland Revenue within 30 days of any settlement into that trust. Although failure to make such a notification is an offence, the breach of Section 218 is not, in itself, the main issue. Rather, it is being viewed by the Inland Revenue as merely the symptom of a greater mischief.

The Inland Revenue takes the view that in many of these cases the purpose of the establishment of the offshore settlement is to evade tax. Worse still, the Inland Revenue believes that in many cases the institutions, or their salespeople, may even be encouraging customers not to make a disclosure to the Inland Revenue and may be suggesting to UK-domiciled customers that the establishment of an offshore discretionary trust is an effective way of hiding efforts from the Inland Revenue. Partly because of the Inland Revenue’s experience with this one financial institution, it believes there is a likelihood of substantial revenue on the same issue from other institutions and their customers.

The Inland Revenue is dusting off its old investigation files and is rumoured to be working its way down a long list of financial institutions with offshore subsidiaries. It is believed that the Inland Revenue’s current view is that the application of Section 218 is not limited only to offshore trusts, but that it may cover settlements in the widest meaning of the word.

The Inland Revenue has broad powers to require from financial institutions the disclosure of documents relating to tax-paying third parties. In particular, it has been using its powers under Section 20(8A) of the Taxes Management Act. Compliance with such notices can be extremely costly, and in the past those who have challenged a Section 20(8A) notice on the grounds that compliance is too onerous have not been successful where the Inland Revenue has been able to show a significant amount of tax at risk.

Any financial institution that finds itself the subject of an Inland Revenue investigation on these issues may be excused for thinking this is primarily an issue for its customers, rather than for the institution itself. However, while it may be true that the Inland Revenue is primarily interested in recovering tax from the individuals concerned, where salespeople have actively encouraged the establishment of such schemes as a means for hiding efforts from the Inland Revenue, then the institution itself may have committed an offence.

A further issue is that, to the extent that the relevant documentary records are held by the offshore business alone, and not in the UK, the Inland Revenue authorities will not have the power to access those documents directly. One of the methods it is using to circumvent this problem is linked to the way in which many of these offshore accounts are used. Many UK-domiciled customers with offshore accounts either use those accounts to pay their own credit card bills or have credit cards issued on those accounts themselves. Those credit cards tend to be processed onshore (either in the UK or in the US), and so for the UK Inland Revenue (as well as for the US Internal Revenue Service), the credit card facilities offered in relation to these type of accounts provide the key to accessing the information required by the authorities.

The Inland Revenue sees this area as potentially being its most productive project at present. To this extent, it has diverted considerable investigation resources away from other projects so that it can focus on identifying the financial institutions that are likely to give rise to the greatest return in this area.

Cross-border issues
In Europe and around the world, fiscal authorities are increasingly making pacts to exchange information on a reciprocal basis on matters concerning tax liabilities, such as deposit interest received by non-resident account holders.

Dawn Primarolo, HM Paymaster-General, has said: “The UK Government strongly supports the use of exchange of information in combating cross-border tax evasion and avoidance.” In Parliament on 9 January 2004, in response to a question about lost tax revenues, she also said: “[I]n order to minimise tax lost or at risk, the UK is committed to encouraging the crown dependencies and overseas territories to match international standards on exchange of information for tax purposes and on fair tax competition, and welcomes the progress that has been made so far.”

Financial institutions, then, should be alive to the multilayered international approach that is being used to clamp down on tax evasion through tax havens when dealing with requests for information and/or voluntary disclosures.

Legal issues
The issues are potentially so serious for financial institutions in the UK that in-house lawyers cannot afford to ignore them. Traditionally, in many organisations, both within and outside the financial services sector, tax matters have been left to be dealt with outside the legal department. Advice is often obtained by non-lawyers who turn
to other professional services firms in circumstances where that advice will not be protected by legal professional privilege. With the recent developments in relation to the law of privilege, it is essential that specialist advice is obtained at the earliest possible opportunity.
Moreover, the new investigation process adopted by the Special Compliance Office involves interviews under caution and conducted in accordance with the Police and Criminal Evidence Act 1984, which is yet another reason for involving lawyers sooner rather than later.

Much work to be done
Most financial institutions with offshore trust businesses should review their current and historic processes as a matter of urgency. The Inland Revenue is likely to proceed more gently with those who approach it voluntarily. The full force of the Inland Revenue’s powers will be felt by those whom the Inland Revenue gets to first.

Neil Gerrard and Jonathan Pickworth are partners in the regulatory group at DLA