Tuesday March 22, 2022

Historic tax avoidance schemes current challenges for accountants and their insurers

Recent years have brought a number of professional negligence claims against accountants relating to apparently legitimate tax schemes that have subsequently fallen foul of HMRC.

The claims – relating to tax structures including film schemes and ”disguised remuneration” schemes – have in many cases arisen from HMRC subsequently investigating and finding against an accountancy firm’s clients. In other instances, clients have proactively referred themselves to the tax authority having investigated and developed their own concerns about a scheme’s structure, or have uncovered potential issues with schemes they participated at the point they are selling their business.

In our experience, liability can arise because many accountants and their clients failed to understand how aggressive these historic schemes were.

Disguised remuneration schemes, for example, saw people paid in loans to avoid paying tax and National Insurance. However, the schemes were shut down in 2019 and HMRC, which judged that the loans were clearly income, demanded any tax that hadn’t been paid.

We’ve also seen multiple claims against the same firm of accountants in relation to a misguided employment benefit structure that it had promoted to its clients. And a lot of claims have been pursued after accountants stepped outside their day-to-day expertise to offer schemes to clients that weren’t in their skill set.

In many cases, the promoters operating such schemes subsequently disappeared into the ether, leaving only the accountants who acted as an introducer to face repercussions. They now face claims on their professional indemnity insurance policies.

Whatever the circumstances leading up to the complaint, this has a direct implication for a defending accountant’s insurers, who could see a potentially sizeable claim on a policy.

With claims usually settled out of court through mediation, thoughtful, thorough assessment of a client’s liability to determine whether they acted as a ‘reasonably competent professional’ will help insurers assess policyholders’ culpability, and ultimately any appropriate settlement.

In this process, there will be a few key steps to keep in mind.

A forensic investigation

The first step of any liability assessment must be to determine what the tax scheme itself was intended to do.

Insurers and their legal counsel will need to know how the scheme was envisioned and designed to operate at its point of execution.

This must be irrespective of how legislation or HMRC guidance subsequently changed or developed – negligence cannot be upheld if it was feasible that the scheme would have been legally permissible at the time an accountant was brought onboard. It will also be critical to examine whether the scheme was subsequently implemented as envisioned by the accountant or promoter, and whether pertinent tax counsel was sought and heeded.

The next stage should include a review of the marketing material for the scheme, the accountant’s interpretation of it and how much, or little, the accountant was involved in promoting it to the client.

In some cases, it will be that accountants merely made introductions to scheme promoters, and may have given appropriate warnings to their clients at the time about potential risks down the line.

If firms were actively involved in a scheme’s execution or promotion, a defence should examine factors such as whether they understood and accounted for their client’s risk appetite; how or whether they outlined the potential for legislation, case law and HMRC’s own guidance on the scheme to change and whether they considered any less aggressive tax-optimisation alternatives.

From here, insurers will need to consider how the claimant acted in any correspondence with HMRC, including whether any alternatives to paying claimed outstanding tax were explored, or whether payment was made immediately to the tax authority without any due consideration of mitigation.

And, importantly, it will be essential to determine the quantum of the loss. This will need to account for any tax bill itself. But claimants may also register a claim for the opportunity cost against an accountant – the potential profit lost when capital that could otherwise have been channelled into the business is now instead paid in tax.

All the answers?

The process of determining negligence can be highly complex. And this complexity can only be compounded by the historic nature of many of these schemes, and the need to identify and source experts with knowledge of how they were operated and implemented at the time in order to build a thorough defence.

Going forward, the UK tax regime will only become more complicated, holding the potential for ever more negligence claims. For insurers, working with accountants to encourage good record keeping of how they advise on schemes will help put them, and their customer, on the strongest possible footing should a claim arise.

It will also be helpful in mitigating risk to encourage accounting clients to ask for appropriate third-party support with complex tax issues when required.

Not every accountant will be an expert in all types of tax, and tax issues can be much riskier than accounting or audit.

With the UK tax code running to more than 6,000 pages, there’s no shame in the accountant in general practice  seeking specialist advice on tax matters – a move that could protect them from receiving claims in the first place, and consequently limit risk for insurers.