It was reported in June 2019 that the ‘tax gap’ (ie the difference between what should be paid to Her Majesty’s Revenue & Customs (‘HMRC’) in taxes and what is being received) is continuing to rise and now stands at £35bn. In addition, it is estimated there is a further £10bn plus of underpaid tax as a result of tax evasion and other criminal behaviour.
After a long period of austerity and the continuing uncertain political and financial climate, it is not surprising that HMRC’s efforts to reduce this gap by challenging both tax avoidance and tax evasion receive broad political and public support.
This article will look at the ways in which HMRC has sought to address this tax gap and how this impacts upon financial remedy proceedings in the family court.
Tax avoidance or tax evasion?
Tax avoidance and tax evasion find their way into the financial press on a regular basis. The attitude is often that the two are interchangeable once morality comes into play, but they are very different.
Tax avoidance is legal and is the arrangement of one’s financial affairs to minimise tax liabilities within the current legislation.
Tax evasion is any act that seeks to mislead or hide taxable income or gains. Worded at its strongest, tax evasion is tax fraud.
Recent changes in HMRC
There has, in recent years, been a noticeable increase in HMRC’s deterrence efforts, as well as in its determination to address historical tax misdemeanours. While HMRC has few de-minimis limits as all tax is ‘fair game’, undoubtedly a key target has been, and will continue to be, high net worth individuals (‘HNWIs’).
HMRC recognises that with wealth comes a likely tax risk. Its focus on HNWIs is reinforced by the fact that a large proportion of the tax shortfall is from underpayment of income tax, national insurance contributions and capital gains tax. The tax gap is not solely down to large international companies underpaying corporation tax.
This focus on HNWIs is one of the reasons why HMRC has created a ‘wealth team’.
Taxpayers with net assets of £10m plus will automatically be moved to this team, where their annual tax returns are likely to receive closer scrutiny by HMRC.
This is in addition to the rapid expansion of the Counter Avoidance Directorate (‘CAD’) within HMRC, which was established five years ago as a ‘pop up’ with only a handful of staff. Five years later, it has now dropped that tag and staff numbers currently stand at around 1,500. CAD focuses on challenging tax avoidance schemes, the participators in which are more often than not HNWIs.
It is no surprise, therefore, that many family law practitioners have experienced a steady rise in the number of clients or spouses of clients with actual or potential historic tax liabilities and ongoing investigations by HMRC. This adds another layer of complexity to financial remedy cases.
CAD has been extremely active in challenging historical avoidance arrangements (from employee benefit trusts to film partnerships) utilised over the last 20 years or so and it has generally been very successful.
HMRC wins around 80% of avoidance cases that go through the tax courts, with the result that many participators in avoidance schemes have settled with HMRC before getting to the stage of contested court proceedings. Other participators have settled as they simply want to draw a line under long-running enquiries where they fear ‘throwing good money after bad’.
Despite thousands of settlements involving avoidance schemes over the last few years however, CAD still has numerous taxpayers on its books that have a tax avoidance issue to address. This can be for a number for reasons, including the continuing litigation of a particular avoidance scheme (eg Ingenious Film Scheme) or where HMRC is still deciding the settlement parameters for a particular scheme. Film partnerships involving a sale and leaseback arrangement are a prime example.
Ongoing enquiries into tax avoidance arrangements inevitably lead to uncertainty, as the final tax bill (which will also include interest and possibly penalties) may be challenging to determine. The final bill may also come as a surprise. Many of the schemes were implemented in the early 2000s, meaning that the interest can sometimes be as much as the tax.
It is not all doom and gloom, however. HMRC may win 80% of the tax avoidance cases that go to court, but that does not mean they are always right. Most avoidance arrangements are extremely complex, and many are open to interpretation. Even if the arrangements fall foul of the courts, there may be process issues that can be challenged, for example, whether there is a valid enquiry for all the relevant years.
In financial remedy proceedings, this uncertainty often means that as yet unquantified liabilities arising from failed or challenged tax avoidance schemes have to be addressed through a mechanism such as reverse contingent lump sums. It may also require the participation by divorced parties in ongoing litigation with HMRC, which is counter to the preferred clean break approach of the family court.
Overall, the appetite for marketing new avoidance schemes and defending old ones is diminishing. Investors in the schemes falling by the wayside are understandably angry.
Most were ‘sold’ tax avoidance arrangements on the basis they were valid tax planning ideas. Some promotors even (incorrectly) claimed that the arrangements had been ‘approved’ by HMRC and assured potential investors accordingly. The same investors now have significant tax bills to pay. The impact currently felt in financial remedy proceedings from failed tax avoidance schemes is therefore likely to continue for some time.
Tax evasion is a ‘black economy’, with individuals or businesses deliberately not declaring all their income and gains.
Undeclared income and gains relating to offshore assets have always been tricky for HMRC to determine primarily due to the lack of accessibility to information from relevant jurisdictions. Over the years HMRC has, therefore, introduced a number of ‘disclosure facilities’ designed to encourage taxpayers to disclose historically untaxed offshore income and gains. All such facilities have however now long closed.
In addition to these disclosure facilities, the Requirement To Correct (‘RTC’) legislation introduced in 2017 imposed a statutory requirement to correct past tax returns. The legislation was designed to encourage taxpayers with offshore financial interests to undertake a full review of their UK tax affairs to ensure their UK tax returns were complete for all years to 5 April 2017.
The RTC disclosure window closed on 30 September 2018, and this was in effect the final chance for individuals to correct their tax position before HMRC started to receive information under the Common Reporting Standard (see below). The RTC also preceded a significant increase in the penalties that can be imposed by HMRC for tax irregularities involving offshore assets.
There are, of course, individuals who chose not to make a disclosure and there will always be those who bury their head in the sand and hope that HMRC never comes knocking at their door. It is a risky strategy, as HMRC has an increasing array of information sources including:
- The Common Reporting Standard (‘CRS’) allows for the automatic exchange of information across the signatory jurisdictions (including the Channel Islands). The CRS requires financial institutions, including banks, trusts, trust company service providers and insurance companies to provide local tax authorities with data on their customers, including income and gains. Local tax authorities will then share this information with overseas authorities with which the customers have a connection.
- Access to beneficial ownership information. Many countries now maintain a register of beneficial ownership of companies and trusts. Some of these countries require the information to be public, and some will be exchanged automatically between jurisdictions.
Whether it is offshore income or gains or UK only, a deliberate failure to disclose full income and gains is tax fraud and HMRC will deal with it (once discovered) in one of three ways:
- A standard enquiry dealt with by the relevant local tax office. This may be the case where the amounts involved are small.
- An investigation opened by the Fraud Investigation Service in HMRC. These enquiries are known as the ‘Civil Disclosure of Fraud’ (‘CDF’) and commonly known by advisers as ‘COP 9 enquiries’. The CDF facility allows taxpayers to fully disclose the tax irregularity and pay the tax without the fear of criminal prosecution. Full disclosure is key, however, and the offer of the CDF process by HMRC can be withdrawn at any time if HMRC believes that the taxpayer is not cooperating or has not made full disclosure.
- A criminal investigation. It is not always possible to second-guess which fraud/evasion cases will be offered the CDF process and which ones will go straight to criminal prosecution. Certainly, the amount of tax involved and the length of time the evasion has been going on will be a factor, as will the profile of the taxpayer in question. If it is a public figure, there is a higher risk they will be made an example by HMRC, as was the case for Ken Dodd and Harry Redknapp.
The COP 9 process can be stressful for the client. Most COP 9 investigations will require a detailed and lengthy report being prepared, and few such enquiries are settled within 12 months.
Overall, therefore, if a taxpayer has undisclosed income of which HMRC is unaware, or they are in receipt of a COP 9 enquiry, there will be a period of angst and uncertainty until the matter is either disclosed to HMRC or the COP 9 enquiry is brought to a close. Needless to say, both a disclosure and COP 9 enquiry need careful management and professional advice.
There are also occasions where the line between avoidance and evasion is blurred. There have been a number of recent high profile HMRC prosecutions of the promoters/managers of tax schemes. The participator is often completely unaware of the underlying tax fraud but may nevertheless inadvertently be caught up in the mire of trying to sort out the tax liability with HMRC.
Tax evasion and the family court
While many family practitioners have come across the fall-out from failed tax avoidance schemes (either with a crystallised or potential liability as a result of a pending investigation), a less common but much more serious issue in financial remedy proceedings can be the revelation of tax evasion by one of the parties.
Given the increasing lengths HMRC has gone to in order to try to counter tax evasion, it is no surprise that they have also in the past tried their hand at persuading the family court to deliver up documents and transcripts of financial remedy proceedings in cases where it is clear from the published judgment that there has been an issue regarding underpaid tax.
Disclosure and confidentiality
In financial remedy proceedings, each party owes a duty to the court (and to each other) to make full and frank disclosure. A party cannot choose what to disclose, and the penalties for material non-disclosure are severe.
As Mr Justice Coleridge put it in one of the key cases in this area of the law:
‘The obligation on a party to an application for financial remedies to make full and frank disclosure is absolute. It is a fundamental principle and is of paramount importance if the court is to fulfil the obligations imposed on it by the Matrimonial Causes Act 1973 (MCA).’ (HMRC v Charman and Charman  EWHC 1448 (Fam),  2 FLR 1119 para )’
Generally, financial documents and information disclosed in financial remedy proceedings are not disclosable to third parties (as governed by the Family Procedure Rules 2010 and the implied duty of confidentiality). This ensures that parties do not feel inhibited from providing full disclosure and thus fettering the ability of the court to exercise its duty under the MCA.
However, there is a balancing exercise to be undertaken by the court to ensure that this confidentiality does not conceal the truth from the court in other proceedings. As put by Mr Justice Goulding in Medway v Doublelock Ltd  1 All ER 1261, there is ‘a general public interest that in the administration of justice truth will out’.
The family court, when faced with questions of underpaid tax, must therefore balance these conflicting public policy considerations. The existing body of case law makes it clear that the factor that tips the balance in favour of disclosure to HMRC is an admission, or clear documentary evidence, of illegality.
The case law addressing this issue is limited to a handful of High Court decisions from the late 1990s/early 2000s and a subsequent decision in 2012.
The leading judgment is that of Mr Justice Wilson in S v S (Inland Revenue: Tax Evasion)  2 FLR 774, which establishes first, that the court has a discretion as to whether to permit the disclosure of the papers to HMRC and second, that it will be rare for that discretion to be exercised in HMRC’s favour.
In this case, after the financial remedy proceedings had concluded, the wife’s brother, who held a grievance against his ex-brother in law, had sent a transcript of the judgment to the Revenue. HMRC sought leave to retain the transcript and rely upon it, as well as orders for further disclosure.
Mr Justice Wilson held that:
‘It is greatly in the public interest that all tax due should be paid and in serious cases, pour encourager les autres, evaders of tax should be convicted and sentenced. It feels unseemly that a judge to whose notice tax evasion is brought should turn a blind eye to it by not causing it to be reported to the Revenue. In one sense that would almost cheapen the law. On the other hand it is greatly in the public interest that in proceedings for ancillary relief the parties should make full and frank disclosure of their resources and thus often aspects of their financial history . . . Between these two opposing public interests must the individual circumstances be weighed.’
Interestingly, while Mr Justice Wilson in S v S had in his original judgment found the husband guilty of tax evasion, he refused the Revenue’s application for disclosure on the basis that his finding of tax evasion arose from inferences being drawn (albeit confidently) by him cumulatively, rather than admission by the husband. No documents disclosed or any line of the transcripts could alone establish evasion.
In contrast to S v S, Mr Justice Wilson in his decision of R v R (Disclosure to Revenue)  1 FLR 922 did give the Revenue leave to retain the transcript of his judgment in the original ancillary relief proceedings, which the judge considered had been provided to HMRC by the wife or her accountant (presumably on the wife’s instructions). Mr Justice Wilson distinguished this decision from his previous judgment in S v S on the basis that in R v R his ‘findings of under-declaration of income were made on far fuller, more explicit material, both documentary and oral’. Unlike in S v S, the husband in this case had admitted to tax evasion.
In A v A; B v B  1 FLR 701, Mr Justice Charles heard together the ancillary relief applications by two wives whose husbands were in business together. The husbands eventually admitted during the course of these proceedings that they had consistently lied about their assets over a 5-year period.
Mr Justice Charles was minded to refer the papers to HMRC. However, both husbands and wives objected; the wives no doubt because they feared the impact on the payment of their financial awards. Mr Justice Charles eventually took no action, as the husbands undertook to make voluntary disclosure to HMRC. Mr Justice Charles’s position was that if ‘the court was satisfied there had been illegal or unlawful conduct (including evasion or non-payment of tax) the usual approach of the court would be to order disclosure to the relevant public authority’.
Twelve years later, Mr Justice Coleridge had to address similar issues in the case of Charman (above).
Mr Justice Coleridge’s decision followed the original ancillary relief application in 2006, which resulted in what was for many years the largest-ever monetary award by the English family court. As part of that original decision, Mr Charman’s potential tax liabilities had impacted upon Mr Justice Coleridge’s determination of Mrs Charman’s claims and evidence was given during those proceedings regarding these liabilities.
Subsequent to that decision, HMRC issued assessments for around £11.5m of unpaid tax by Mr Charman between 2001 and 2008. Mr Charman disputed these liabilities and appealed the assessment. For the purposes of the tax appeal, HMRC wanted sight of and to be able to use the transcripts from the original ancillary relief proceedings, as well as numerous other documents disclosed/relied upon as part of those proceedings, including witness statements and written submissions.
HMRC’s position was that ‘it is always in the public interest for the right amount of tax to be paid by taxpayers’. Specifically, HMRC wanted to be able to use the transcripts and documents ‘for the purpose of cross examining the husband especially if he seems to be presenting a case which is factually different to the one relied on him now in his appeal’ of HMRC’s tax assessments.
Mr Charman’s position was that he:
‘. . . gave evidence during [his] divorce in private and [he] was protected by the cloak of privilege and the parties’ duty of confidentiality. For that to be lifted now, with no justification, with no wrongdoing having been proven on [his] part by HMRC . . . would be entirely unfair . . . HMRC’s application is little more than a fishing expedition.’
Mr Justice Coleridge paraphrased the law, stating:
‘As a general rule documents and other evidence produced in financial remedy proceedings are not disclosable to third parties outside the proceedings save that exceptionally and rarely and for very good reason they can be disclosed with the leave of the court. The fact that the evidence may be relevant or useful is not by itself a good enough reason to undermine the rule.’ (Charman para )
He went onto say ‘no one would seriously argue with the proposition that it is in the public interest for the right amount of tax to be paid by taxpayers’ (Charman para ) and he was in no doubt that the documents sought by HMRC would be relevant to the appeal proceedings, but that is not the test to be applied.
Mr Justice Coleridge held:
‘Having considered and balanced the competing public interests here, I have no hesitation in finding that there is nothing rare or exceptional about this case which takes it outside of the general rule’ (Charman para ).
Mr Justice Coleridge’s view was fortified by the fact that there was no suggestion that the husband was guilty of tax evasion or criminal conduct in relation to his tax affairs. This was a routine tax assessment, and HMRC’s application was dismissed.
The judge did go on, however, to make the point that if Mr Charman wished to rely upon documents/evidence produced during the original financial remedy proceedings, then he may have leave to do so but he must disclose all relevant material to the tribunal and not just the elements that support his case.
HMRC’s efforts to close the tax gap have noticeably stepped up in the last few years, and tax avoidance schemes have increasingly come under fire. This has often had significant consequences for the participators, as they are liable not only to pay the unpaid tax but often substantial interest and penalties.
Tax avoidance schemes are relatively commonplace in financial remedy proceedings involving HNWIs and where the quantification of these liabilities is still pending at the time of a divorce, it may be necessary for a mechanism to be put in place to provide for the future payment of the liability. This, together with ongoing litigation with HMRC regarding the validity of such a scheme, can add a further layer of complexity to some financial remedy cases.
Where matters become much more serious is in relation to cases where tax evasion is revealed during the course of the financial remedy proceedings. The case law, as outlined above, is clear. The circumstances in which disclosure to HMRC would be ordered is limited, and usually the public interest in ensuring full and frank disclosure in financial remedy proceedings will triumph. However, where there is an admission or clear documentary evidence of illegality in relation to the non-payment of tax, the family court can and should order the disclosure of documents to HMRC, which is likely to lead to a criminal investigation.
This article was first published in Family Law Journal. A summary can be found here, and the full article can be read in the 13 January 2020 edition.
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