Retrospective legislation? How dare they?!

This Law-Now complements our recent Law-Now of 9 December 2004 on the changes to ITEPA announced in early December by Gordon Brown and Dawn Primarolo aimed at combating employee remuneration-linked tax planning.

Although the amendments to ITEPA announced in the pre-Budget report are important in their own right, perhaps the most interesting aspect of the press release of 2 December 2004 is the clarification of what the Government intends to do with the information disclosed by promoters of tax avoidance schemes in the employee remuneration sphere pursuant to the disclosure rules introduced in the Finance Act 2004.

The expectation of taxpayers and tax advisors alike has been that the new disclosure rules will permit the Revenue to act quickly to legislate against schemes of which it does not approve. However, the expectation was also that such legislation would, in accordance with years of policy and practice, be on a prospective basis rather than a retrospective basis.

The press release of 2 December 2004 has proved how wrong these expectations have been! Not only has the Inland Revenue attacked the use of money box companies paying dividends to satisfy City bonuses going forward but also it has attacked those schemes that are in the course of being executed i.e. where shares are held as at 2 December pending the receipt of dividends. The only situations unaffected will be those where events have already taken place resulting in the “bonus payments” subject of course to any challenge that the Inland Revenue might, indeed has threatened to, bring through the courts.

Going forward, the Government tells us that where it becomes aware of arrangements that attempt to frustrate the intention (of Government) that the employer or employee should pay the “proper” amount of tax and NICs on the rewards of employment it will legislate to close them down, if necessary with effect from 2 December 2004.

What does this all mean and what might be the result? Taking it to its extreme, and a number of commentators have done so, this could mean that all those tax professionals focussing on developing tax efficient methods of providing bonus payments to City employees will be out of work as any scheme they think up can be stifled at birth. Beyond that, it may mean that City high-flyers have to accept a lower after-tax level of remuneration or, depending on expectations and the importance placed on retaining the services of these high-flyers, that their employers end up having to bear the extra tax charge, thereby increasing the costs of the employers and decreasing the return to shareholders.

On a macro-economic scale does this affect the very position of London as the financial centre of choice outside New York? Certainly, the benign tax regime in the UK has contributed to the continued influx of expertise in the financial sector both from the USA and Europe as well as the continuing popularity of the UK as the home of choice for the wealthy expatriate community around the world. It is to be hoped that Gordon Brown does not eventually kill the golden goose with his continuous stream of calvinistic attacks upon tax planning. It is interesting to note that the Pre-Budget Report confirmed the continuing review of the UK domicile rules moving towards an eventual consultation paper foreshadowing possible reforms.

The practical effect of the new approach could be that the fundamental relationship between Government and the taxpayer will change and the principle of legal certainty will be undermined. Such retrospective changes are arguably not consistent with EC law principles of effectiveness or legitimate expectation and although the State has a wide discretion on tax matters, it is not unfettered. The European Convention on Human Rights (the Convention), now incorporated into UK law, does not prohibit the use of retrospective tax legislation, but the Government proposals may be challenged under the Convention. Cases such as National & Provincial Building Society v United Kingdom [1997] S.T.C. 1466 (ECHR), reveal that an interference with the right to enjoyment of property under Article 1 Protocol 1 of the Convention (which protects the right to enjoyment of property) requires a balance to be struck between the demands of the general interests of the community and the requirements of the protection of the individual’s fundamental human rights: there must be a reasonable relationship of proportionality between the means employed and the aims pursued. In National Provident, the retrospective legislation was deemed to be within the State’s ‘margin of appreciation’: the applicants had attempted to exploit loopholes in the legislation when it could reasonably have been anticipated that the Revenue would react in such a way as to remedy the technical defect and legislate to close the loopholes retrospectively.

Just how wide the State’s margin of appreciation is in these matters and how reasonable a foundation the Government have for their proposed regime may very well again come under the Strasbourg microscope. The Government is likely to respond by saying that taxpayers have been put on notice of its approach by the press release of 2 December 2004. Some commentators have speculated that this will result in a chaos of uncertainty over tax planning and companies having to pay tax which they believed had been legally avoided. One thing at least seems clear, namely that those seeking to exploit loopholes with ever more far-fetched structures have had fair warning, both from the Government and existing case law, that their inventiveness, even if technically impeccable, may not ultimately succeed in the battleground as to what is acceptable and what is unacceptable tax planning.

All of this debate stems from the zealous pursuit of tax planners we have seen increasingly from Gordon Brown in recent times and rather begs the question as to why the government would rather be pursuing relatively marginal sums of money from employment taxation, the retention of which by taxpayers may in fact turn out to be beneficial through the economic impact of increased spending and the maintenance of London’s role as a key financial centre. Would this time not be better spent addressing other areas of leakage that the government currently faces, including for example the continuing challenges from the European Court of Justice in relation to the compatibility of the UK tax system with European law?

For further information, please contact Mark Nichols at [email protected] or on +44 (0)20 7367 2051.