Lords hearing: Lawyers argue for safeguards for new promoters offence

Background

The Finance Bill Sub-Committee of the House of Lords Economic Affairs Committee undertakes an annual investigation into selected measures in the government’s draft tax legislation. This year the sub-committee’s inquiry is focusing on four areas within draft Finance Bill 2023-24:

• Reforms to Research and Development (R&D) tax credits which merge the two existing schemes as well as providing a higher rate of payable tax credit for loss-making R&D intensive SMEs
• Measures dealing with the promoters of tax avoidance
• Increasing the maximum prison term for tax fraud
• A requirement on certain taxpayers to provide additional data to HMRC

For a second year in a row the sub-committee is chaired by Lord Leigh of Hurley, a Conservative peer who is also a chartered tax adviser and a chartered accountant.

The sub-committee held its first evidence session for this inquiry on Monday 23 October with witnesses from CIOT and other tax and accountancy bodies. You can read our report on this session here. This report covers the second and third evidence sessions, which took place on Monday 13 and Monday 20 November respectively and featured four separate panels and 15 witnesses. A final session, with the Financial Secretary to the Treasury, will be held on 29 November.

Written evidence has also been submitted to the inquiry, including by CIOT. You can read this here.

Evidence session – Monday 13 November – Lawyers and R&D specialists

The second evidence session took place on 13 November. The session was divided into two separate panels.

The witnesses in the first panel, who were asked about promoters and tax avoidance and sentences for tax fraud, were:

• Lydia Challen, Co-Chair of the Tax Law Committee, Law Society of England and Wales
• Isobel d’Inverno, Tax Law Sub-Committee Convenor, Law Society of Scotland
• Adam Craggs, Partner at Reynolds Porter Chamberlain LLP (RPC)

Full transcript of this panel session here.

The witnesses in the second panel, who were asked about reform of R&D credits, were:

• Mark Davis, Managing Director, ela8 Ltd
• Justin Arnesen, Partner, R&D Tax and Government Grants, Business Tax, Evelyn Partners
• Benjamin Craig, Associate Director, R&D Tax Incentives, Ayming UK

Full transcript of this panel session here.

Evidence session – Monday 20 November – Industry and Various

The second evidence session took place on 20 November. The session was again divided into two separate panels.

The witnesses in the first panel, who were asked about reform of R&D credits, were:

• Colin Hailey, Chair, Finance and Tax Advisory Committee, UK BioIndustry Association
• Dr Roger Barker, Director of Policy and Corporate Governance, Institute of Directors (IoD)
• Michael Moore, Chief Executive, British Private Equity and Venture Capital Association (BVCA)
• Gillian Thomson, Group Tax Manager, Skanska.

Full transcript of this panel session here.

The witnesses in the second panel, who were asked mostly about providing data to HMRC, were:

• Dr Andy Summers, Associate Professor of Law, London School of Economics
• Bill Dodwell, Member, Administrative Burdens Advisory Board (ABAB)
• Kevin Hart, Chief Executive Officer, Business Application Software Developers Association (BASDA)
• Samantha O’Sullivan, Policy Lead, Chartered Institute of Payroll Professionals (CIPP)
• Joshua Toovey, Senior Research and Policy Adviser for the Association of Independent Professionals and the Self-Employed (IPSE)

Full transcript of this panel session here.

To make the evidence easier to follow we have grouped it by topic rather than panel.

Tax avoidance promoters

Lydia Challen said the Law Society was concerned that the timing of these measures is premature. “The civil measures have not been tested properly yet. The civil regime is quite onerous; its financial penalties can be very substantial. The Revenue has considerable discretion in those civil measures in bringing proceedings under them. It seems to us that introducing a strict liability criminal offence, which is what these measures propose, before the existing regime has been tested is a bit disproportionate at this stage.”

Isobel d’Inverno and Adam Craggs agreed. d’Inverno said it would be better to wait until the stop notices’ provisions have been operated by HMRC for a longer period before adding this strict liability offence. Craggs added that, at £250,000, the maximum fine is ‘fairly substantial’.

Lord Palmer asked whether additional safeguards are needed if this offence is introduced. “Should there be some independent oversight of HMRC’s decision to prosecute? If so, what do you think it should be?”

Craggs though there should be independent judicial review before one of these notices is issued, given the potential criminal liability. “My own view is that there should be authorisation by the Upper Tribunal and, ideally, by a High Court judge.” d’Inverno agreed, saying that HMRC being able to impose a criminal sanction without any oversight from elsewhere is a dangerous precedent to set. “We would recommend, at the very least, an application to the tribunal being required before HMRC could proceed with imposing a strict criminal liability.”

Challen agreed too. She suggested a possible process that could be adopted. In the wider courts system, you can attach a ‘penal notice’ to a court order, “which makes it very clear to the recipient that breach of the order will lead to a criminal sanction. It is normally for contempt of court, but it could be adapted for this. It would not impede the Revenue in issuing stop notices under the civil regime, if that is what it wanted to do, but if it wanted to make something a criminal offence, it would have to go to the court and get the court to attach a penal notice to the stop notice. The addressee would then be very clear about the fact that a breach carried criminal sanctions.”

Baroness Valentine noted that, to serve as an effective deterrent, there needs to be a realistic prospect of prosecution. Sha asked how likely the prospect of prosecution is.

Craggs thought it was ‘probably unlikely’. “I say that, because the Criminal Finances Act 2017 brought in some offences to prevent tax evasion and, to my knowledge, to date—five or six years later—there has not been a single prosecution. Certainly, when you talk to large corporate clients and explain this position to them, there is a feeling that the chance of HMRC ever bringing a prosecution under the provision is very slim, so the deterrent effect gets less with every passing year.”

d’Inverno said that prosecuting people who are based abroad would be particularly difficult. Challen said that one difference between this and the criminal finances legislation is that there is a defence under that legislation of having reasonable prevention procedures in place.

Lord Rooker homed in on the overseas promoters point. “HMRC says that it can use international treaties to operate against promoters based overseas. In your view, can this work?”

Craggs said that it could work in theory, though in practice it would ‘slow the process up inordinately’.

If you prosecute someone overseas, our understanding is that you would need to extradite that person, said Challen. As well as being time-consuming (and costly, d’Inverno added), another hurdle “would be that one of the principles for extradition is that there has to be dual criminality: it has to be a criminal offence here and in the jurisdiction where the person is based. As this is a relatively niche procedural offence, it seems to us unlikely that there will be a sufficiently equivalent criminal offence… to be able to form the dual criminality aspect.”

Rooker wondered why promoters should be able legally to operate offshore in the first place. Challen said it was difficult to stop it. Lord Leigh observed that there is no precedent for a promoter being required to be in the UK. Craggs said that in some of the arrangements he has seen, the promoters “have deliberately ensured that they are in places like northern Cyprus, so it would be very difficult to extradite them”.

The sub-committee also asked the lawyers about the provisions targeting company directors.

Challen said the Law Society agreed that the measures against directors should be targeted at the people who are the controlling minds of these operations and not against so-called stooge directors. However they are concerned “that a director can be prosecuted if a company of which he is a director fails to comply with a stop notice. If the company does that with the consent or the connivance of the director, that seems fine, but it can be as a result of their neglect. The neglect limb is concerning in the context of the potential for stooge directors.” Also there should be court involvement in any decision to disqualify a director.

d’Inverno said it was “debatable whether [this] is aiming at the right target anyway, because the really bad thing about all this is the mis-selling of these schemes to individuals who do not understand what they are letting themselves in for, particularly individuals on low incomes. The Low Incomes Tax Reform Group has been trying to warn people not to be sucked into these schemes, but this seems to be an area where a cross-departmental approach needs to be adopted, with advertising standards and that kind of thing, so that people on very low incomes cannot be adversely affected.”

Lord Palmer also asked the second panel of 20 November about this topic briefly. Bill Dodwell (ABAB) said he was happy with the proposed legislation. He explained that it was important to have as many deterrents as possible against promoters of aggressive tax avoidance. Stop notices are really important as part of that, he continued, noting that the 13 currently in effect are all about ‘so-called loan charge schemes’. “It is really about taxpayer protection, although there is also a bit of Exchequer protection and HMRC protection too. If by adding a criminal sanction we make it even harder for anyone to ignore a stop notice and carry on marketing their aggressive avoidance scheme, that can only be a good thing.”

Joshua Toovey also welcomed the proposals, noting that many contractors have fallen foul of tax avoidance schemes in recent years, including the loan charge. “It is quite right that the Government are now looking at going to the source of this issue rather than going after the contractors themselves, who quite often are unaware that they are inadvertently falling foul of these tax avoidance rules.

Sentences for tax fraud

The sub-committee asked Adam Craggs whether doubling the maximum sentence for tax fraud would be an effective deterrent.

Craggs said he does not think it is, and is not convinced that it is necessary. “In most of the tax fraud investigations that I deal with, the Revenue generally charges with a common-law offence, such as cheating the public revenue, which has an unlimited fine and could in theory lead to the imposition of a life sentence. In practice, the average custodial sentences that I see are of around four to seven years, so I am not convinced that there is a great need to increase the headline custodial sentence. I do not think I have ever been involved in a case where someone has not been charged with a common-law offence.”

Craggs added that if the proposals are enacted, it will be important for HMRC to bring prosecutions, because if nothing happens for five or six years, as with the Criminal Finances Act, the deterrent effect will weaken. Asked whether there were any other changes to HMRC's strategy in tackling tax fraud that could help with deterring it, Craggs said again that the key was more prosecutions.

R&D schemes reform

The sub-committee started their questioning of the R&D specialists by asking about whether the merging of the two schemes would be a simplification.

Mark Davis (ela8) thought it was “a little simplification… but not an enormous amount”. The other two witnesses shared that analysis. Justin Arnesen (Evelyn Partners) said it was a simplification from a mechanism point of view, “but it becomes problematic when you have an intensive regime with a determination of the benefit potentially coming down the line that is not consistent with the RDEC approach. Simply, moving to an above-the-line credit holistically is probably the preferred option.”

Davis said nothing particularly stands in the way of an entirely unified scheme. He added that the technical question about what R&D is (not covered in this legislation) is the thing that causes the greatest amount of consternation. “It is a complicated area—it is even more complicated to legislate for it—but perhaps that could be used to add simplicity.”

Lord Palmer asked about subcontracting. Arnesen said we often see R&D occurring on projects where it was not known at the outset, which is very different to R&D planned at the outset of a project. There is a lack of clarity around the former. In his view, in both scenarios, “the entity that should be claiming is the entity that has the technical know-how in that particular area, as opposed to a funder who is ultimately paying for an activity but does not necessarily understand the scientific baseline or the advances or uncertainties that are required or that need to be overcome in order to make that development happen.”

Davis agreed. He warned: “Under the legislation as drafted, a whole load of companies will have no idea that R&D is taking place as part of an arrangement that they may have with somebody else. They suddenly become eligible claimant organisations, but they will have no understanding of the R&D, they will not have a competent professional to support the making of an R&D claim, and they will be poorly equipped to go through the process of making a claim for relief.” This will stifle innovation in the UK, he said.

Benjamin Craig (Ayming) gave a concrete example. “We currently represent businesses in the civil engineering sector that have carried out R&D to construct a new football ground and to extend a major hotel in central London. HMRC’s argument is that those businesses have been subcontracted to do the R&D: hence, under the proposed merged schemes, it would not be the civil engineers making the claim but the major London hotel and a Premiership football club.” But he does not feel that either of those businesses—the hotel or the football club—knows that R&D is going on. “I do not think they are particularly bothered that R&D is going on, and I certainly do not feel that they would be incentivised by the scheme being targeted at them rather than… at the civil engineers who are deciding whether to do R&D.”

Baroness Valentine asked about defining R&D intensive businesses. Craig said this was complex. “The biggest challenge is that essentially it says that your R&D expenditure needs to be at least 40% of your expenditure deductible for your corporation tax calculation. In most cases, businesses will be fairly squarely on either side of that line, but those that are on the cusp will not know whether they are in the intensive scheme until they do their corporation tax calculation, which could well be up to 12 months after the end of the year, and so potentially nearly two years after they spent the money on the R&D in the first place.”

Craig added that R&D schemes are most effective when there is stability and predictability, because businesses can factor that into their decision-making processes. Davis observed that where a firm does not have a professional adviser involved, “there is a very strong chance that it will not know that any of this is happening or understand the consequences on them of it”. Craig agreed, saying virtually every business he has spoken to had not heard about these changes until his firm drew attention to them.

If the merger is aimed at making R&D relief more central to decision-making, will the proposals achieve this, asked Lord Palmer.

Craig said moving the SME scheme to an above-the-line credit similar to RDEC is a very positive change and long overdue. “We have certainly seen changes in behaviour from the larger businesses since the move to above-the-line RDEC for large companies 10 years ago.”

Baroness Valentine asked whether the proposed changes would help or hinder HMRC’s efforts to tackle error and fraud in R&D relief.

Davis thought they would reduce the benefit further in relation to fraud, but would potentially introduce new complexities, which offer new opportunities for error. “The nature of a cliff-edge step-off in an R&D intensive scheme might stimulate people to wonder how they might think about their expenditure during a particular period to manage that. Some of that might be legitimate and some of it might not.” Craig agreed that the ‘pace and magnitude of this legislation’ brings in the potential for businesses to make more errors than previously.

Finally, Lord Rooker asked about the idea of a minimum threshold for claims.

Davis said that if small claims are driving a significant volume of error and fraud, it would seem sensible to put a threshold in. Arnesen said a threshold should be introduced. Craig said that if a threshold is to be introduced, there needs to be a clear understanding of the motivation for it. “In the consultation leading to the changes in the spring, it felt very much as though the primary driver was simply to reduce the volume of claims going in and hence reduce the workload on HMRC in managing it. If that is the motivation, I do not think that is a reasonable justification for introducing a threshold.”

“If there is not going to be a threshold, this set of arrangements needs to arrive at a point where a small company with one or two people in it could make a claim for relief,” Davis added. “The borrowed wisdom on this side of the table would probably be that it would be extremely difficult for a small company to make a claim without professional support in this space at the moment, given how complicated these regimes are to operate within.”

The peers also asked began their session with the industry representatives by asking whether the reform would be a simplification.

Gillian Thomson of Skanska said they do believe that a single scheme is a simplification, but they are slightly disappointed with the way the legislation is written as it “is currently drafted in a way that could mean the removal any future claims from the main contractors in construction”.

Michael Moore said BVCA “slightly challenge the idea that this will create a simple scheme. It is a lot easier than before in certain respects, but there are still two schemes and there is the possibility of a cliff edge in terms of whether one hits the 40% mark in the intensive scheme”. Colin Hailey (BioIndustry Association) said the merged scheme is a simplification for SMEs, “provided that we remove the restriction on subsidised expenditure so that, if you are not R&D intensive, you have one set of rules for every project you work on”. The R&D-intensive aspect is complicated though.

Roger Barker said IoD members do not support merging the schemes. “There is recognition that there have been concerns about fraud in relation to the current SME scheme, but we think that would have been best addressed directly by trying to counter or improve compliance in the context of existing schemes. We think that changing the system will create a good deal of uncertainty and disruption to the overall R&D tax relief regime. If the Government are not very careful, there is a real risk that the net result will be less R&D investment.” He added that when the IoD asked their members: “Do you think this new merged scheme will result in more expenditure and investment in R&D?”, 47% said that they thought it would not and that it could result in them spending less on R&D than in the past.

Hailey identified a problem in that “all SMEs and life sciences want to get into the R&D-intensive category, but it will be difficult to know whether you do”. He continued: “There is no life sciences-specific guidance and only one bit of guidance from the Revenue on what is qualifying overseas expenditure, which is that, if you are doing research into volcanos, you are allowed to do it outside the UK, and that is it. So all the complexities of complex supply chains, the life science industry and all of that are not captured; there is no guidance.” We need guidance rapidly, and we need a more sophisticated test, he said. He added that currently HMRC inspectors take different approaches on overseas expenditure – some set a high bar, others take a light touch approach.

Barker said that, although in principle the single scheme “is a more straightforward and less complex framework, the fact that it is new and will be set up on a completely different basis will create uncertainty for a lot of SMEs.”

Moore spoke about HMRC’s ‘additional information form’, which demands a lot of detail from applicants. “We have an example of an AI-focused business that has been asked for hundreds of documents and is spending hundreds of hours trying to define all of this. When they get to the point of believing that they have done a knock-out proof that this is definitely research and development expenditure, they hit a second problem: there is not the technical expertise to assess what has gone in. There is a real danger that what starts with a really important principle—making sure that taxpayers’ money is being targeted appropriately and used genuinely—quickly becomes a nightmare.”

On subcontracting, Thomson said this is the main issue in the construction industry. The draft legislation represents ‘a complete change’. “There are two layers here. There is the subcontracting of an R&D project, which is not what we are involved in in the construction industry. We are involved in R&D that is imbedded in a wider commercial project that we are brought on board to do… As main contractors, we need to design and build what our customer wants… We are the ones who need to come up with innovative ways of dealing with any engineering or uncertainty that we come across in those projects. We do not think that the Government, or HMRC, have really looked at the two different layers of subcontracting.”

Moore said people might not realise who or where the relief is supposed to be claimed. “A simple way of fixing it might be to introduce an election procedure whereby people can choose one or the other to act as the recipient, or to have a default provision that says that if there is no election it sits with the customer, or whatever.”

Hailey differed slightly. “It would certainly be good for the Treasury to keep this under review and keep trying to refine it if it can, but the fundamental principles are pretty good. As a UK taxpayer I think they get into the right place, and for the life sciences industry I think they get into a good place.”

Barker agreed that, ultimately, tax relief should apply to the customer, the organisation that is taking the risk.

“How should the new merged relief deal with subsidised expenditure?” asked Lord Altrincham. Thomson said Skanska “have contracts where we take the risk, and we undertake to do the R&D to reach a position that our customers want, so we believe that the subsidy part should be taken out altogether. There should not be any penalty for us for being able to claim the R&D purely because we are getting some income towards the project as a whole rather than the R&D itself specifically.”

Hailey said that, from a life sciences point of view, the commonest subsidy is grant funding. The RDEC scheme permitted that; you could have subsidy and still claim your credit. He hopes we will get to the same place with the new relief, “otherwise, we will have to start splitting between subsidised and non-subsidised projects.” Barker agreed.

Lord Roborough asked about the relief for R&D-intensive SMEs. Hailey said it would be lovely if the rate of credit went back up to what it was and also repeated that the biggest issue for his sector is overseas expenditure. Uncertainties mean people are concluding: “Given that I have overseas expenditure, I may not be R&D intensive and I have a problem”. Moore echoed these comments.

Hailey added that it would be helpful if there were clear rules about what to exclude when calculating R&D intensivity. “Would you exclude financing expenses and costs? Are capital allowance costs in there? If we are going to continue allow full super-deduction, full expensing, on capital allowances, then—again, from a tax point of view—that goes in the bottom of the fraction, so what is a benefit on capital expenditure in one part of the tax system damages your ability to be R&D intensive in the other. It gets very complex very quickly.”

Barker said it would be better to go back to how things were. The previous schemes were being relatively successful at driving additional investment in R&D, he argued. “We have received a long list of submissions from members saying they have already reduced the amount that they are spending on R&D in the UK, while others are reconsidering whether the UK is the place to start up an R&D-intensive business. It really seems as though these changes have shot the UK in the foot.”

During the session with Kevin Hart of BASDA as a witness, Lord Roborough asked how long software companies would need to make the necessary changes to tax software for the merger of R&D reliefs. Is there enough time for it to be done for April?

“The answer is no,” said Hart. “It takes time to get correct specifications from HMRC along with the provision of all the necessary coding requirements and the test systems. The software developers then have to factor that into their road map when they are developing different products and feature sets. It is very much our view that that is an artificial date and it is just too tight—particularly for those who, as I mentioned earlier, are making Making Tax Digital products.” April 2025 would be achievable but only if “sufficient information is declared very early next year to allow them to analyse, assess and develop accordingly, particularly since my understanding is that this new R&D system is likely to be a hybrid of two”.

Data collection

The only panel asked about providing additional data to HMRC were the final group on 20 November.

Lord Altrincham asked about collecting data on employee hours. Samantha O’Sullivan of CIPP said this data is invaluable. “It is the basis of multiple calculations with regard to payroll administration, holiday pay, and determining whether employers are paying and adhering to national minimum wage regulations. If it is shared with other government departments or agencies, that could result in a more holistic and compliant approach, which again could only be a good thing.”

Andy Summers emphasise the potential utility of systematically collecting employee hours data for statistical analysis and policy development purposes, not only in HMRC but across government departments. His view is that there should be a lot more sharing of microdata—in other words, individual-level data—between government departments, appropriately pseudonymised so that there is no risk to the privacy of the individuals.

Bill Dodwell said ABAB also support the idea. The key principle is to make sure that data is collected in a manner that is convenient for the supplier of that data.

However Joshua Toovey noted that collecting data from the self-employed on the hours worked is notoriously difficult. IPSE “would be quite keen if the self-employed were excluded from this proposal”.

Kevin Hart of BASDA, meanwhile, “struggled to understand the problem statement. It was not really clear what issue this is looking to resolve. It certainly did not seem to have a fiscal benefit, while the costs… are not insignificant”.

Altrincham wondered if the very action of collecting the data might lead an employer to try to pull back the number of hours that people are working. “We as a country need people to work more… So if we set up systems that tend to reduce the amount of work that goes on, we all bear a large economic cost, even larger than the friction costs of collecting this kind of data.”  

Dodwell sought to alleviate this concern, pointing out that the government have said they will only collect contractual hours so they would only be collecting actual hours for people who are paid by the hour.

Lord Roborough wondered what systems changes will be necessary to enable employers to supply data on hours. Hart provided a detailed response, concluding with the summary that “probably close to 1 million actual end-users of software are having to do this piece of work” and HMRC’s estimate of an average £35 per business to implement it “is nowhere near enough”.

O’Sullivan said that there are service providers that “simply do not receive the total number of hours worked. They may say, “Pay Samantha £1,000 this month”, but there are no hours there, so again you are essentially plucking a figure out of thin air and putting it on the real-time information submission just to get your payroll processed”.

Lord Leigh asked how realistic a start date of implementation in 2025 is. Dodwell said it is “perfectly achievable by 2025, because that gives us 15 months’ notice… But you will need HMRC to release the forms in plenty of time, because that will need to be incorporated into software.” Hart agreed, adding that there “will need to be awareness and understanding, particularly by accountants and bookkeepers, of how they need to operate this and what it means if there are any other consequences. It is not just an up-front development piece; there is some training and familiarisation involved”.

Could HMRC get any of this data from existing sources, asked Altrincham. Yes, said Summers, by making it possible to link individuals’ Companies House records and HMRC records. “That seems to be a big missed opportunity to streamline the way these data are used.” Dodwell noted that that would require that each individual had a unique identifier. Relying on name and address will not be good enough.