TAX: CONTENTIOUS: An Introduction to UK-wide

 Introduction

The political landscape in 2024 will create a busy and uncertain period for tax and the October 2024 Budget will be a significant milestone. The reported tax gap for 2022/2023 was GBP39.8 billion. The Labour government will want to be seen to be prioritising HMRC’s enforcement and collection activities and have stated an intention to invest GBP3 billion on recruiting 5,000 extra HMRC staff and an additional GBP1.5 billion on technology for HMRC to reduce that gap (Labour’s Plan to Close the Tax Gap).

Corporate Taxes

International tax

Transfer pricing

With such a large tax gap, the tax policy incentive behind big companies, especially MNEs, paying more is patent. But the UK is not the only country looking to impose greater taxes on those companies. The OECD Pillars 1 and 2 will increase the likelihood of double taxation and therefore increase the risk of MNEs encountering disputes. Such attitudes have already translated into other European countries introducing criminal liability into the sphere of transfer pricing. This stricter approach is also reflected in the decrease of advance pricing agreements made in the UK from 27 in the tax year ending 2018 to just 15 in the tax year ending 2023. This is despite applications in that same period more than doubling from 16 to 45. With the average time to settle transfer pricing enquiries increasing by 55% in that period to 38.9 months, the impact on MNEs cannot be understated.

Interpretation and application of EU law in tax disputes following Brexit

2024 has continued to see the UK courts and tribunals grappling with the current status, interpretation and application of EU law in tax disputes, including cases where the relevant facts of the case arise in pre-Brexit tax years.

While the procedural mechanism for domestic courts to refer questions of EU law to the Court of Justice of the European Union (CJEU) has been removed since the end of the implementation period, the CJEU recently considered the onward appeal of the General Court’s judgment that the group financing exemption within the UK’s controlled foreign corporation rules amounted to state aid. The outcome is relevant to many multinational groups who have been awaiting this decision to see if HMRC may determine them as recipients of the alleged state aid and seek recovery of the same.

The interpretation of the European Union (Withdrawal) Act 2018 as well as the Retained EU Law (Revocation and Reform) Act 2023 and the ongoing relevance and proposed application of CJEU case law in litigation (recently considered by the Supreme Court in Lipton v BA CityFlyer in a non-tax context) can be incredibly complex.

Domestic corporate taxes

VAT

VAT, the second largest component of the tax gap after corporation tax, is set to continue to be the most litigated corporate tax for three reasons:

1. it is comprehensive in nature (as opposed to prescriptive) which means technical disputes and differences as to factual applications are more likely;
2. the statutory mechanism to appeal against a decision of HMRC engages the tax tribunal earlier in proceedings than in direct tax disputes; and
3. the VAT accounting system inherently creates greater room for error or misuse.

Loan relationships – unallowable purpose

In 2023, HMRC made substantial changes to its guidance on the unallowable purpose test for loan relationships set out in its Corporate Finance Manual. Those amendments included guidance on specific contentious issues which remained subject to litigation and the provision of example factual scenarios. This was an attempt by HMRC to clarify its position on its proposed application of the relevant legislation and case law.

The Court of Appeal considered some of those contentious issues in a series of onward appeals brought by impacted groups from the upper tribunal culminating in three judgments released during 2024. Those judgments, while insightful, have not resulted in clarification on broad principles for general application which many multinational groups and their UK tax advisors may have hoped for. Unallowable purpose disputes are by their very nature heavily fact dependent. As such, the strength and relevance of any evidence, including witness statements and contemporaneous documents served as part of the litigation, are crucial in determining the eventual outcome of those disputes.

With the pendulum of recent reported case law on unallowable purpose regularly finding in favour of HMRC and yet to swing back the other way, combined with the potential for onward appeal to the Supreme Court on certain issues, this continues to remain a live topic for many taxpayer groups with often historic unresolved disputes.

Tax Fraud and Tax Evasion

Labour have expressed dissatisfaction with HMRC’s prevention and enforcement activities in this area (Labour’s Plan to Close the Tax Gap) and increased activity should be expected across all taxes in (i) civil investigations and enforcement by HMRC’s Fraud Investigation Service and (ii) criminal prosecutions. Between 2018 to 2023 the number of prosecutions pursued by HMRC dropped by around 60%. Pre-election, Labour specifically decried the lack of any prosecutions under the new corporate offences introduced in 2017 of “failing to prevent the facilitation of tax evasion” and the new offence of “failing to prevent fraud” is expected to come into force in 2025.

Personal Taxes

Non-domicile regime

Under the current non-domicile regime, taxpayers can elect to pay tax on foreign income/gains only when remitted to the UK. From 6 April 2025, the remittance basis of tax will be abolished and domicile as a connecting factor for tax will be replaced by a simplified residence-based regime. The impact of such a seismic shift will cause many individuals to leave the UK (some followed by a significant inheritance tax (IHT) tail) particularly if excluded property trusts lose their protected trust status. Those who remain and do not qualify for the short period of favourable tax treatment will find their worldwide income and gains exposed to UK tax, and HMRC will need to pour significant resources into policing the new regime effectively. Taxpayers should expect changes to the various and complex anti-avoidance legislation in this area. The implications for IHT in the context of the new regime will also need to be navigated carefully.

Legislation and detailed plans will not be announced until the 30 October 2024 Budget, leaving little time for consultation and preparation before implementation. The risk of errors in taxpayers’ returns may be high, exasperated by complex transitional rules such as “Temporary Repatriation Facility”. Double tax treaty disputes will no doubt increase with tax mismatch disputes as well as entity classification disputes. Existing domicile disputes will not fall away.

The aftershocks of the non-dom changes will be felt through Statutory Residence Test disputes (particularly for leavers managing their day counts) as well as potential rushed and failed capital gains tax and IHT planning. There will be additional fall out and vulnerabilities with respect to pensions.