By Phil Mitchell, Director, Harbour Key.
Tax evasion may be typically associated with celebrities and the super-rich, but a recent HMRC report found that more than half comes from small and medium sized business owners who have deliberately evaded tax. Following in-depth interviews with 46 business owners, they concluded that small and medium businesses are responsible for 51 per cent (£5.2billion) of the tax gap i.e. the difference between what is owed in tax and what is actually paid.
Based on this, HMRC has defined four distinct profiles of tax evader:
- The unthinking evader – engages in habitual low-level evasion without thought, despite seeing themselves as a law-abiding citizen.
- The invested evader – sees tax evasion as an unfortunate financial necessity to help their business survive, for example understating cash receipts, backdating invoices.
- The lifestyle evader – uses tax evasion to achieve a lifestyle that would otherwise be out of their reach, which is ‘justified’ by the tax they do pay.
- The systematic evader – engages in complex structured schemes and it is integral to their business model.
All justified their actions by saying that the sums were small compared to the amounts avoided, or those evaded by big businesses, and believed they had little chance of being caught.
However, tax evasion for any reason and by any means is a criminal offence with serious consequences. As well as the financial cost (unpaid tax, interest and penalties), it will have an impact on the future sale of a business. Any buyer will put in place legal measures that protect themselves against such liabilities and pass the blame back to the seller. This can leave sellers living with the possibility of retrospective claims against them for years after the sale has completed.
HMRC has now gone one step further and introduced two new criminal offences: failure to prevent facilitation of UK tax evasion and failure to prevent facilitation of non-UK tax evasion. These came into effect on 30th September and apply to all corporates and partnerships (not sole traders), not just professional and financial services businesses who offer tax planning schemes. However, expectations of a large international business will be higher than for a smaller, low risk one.
All businesses need to consider the impact of the legislation immediately and implement appropriate measures to protect their business. Both offences are ‘strict liability’, that is, the senior management of the organisation need not have participated in, known about or even suspected either the facilitation or evasion of tax for the organisation to be held criminally liable. If successfully prosecuted, they could face an unlimited fine as well as significant commercial, reputational and brand damage. The only defence is that they had in place ‘reasonable’ procedures designed to prevent their associated persons from criminally facilitating tax evasion.
There are two key points to be aware of. First, even if the taxpayer themselves has not been convicted or prosecuted for tax evasion, HMRC can bring a prosecution against the business if it has evaded tax. Evasion does not arise from mistakes or carelessness; it is where the person knows they have a tax liability and forms the dishonest intention not to declare it.
Second, the offence applies if any person associated with the business facilitates the evasion. This includes employees, agents and sub-contractors – anyone performing services for or on behalf of the business. For example, if a subcontractor is committing tax evasion within your contractual arrangement with them, you as an associate could also be considered to be breaking the rules. This example is taken from the original consultation document.
A mid-size car parts maker operating in the UK and Europe enters into a sub-contracting arrangement with an UK distributor. The senior managers of the UK distributor create a false invoicing scheme with the assistance of a purchaser, allowing the purchaser to evade UK taxes due on its purchase of the car parts in the UK. The UK distributor has facilitated tax evasion and is an associate of the car parts maker.
The only defence is to have ‘reasonable’ and robust procedures in place designed to prevent all associated persons from criminally facilitating tax evasion. This means that all businesses must ensure that they are aware of, and have control over, how their employees, agents and service providers are operating to reduce their risk. To help you do this, HMRC has provided guidance under six principles.
- Carry out a full risk assessment of the business to identify where, if any, the risks lie. Even if you conclude that they are negligible, the assessment must be conducted and recorded in writing.
- Devise and implement prevention policies and procedures proportionate to the identified risks and the size of business. This might include updating existing compliance and ethics policies, adding appropriate terms to employment contracts, and implementing procedures for reporting, monitoring and enforcing compliance.
- Encourage a culture of ‘zero-tolerance’ from the Board down, and ensure that they are involved in risk assessment and the creation and implementation of preventative procedures.
- Apply appropriate due diligence procedures to anyone working in or performing services on behalf of the business, proportionate to the identified risks.
- Communicate prevention policies and procedures throughout the organisation, ensure they are understood, and train for staff and other associated people.
- Monitor and review prevention policies and procedures on a regular (at least annual) basis and make adjustments and improvements in response to any changes.
Many professional services firms will have some of the required processes already in place, but these will need to be reviewed, pulled together and if necessary updated. Businesses not used to this type of regulation will need to review the risks, implement appropriate procedures and ensure that all employees and agents understand what is required. If you have committed any form of tax evasion, you are best advised to make a voluntary disclosure and normalise your tax affairs as soon as possible.
For more information visit www.harbourkey.com