About Section 58
In 2008 the Government published Budget Note 66 (BN66), indicating their intention to introduce Section 58(4) of that year’s Finance Act. S58(4) targeted tax planning schemes that made use of offshore trusts and double taxation treaties to manage tax liabilities paid by the scheme’s users. These schemes were marketed to freelancers and contractors after the introduction of the deeply flawed IR35 as they offered more certainty than would be the case if running a limited company. They were entirely legal and transparent, and were properly notified to HMRC under the disclosure rules. Indeed, they had been mentioned in HMRC’s tax manual since the 1990s. By introducing S58(4), the Government retrospectively changed the law so that not only could these schemes not operate in future, but they were effectively made unlawful for the whole period they were in operation.
The case against S58(4)
When bringing in the retrospective changes through S58(4), HMRC claimed that BN66 was simply a clarification of an existing piece of retrospective legislation, Clause 62(2) of the Finance Act 1987, known as ‘Padmore’. Padmore retrospectively closed a loophole that meant UK residents could not be taxed on their share of any profits from a foreign partnership. HMRC argued that S58(4) simply clarified this retrospection and made it clear that the law from Padmore still applied and had always applied. However, it is clear that the advice given to Ministers by HMRC on this issue was deeply flawed. The schemes dealt with under Padmore were materially different to those affected by S58. Padmore was concerned with arrangements made using foreign partnerships, which are entirely different legal entities to the trusts that were targeted by BN66. The Chancellor at the time, Norman Lamont, said that Padmore was only intended to apply to “a very restricted class of person – partners in foreign partnerships”. The nature of the retrospection also differed significantly between Padmore and BN66. Under Padmore, Parliament made clear the purpose of retrospection was to ensure foreign partnerships could not generate new tax relief claims for the previous six years. Padmore did not retrospectively tax anyone, or generate demands for payments that were not due at the time the schemes were in operation. It excluded any retrospective demands for payment from anyone who had already filed a claim for tax relief. The retrospective elements of S58(4) produced the inverse effect, and meant that those using the schemes caught out by BN66 became liable for tax and interest payments stretching back as far as 2001. This is despite the fact that for more than seven years HMRC made no attempt to claim Padmore applied in the schemes caught out under S58(4). Indeed, as far back as July 2002, HMRC issued an internal Technical Exchange (TN63), which confirmed their recognition that the scheme was widespread and legitimate. By bringing in S58(4), the Government ignored the accepted practice to only apply retrospective tax legislation in areas where HMRC had already announced that it would do so in the future. This breached both the ‘Rees Rules’, which states that clear warning must be given, and the ‘Dorrell doctrine’, which states that retrospective legislation should only be used in very exceptional cases, and again, only where clear warning has been given in advance. Following publication of BN66, the Government received vociferous objections from various professional bodies. The Chartered Institute of Taxation called S58(4) “extreme and unjustified”. The Law Society stated it was “wrong in principle”, and the Institute of Chartered Accountants (ICAEW) stated that it sent out a damaging signal about the stability of the UK tax system. S58(4) and BN66 have since been widely condemned in numerous academic and professional journals.
The passage of S58(4) through Parliament
It is clear that when S58(4) was debated in Parliament, the Minister at the time, Jane Kennedy, was not aware of the extent of the opposition to this clause and the large number of people who had been encouraged by HMRC’s failure over the previous seven years to challenge the scheme in the tax courts to assume that it was perfectly legal. Jane Kennedy has since encouraged victims to write to their MPs urging HMRC to examine every case. S58(4) was opposed by several prominent Shadow Ministers, including David Gauke, now the Exchequer Secretary, who said that the retrospection was unacceptable and that, once in power, the Conservatives would look at the practicalities of repealing it. The Liberal Democrats also sought in vain to amend the clause to remove its retrospective elements. The matter was even referred to the Parliamentary Joint Committee on Human Rights who concluded that S58(4) was arguably in breach of Human Rights. The implications of S58(4) were considered so far reaching that two scheme promoters challenged the validity of Parliament’s right to introduce such draconian retrospective legislation. Although the Judicial Review and subsequent Court of Appeal hearing confirmed Parliament’s supremacy to introduce retrospective legislation, the judge was very critical of HMRC. The evidence revealed in the hearings highlighted that the information laid before Parliament (when the Bill was passed in 2008) lacked the full background necessary to make an informed judgement, including the previous acknowledgement by HMRC that the schemes were widespread and could not be challenged in the tax courts, serious discrepancies in the argument that the retrospective changes were a clarification of Padmore, the astonishing fact that no standard Impact Assessment was carried out, that HMRC’s internal protocols were breached, and that standard and established procedures for introducing retrospective taxation were ignored.
The impact of S58(4)
The overwhelming majority of the approximately 3,000 individuals affected by S58(4) are British people who invest and spend their incomes and support their families in the UK. Many of them are contractors or self-employed people who used trust schemes as a way to plan for greater certainty in their tax affairs, but they also include healthcare workers and others on modest incomes. Faced with demands totalling tens or hundreds of thousands of pounds, many people stand to lose their homes or be forced into bankruptcy. The stress has affected people’s mental and physical health, and some marriages have already collapsed under the strain. The arbitrary use of retrospective tax legislation against the clear principles laid down in the Rees Rules also sends out mixed signals to individuals and companies who wish to invest and settle in the UK and create job opportunities; it also contradicts the Government’s stated intention to create a more simple and fairer tax system, and has serious repercussions for the rule of law, which is an essential component of a competitive economy.
While we acknowledge the right of Parliament to amend tax legislation, the retrospective nature of S58(4) is clearly contrary to Parliamentary and HMRC protocols and, more importantly, it is quite clear that Parliament was not in possession of the full facts when it passed the legislation. We are calling on Parliament to amend S58(4), to change the wording from “as always having had effect” so that it reads “to have effect from 12th March 2008”. This would bring the Finance Act in line with the Rees Rules and HMRC protocol, and mean that retrospective tax liabilities would only accrue from the moment the intention was announced to close the affected schemes through publication of BN66, and not for the period during which they were considered by HMRC to be operating legally. It would also give victims the ability to fight their case in the tax courts, which is an option that S58(4) denied to them.