Fiscal democracy in crisis

The individual’s right to taxation freedom has been challenged by the decision of the Supreme Court to rule in favour of the Revenue and Customs (“HMRC”) in a £1.5bn tax avoidance case. As important are the words spoken by the Prime Minister which are reviewed below.

The case (being headlined as ‘The Mickey Mouse deal’ because of the innocent involvement of Disney executives) involves Eclipse 35, a film investment partnership involving many high profile names including Sir Alex Ferguson, Steven Gerrard and two advisers to David Cameron, Sam Laidlaw and Dick Olver. The original idea was to encourage investment in the British film industry. Money poured into a number of finance schemes. The fiscal rules were written in such a way that in the case ruled on by the Supreme Court each of the 289 members of Eclipse 35 could have gained up to £404,000 in tax relief on a personal investment of £173,000.

The words spoken by David Cameron are important:

“There is a form of tax avoidance where people are almost specifically setting up a company to avoid tax rather than wanting to invest in start-ups.”

The Prime Minister then made a distinction between legitimate ways of minimising tax bills and practices he regards as wrong.”

A senior tax adviser (quoted in ‘the Times’ 24 April) said:

“The courts are taking a purposive (sic) approach which means they look at what Parliament intends.”

Last Autumn the Chancellor of the Exchequer announced what is being called the SEED EIS scheme. In essence  a new or up to two years old company with gross assets of less than £200,000 can raised (once only) £150,000 from investors. The taxation advantages are mouth-watering. There are 50% income tax relief, up to 28% capital gains tax relief, dividends free of tax and no tax on gains from share sales. No investor can put in more than £100,000 and the shares must be held for at least three years. During that time the company must retain its tax qualification status for the tax reliefs to be valid.

The scheme is to encourage early stage investment in newer companies.

The regulations for the SEED EIS scheme are contained in The Finance Bill (no 4), section 38 and schedule 6. Sections 39 and 40 and schedules 7 and 8 also apply. This aggregates to over fifty pages of sometimes unintelligible draft law. The Finance Bill is expected to be passed by Parliament in July.

I spoke at length to a senior corporate lawyer at one of our main law firms. Her view was that she would need at least five hours of chargeable time to advise the directors of a company intending to raise money though this scheme of their responsibilities and potential liabilities. That assumes that the company itself is structured correctly (eg. shareholders’ agreements) which is unlikely and so more legal time might be incurred. The final bill might be over £5,000.

How many boards of directors will take that course of action? My guess is almost none. It is against the instinct of directors to incur such costs. They’ll take the risks.

So what happens in two years time if the Supreme Court, HMRC and/or the Prime Minister decide that the scheme has worked out in a way that was not foreseen?

The directors of the investee firms could find they have some very angry (and litigious) shareholders.

Fiscal democracy is in turmoil. British tax payers and company directors can only act if they have certainty.

This is a worrying situation.

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