Financial advice on tax-related investment schemes: (why) a surge in claims?

This article was first published in the Journal of International Banking and Financial Law.

James Hall has been undertaking professional negligence work for over a decade, with a particular emphasis on claims relating to financial services including investments.  During the past four to five years, the predominant source of such cases has shifted from lender claims arising out of the economic woes from 2007 onwards to claims against financial advisers, be they ‘true’ IFAs, advisers attached to a network or in-house advisers at banks, and in particular relating to tax ‘deferral’ or ‘mitigation’ schemes (or which HMRC would describe as tax ‘avoidance’ or even, sometimes, ‘evasion’ schemes).  This article examines some possible reasons for the apparent surge, and the challenges that such claims face, in particular in relation to limitation.

The nature of such tax schemes

The underlying rationale is not new; someone devises an investment scheme with the aim of creating a ‘loss’ which can be offset against other income or capital gains so as to reduce the investor’s tax liability, via the process known as ‘sideways loss relief’. 

The legislative provisions permitting such relief claims have evolved over time, as has HMRC’s practice in enquiring into the relief claims.  Whether such losses qualify for any relief at all in turn depends on the subject matter of the investment.  Successive iterations of the UK Government have sought to promote investment in different industries and sectors (such as British films, urban and industrial redevelopment in the form of enterprise zones and various others) granting reliefs for such investments with the primary political aim of assisting those sectors. 

However, whilst some such investment has benefitted those sectors (a number of popular and successful films of the last 15 years have been part-financed by such investment), often the primary purpose for the investor is not to benefit the recipient of the investment monies but to create the investor’s own loss (should the investment not prove, or at least not prove immediately profitable) to alleviate their tax burden. 

The only way to make such investments effective for that, tax-related, primary purpose, is to ‘gear’ them up by way of loans to the investor.  Classically, a ratio of 1 part investor’s cash to 3 parts (25%/75%) ‘gearing’ loan is used, on the basis that (at most of the key times) the highest marginal rate of income tax was 40% and thus 40% of the total investment (comprising all 4 parts) would be more than the one part (25% of the total) put in by the investor, creating an instant ‘profit’ by way of loss relief.  However, the author has encountered ratios ranging from 10%/90% to 40%/60% in various schemes.  If the relief is claimed on past earnings, then it is received as a rebate.  It is not uncommon in the more elaborate schemes for the 1 part invested by the investor to be funded by the rebate itself, or for the 1 part to be provided by way of bridging finance from an entity linked to the company promoting the scheme, so that the investor need not in fact utilise their own, pre-existing cash at all.  Suffice to say, to be able to take sufficient advantage of the schemes, investors need to be higher-rate taxpayers at the time of investment.

The total investment is used to directly purchase an asset (frequently intellectual property rights), or to invest in units in a collective investment scheme, or to subscribe to become a member of an LLP (the LLP’s losses being treated as those of the members for taxation purposes) which LLP in turn funds a transaction of the acquisition of an asset.  The paradigm example is the film sale and leaseback scheme, but the author has seen, and the reported tax case law discusses, many and varied (and superficially ingenious) subjects such as carbon credits and videos embedded in text messages as the underlying ‘asset’ invested in.

The taxpayer/investor claims the relief (against future tax) or rebate (of past tax paid) in their tax return for the year of investment; though ‘which year?’ can itself be the subject of debate with HMRC and give rise to claims.  HMRC then, generally, has until the first anniversary of the last date on which such tax return could be filed in order to notify the taxpayer that it is ‘enquiring’ into the relief/rebate claim (although in limited circumstances HMRC may sometimes be able to enquire at later dates).  It is then for HMRC to decide whether to allow or deny part or all of the relief/rebate claim, notwithstanding that the same may already have been paid (in the case of a rebate) or factored in (in the case of a relief, where the taxpayer factors that in in declaring what tax they are liable to pay, on a self-assessment basis).

The triggers for claims against financial advisers

In some cases, investment is made for return as well as (or even primarily instead of) tax benefits.  In those cases, underperformance of the investment may lead to a complaint and/or claim against the financial adviser.  Where tax mitigation/deferral is the primary (or only) goal of the investor, then if (as was common, historically) the relief or rebate is received before any HMRC enquiry is commenced, then depending on the course of that enquiry (and whether, as is also commonly the case, the financial advisor and/or scheme promoter has indicated prior to investment that an HMRC enquiry is likely, as a matter of ‘routine’), the investor may not be alert to the possibility of a claim for many years after the investment was made.  HMRC has taken in some cases over a decade to finalise its enquiries, particularly where a particular investment scheme involves large numbers of investors – see, for example, the Eclipse film finance scheme which featured 40 LLPs each with multiple investor members ([2015] EWCA Civ 95, [2013] UKUT 639 (TCC)).  There has also been very recent press coverage of both the Invicta film finance scheme and the Ingenious Media scheme (see the Times 8th October 2016 and 14th October 2016); Ingenious having also been the subject of a recent First Tier Tribunal decision ([2016] UKFTT 521 (TC)).

Aside from the start of the HMRC enquiry, various points during or even at the conclusion of that enquiry, other factors which might cause an investor to query the original advice given on the scheme include the point at which there is a failure of the underlying asset (though in a scheme where the investment was purely for tax reasons, of itself this might not be a trigger) such as, where real property is involved, the crash in property values from around 2007 onwards.

The factors leading to the surge

In the author’s view, and based on a mixture of anecdotal evidence collated from various sources as well as the increasing prevalence of reported cases and publicity around these tax schemes, a combination of the following factors appear to be leading to a surge of claims relating to the advice received by investors on these schemes:

1. The start date and length of the underlying schemes – many of the film finance type schemes were ‘sold’ in the early to mid-2000s and have a 15 year lifespan and were designed so that, having obtained tax relief at the outset, investors largely forgot such schemes or did not have to pay them much attention apart from filing the appropriate tax return material each year;
    
2. Increasingly exotic schemes – as certain types of relief were ended (e.g. film finance in around 2007/2008), scheme promoters/devisers began to look to increasingly exotic subject matter – see, for, example the ‘carbon credit trading’ schemes.  See also Tower MCashback ([2011] UKSC 19) for an interesting example of a more esoteric subject matter.  The evolution of these schemes has led to increasing interest from HMRC in challenging tax relief/rebates claimed;
    
3. The initial slowness of HMRC to close enquiries – historically, HMRC, appears to have been less concerned about schemes, particularly if of the ‘vanilla’ ‘deferral’ type rather than more complex/ avoidance types.  In any event, even if HMRC took an interest in a scheme (of whatever type), generally they were slow to launch an enquiry, and slower still to progress the same, with enquiry lengths of over 5 years and up to 7 or 8 years before closure (unless a closure is forced by the taxpayer earlier, through the Tribunal) being common;
    
4. The economic crash – this had a direct effect on the value of underlying assets (particularly real property or assets such as units in Unregulated Collective Investment Schemes which are linked to real property); but has also led to a shift in UK Government /HMRC policy towards more aggressive counter-avoidance tactics, meaning that more enquiries appear to have been started and more have concluded with less favourable outcomes for taxpayers in recent years;
    
5. Control of information by scheme promoters and administrators – the schemes invariably have a corporate entity administering the investment and tax claims on behalf of the investors, the entity usually being controlled by those that devised and/or promoted the scheme in the first place.  Given the number of investors in such schemes, and the risk to both the viability of the scheme itself and also the professional reputation (and/or assets) of the promoters/designers (and to the viability of future iterations of such schemes), those administering the schemes have often been less than forthcoming with investors as to the progress of the investment and/or any HMRC enquiry.  However, there is only so long that such secrecy can and has been maintained, and eventually investors (whether individually or as part of an action group) do raise questions;
    
6. The introduction of Accelerated Payment Notices (“APNs”) and Partner Payment Notices (“PPNs”) – from June 2014 HMRC has had the power (pursuant to the Finance Act 2014 ss219-229) to issue these notices which require the taxpayer to make payment of HMRC’s estimate of the (understated) tax they will owe on the outcome of any open enquiry, provided certain criteria are met (essentially, if the scheme in question is one or is similar to one which has already been determined as ineffective, in part or whole, for tax relief/rebate purposes).  Reported figures as to the number of such APNs and PPNs issued vary significantly but there certainly appear to have been tens of thousands issued to business and individuals since 2014.  Attempts continue to challenge the APN/PPN regime (see e.g. R. (on the application of Vital Nut Co Ltd) v Revenue and Customs Commissioners [2016] EWHC 1797 (Admin); appeal outstanding at the time of writing), but it remains in force at the time of writing.
    
7. Increased awareness of the possibility of claims – there are now various investor/tax-payer groups and forums, as well as there being an element of claims management and ‘farming’ in the sector, including by former financial advisers themselves.

The challenges faced by claims against financial advisers, arising from such schemes

It is not often difficult to establish that these schemes were ‘missold’ to investors, by virtue of both process failures (in terms of ‘fact finds’ as to the investor’s financial circumstances, risk attitudes and investment/tax objectives) and mismatches of perceived or actual riskiness of the scheme to the investor’s risk attitude and objectives.  These failings may sound either as breaches of contractual/tortious duties of care or breaches of statutory duty (i.e. of the rules in the FSA/FCA Handbook, actionable under s138D FSMA 2000 (as it now is); though in some cases there may well be argument as to whether the investment in question is a regulated activity for the purposes of s22 Financial Services and Markets Act 2000 and the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 SI 2001/544.  Less commonly, there may even be sustainable allegations of breach of fiduciary duty.

Some core challenges for potential claimants, other than limitation (see below), are:

1. Scope of duty/basis of relationship – there may no doubt be argument as to whether the putative defendant really was an advisor, or was simply passing on information to the claimant without giving advice.  However, and assuming there is no contractual estoppel which might prevent claiming advisory duties/actions on negligent misstatements (see Springwell v JP Morgan Chase [2010] EWCA Civ 1221), the Court will ultimately look at substance rather than form (see Rubenstein v HSBC [2011] EWHC 2304 (QB), not disturbed on appeal on this point); though note the potential impact of SAAMCo [1997] AC 191, of course;
    
2. Factual causation of loss – the claimant must convince the court as to what, on the balance of probabilities, s/he would have done but for the breach of duty.  It is relatively easy for the putative defendant to assert that either the claimant would have proceeded (even if properly advised) in any event, due to their desire to avoid tax and/or make a return and/or that even if the claimant had not proceeded with this investment, they would have invested in something similar with equally negative, or at least somewhat negative results;
    
3. Funding – this is a practical rather than legal but far from insignificant difficulty for many claimants, who may once have been high net worth individuals but may now, by conspiracy of circumstances including  HMRC’s hardened approach (and particularly if they have received an APN or PPN), have less or no disposable cash to pay legal fees.  With the withdrawal of old-style conditional fee agreements, there are less obviously attractive routes for funding other than traditional private payment of their lawyers by the claimant, but there are some Before The Event insurance policies, bundled with household and other insurance policies, that even cover claims against financial advisors to varying degrees; as well as litigation funders who may be prepared to cover some of the larger claims.

Limitation of actions

Limitation, however, is the real key battleground for many claims of this nature.  As set out above, they are often historic investment schemes and loss (principally deriving from the actions of HMRC) is often not crystallised or discovered until many years later. 

The primary limitation periods are six years from breach (in contract: s5 Limitation Act 1980 (“LA 1980”)) or damage (in tort: s2 LA 1980).  In practice, these periods tend to start at the latest by the date that the investor is contractually committed to the investment (see Shore v Sedgwick Financial Services [2008] EWCA Civ 863). There is rarely scope to mount a Nykredit [1997] 1 WLR 1627 argument as to a later ‘damage’ event in tort; though fraud or deliberate concealment of breach may give rise to postponement of the start of the primary limitation period (see s32 LA 1980: and, for an example, see Horner v Allison [2012] EWHC 3626 (QB).

Thus the claimant will usually need to resort to the alternative limitation period under s14A LA 1980, i.e. three years from the date of actual or constructive knowledge, for negligence-based tort claims.  S14A is relatively labyrinthine and it is not possible to cover all aspects of it concisely in this article.  However, the key points to note are:

1. The threshold for ‘knowledge’ is a low one: essentially being reached when the claimant knew enough for it to be reasonable for him to investigate further the possibility of a claim against the adviser (see Haward v Fawcetts [2007] UKHL 9);
    
2. The knowledge must be of both the material facts about the damage in respect of which damages are claimed and that the damage is attributable (at least in part) to acts or omissions alleged to constitute negligence and of the identity of the wrongdoer (i.e. attributability to the defendant)(s14A(6) and (8));
    
3. Knowledge includes that which the claimant actually has and that which they might reasonably be expected to have acquired from facts ascertainable by him/her or from facts that s/he could have discovered with the help of an appropriate expert (i.e. a specialist lawyer, tax adviser, financial adviser or accountant, for these cases) which it was reasonable for him/her to seek (s14A(10));
    
4. The burden of proving the earliest date of actual knowledge is on the claimant (Haward v Fawcetts), who will also likely have control of most of the documents relevant to constructive knowledge (though technically the burden of proof on that issue is on the defendant: Skipton Building Society v Sorsky [2003] EWHC 930 (QB)).  Thus, the claimant often has to ‘prove a negative’ by an extensive physical and electronic disclosure exercise.

S14A(10) is of particular interest as this deals with constructive knowledge (it being relatively easy in most cases for the claimant to plausibly deny actual knowledge at any relevant earlier point).  Examples include Williams v Lishman Sidwell Campbell & Price Ltd [2009] EWHC 1322 and Jacobs v Sesame Ltd [2014] EWCA Civ 1410 where claimants have failed to pass the constructive knowledge test.  For a contrasting recent decision see Lenderink-Woods v Zurich Assurance Ltd [2015] EWHC 3634 (Ch), though it should be noted that (a) that was only the failure of a summary judgment application by the defendant, not a decision after trial and (b) the claimant may have been at the more sympathetic end of the spectrum, in view of her advanced age.  What emerges from these and other cases is quite how fact-sensitive the application of the tests in s14A is.

Williams v Lishman Sidwell Campbell & Price Ltd also highlights the double-edged nature of s14A(10).  Whilst in the right case (see next paragraph) it might come to the aid of the claimant (in  terms of reassurance from an expert preventing the accrual of constructive knowledge), it can also be their undoing.  In Williams, it was decided that (with reference to earlier Court of Appeal authority), the ‘appropriate expert’ cannot include the defendant themselves, however reassuring the defendant might have been – if the claimant had good reason to question the accuracy of the original advice then reassurance from that original advisor cannot qualify as ‘appropriate expert advice’; the subsection contemplates someone independent of the original advice.

The key issues in s14A (and, again, particularly s14A(10)) were recently highlighted in the case of Barker v Baxendale-Walker Solicitors [2016] EWHC 664 (Ch).  The judge, Roth J, found that the defendant had not fallen below the standard of care, in a way which was factually causative of loss, regarding advice in 1998 on the construction of the Employee Benefit Trust (“EBT”) in question and the interpretation of s28 Inheritance Tax Act 1984.  However, as to limitation (obiter), and notwithstanding that the claimant had received advice from other solicitors (including in 1999) and from multiple leading and junior counsel of various specialisms relating to potential problems with the EBT (including in 2006), and had received the first notice of assessment from HMRC in 2010 (just over 3 years prior to issue), Roth J found that the claim was not time-barred in that the date of knowledge had not been triggered more than 3 years prior to issue.  The concerns expressed by later lawyers over the defendant’s advice were as to aspects of it which were not causally connected with or relevant to the specific alleged negligence that formed the basis of the claim.  The mere instigation of an HMRC assessment was also insufficient; the possibility of an assessment was known from the outset and the particular issue taken by HMRC over s28(4) was not raised until some days after the point 3 years prior to issue of the claim – and even then the claimant had sought and, a little later, received reassurance from a QC that HMRC was wrong.  This decision illustrates quite how nuanced the application of s14A (and in particular s14A(10)) is, in that even general concern about other aspects of advice from the original advisor may not be enough to trigger constructive knowledge in relation to the damage in respect of which damages are claimed (see s14A(6)).

It should also be noted that even claims where s14A applies are subject to a ‘longstop’ limitation period of 15 years from the date of last act or omission (at least partly) causative of the loss in question.

Conclusions

In the author’s view, and whilst it is hard to be certain, the factors outlined above have already led to an increase in claims against financial advisers and their employers (including several of high street, private and investment banks based in or with operations in England and Wales) arising from tax-related schemes, and the surge in such claims is likely to continue; and to have a ‘long tail’ over the years to come, in terms of both new claims and the resolution of existing claims.

In particular, however, limitation will provide fertile soil in which the putative defendant can plant its defence.  The increased taxpayer/investor awareness of (potentially) negligent advice, failure of such schemes (whether for tax or investment purposes) and HMRC’s hardened attitude will make it harder and harder for claimants to rely successfully on s14A LA 1980 and that, together with the decline of new such tax schemes, will likely mean that volumes of sustainable claims begin to reduce over the next 5 years or so.  The longstop under s14B LA 1980 will likely mean an absolute end date in the early to mid-2020s for bringing most of these claims, in any event.