As (relatively) recent press coverage of celebrity participants shows, litigation relating to tax mitigation (or avoidance) schemes is on the rise. HMRC has taken an increasingly harder line in recent years both in tightening the legislation surrounding tax avoidance and in refusing and litigating claims for tax relief based on "losses" incurred in tax mitigation schemes. Investors who have lost out are increasingly turning to their original financial advisers for recompense. Unfortunately, many such claims are only considered or intimated after the primary limitation period has passed.
The typical tax mitigation scheme
The author has experience in practice of advising in professional negligence claims arising out of quite a number of such schemes. Such schemes typically involve investments (often via membership of an LLP which in turn invests in the underlying business) being made in start-up businesses, often based around supposedly "commoditisable" products such as new technology for consumer use, on the basis that if the business does well a return will be made or if it fails completely then the loss could be set off against other income or capital gains for tax purposes.
Alternatively, the scheme may be envisaged as one of tax deferral whereby there will likely be initial losses but longer term gains – putting tax bills "into the long grass". The real attraction of many such past schemes, for the investor/tax mitigator (avoider?), however, is the gearing loans which transform e.g. £100,000 of cash investment into £500,000 total investment by way of a £400,000 loan. That loan is typically either non-recourse or, more likely, in theory repayable but in fact covered by income warranties and deposits in offshore accounts so that the investor has only the slightest risk of ever having to repay it – but can still try and claim it as part of their losses on investment, for tax purposes. For further details of such a scheme and how the tax relief claim largely failed, see the MCashback case  UKSC 19.
The typical investor claimant
In the author’s experience, most investors in these schemes are cash rich1 but time-poor and lacking in financial acumen. The schemes have almost always been introduced by financial advisors/wealth managers who received commissions for the introduction. Most of the schemes are unregulated collective investment schemes for FSMA 2000 purposes. It will not often be difficult to establish a failure to assess suitability/advise on risk properly in a claim against the advisor. There is often an important issue about whether the financial advisor (who may typically not carry his or her own professional indemnity insurance but instead be reliant on the insurance of their principal, for whom they are an appointed representative under FSMA 2000) was acting inside or outside their usual remit. There may be issues about causation, crystallisation and mitigation of loss to deal with. However, a common theme in these cases and which for defendants represents a potentially easy "win" is limitation; because of the delays inherent in the process of investment, realising losses, completing accounts and filing tax returns, and having tax relief claims processed, as well as the investor’s trust in the advisor and general lack of interest in details of investment, it is common for the primary limitation periods in tort and contract to have expired by the time the investor seeks to bring a claim against the advisor.
Primary limitation periods
In the majority of such cases the primary limitation periods in contract and tort will have started running by the time the investment is committed to2. Accordingly, unless there are circumstances of deliberate concealment such that s32 Limitation Act 1980 (“LA 1980”) applies, the investor will often have to resort to reliance on the alternative three year limitation period from the date of knowledge, under s14A LA 19803.
S14A LA 1980- "latent damage"
S14A is a lengthy, complex provision and not all nuances involved in interpreting it can be dealt with in this article. For the purpose of what might be loosely categorised as "financial misselling" claims, the intertwining provisions can properly be summarised to provide a date of knowledge when the following have all been fulfilled:
- The Claimant needs to have suffered relevant "damage".
- The Claimant needs to be aware actually or constructively (see s14A(10) – the Claimant may be aware of certain matters which would justify seeing a solicitor or accountant whose advice might lead them to knowledge of any other requisite facts):
i. of damage that is sufficiently serious to justify bringing a claim (on the assumption that the defendant will and can pay);
ii. that the damage was caused in whole or part by negligence;
iii. to whom that negligence can (possibly5) be attributed;
iv. how any other defendant6 might be vicariously liable for that negligence.
The remainder of this article will focus on the meaning of actual or constructive knowledge in the context of claims against financial advisors relating to tax mitigation schemes. There have been some recent authorities in a similar, though not identical, factual context; and it must be remembered that the effect of s14A in any given case is exceptionally fact-sensitive, so this article seeks merely to provide some handy pointers rather than outright answers.
It stand to reason that the more sophisticated or experienced in financial, legal or litigation matters any particular Claimant is, the more likely they will have an earlier date of knowledge, and vice versa.
The key case on the overall level of knowledge required is Haward v Fawcetts  UKHL 9: concerning only actual rather than "constructive" knowledge, the House of Lords found the claim to have been time barred; the claimants had failed to discharge their7 burden of proof to show that the earliest date when they knew enough for it to be reasonable to investigate the possibility that the advice received had been negligent was less than three years before issue of the claim. They had known all material facts and the connection between the defendant’s advice and the damage was obvious. The defendant had advised on the claimant’s acquisition, in 1994, of a business which proved disastrous and which required injection of further capital from 1995 on an annual basis until 1998. By 1998 they had instructed corporate recovery specialists. The claim was issued in December 2001. They had contended for a date of knowledge no earlier than May 1999- but the earlier events threw considerable doubt on that.
In Williams v Lishman Sidwell Campbell & Price Ltd  EWHC 1322 (QB) the court found that the claimants’ claim should be struck out as disclosing no real prospect of success on the s14A issue. They had been advised, in 1997, by the defendants that there would be no erosion of capital as a result of the change to pension plan/investment they were advised to make, whereas by around 2002/2003 it was "abundantly clear" that that advice was wrong, there having been very significant such erosion. It appears that the judge concluded that the very specific nature of the advice given (and specifically requested by the claimants), coupled with the very significant losses sustained was enough to infer that the losses were attributable (or at least could be) to negligence by the defendants; certainly enough to justify investigation of a claim, per Haward v Fawcetts.
In Integral Memory v Haines Watts  EWHC 342 (Ch) in 2003 the defendant had failed to advise the claimant about a change in tax law. It was clear that the claimant was unhappy about that advice from the same year and that it had considered taking advice from counsel on the situation and thus knew enough to for it to be reasonable to investigate further which would have revealed the negligence, and thus proceedings commenced in 2011 were time-barred.
In Jacobs v Sesame Ltd  EWCA Civ 1410 in 2005, the claimant, an inexperienced investor, invested £65,000, which was most of her life savings, in a bond invested entirely in commercial property. She received annual statements which showed initial growth of about 10 per cent for the first two years but then a catastrophic fall in value. In July 2009, she spoke to another advisor, who advised transferring the fund to a more balanced portfolio, which she did. She claimed to have been advised initially by the defendant that she was guaranteed to get her investment back, though she also alleged that the fund was moderate rather than low risk as she had believed. The Court of Appeal held that the claim was time-barred by at the latest July 2009, as the claimant had acquired relevant constructive knowledge that she had suffered damage because the return of the amount invested was not guaranteed. At that point she might have asked her second advisor whether, despite the catastrophic fall in her bond's value, she was guaranteed to recover her initial investment if she left it in place for five years. She could also have found the same information from her documentation, which clearly stated in plain English that there was no guarantee.
On the other hand, in Kays Hotels Ltd v Barclays Bank plc  EWHC 1927 (Comm): in 2005 the claimant entered into an interest rate hedging product with the defendant, pursuant to which following the fall of interest rates in 2008 the claimant began to make substantial payments to the defendant. By around November 2009 the claimant had already made circa £36,000 of payments but the court held (on the defendant’s application to strike out) that the mere fact of those substantial payments was not enough, or at least that there was a real prospect of the claimant arguing that it was not enough, to give rise to a reason to begin to investigate the claim and therefore to give rise to constructive knowledge. Of course, that decision was only on a strike-out application; leaving the possibility that the claim might still be found, at trial, to be time-barred.
Potential trigger events for "knowledge"
Whilst every case, therefore, very much turns on its own facts, appropriate "triggers" therefore, for the date of knowledge under s14A could be:
- General unhappiness with the advice received, coupled with active consideration of the need to take independent advice on whether the original advice was correct (as this probably indicates the level of suspicion necessary).
- Knowledge that an investment may well be significantly impaired in value despite the original financial advisor having stated that it would offer a good prospect of a return (though it depends on how strident the original advice was, and how far the value has fallen; and whether the investor relied on advice that there would be a return or invested purely for the tax benefits). Such knowledge might in turn stem e.g. from knowledge of the performance of the Scheme invested in; or of the insolvency of the entities running that Scheme (which would have a knock on effect).
- Knowledge that the investment is highly unlikely to be successful as a tax mitigation device (e.g. because it is materially identical to an existing scheme which has been successfully struck down by HMRC such as MCashback though there may be room to argue that subtle differences between schemes mean that knowledge of failure of one does not equate to likelihood of failure of another).
- Knowledge may come not only from the specific discussions and correspondence between the parties, or between the client and subsequent advisors, but also from public sources e.g. media reports regarding such tax mitigation schemes and HMRC’s likely attitude to them. The availability of (admittedly, often inaccurate) information on the internet via Google and websites such as Wikipedia, newspaper and other news outlet websites does lead to the possibility of arguments by defendants that the claimant "must have picked up on" the problems with a given investment.
- On the other hand, a potential trigger event may not in fact provide the requisite knowledge if its impact is ameliorated by some reassurance given by e.g. a professional advisor or even investment scheme organiser that the potential bad news is not as bad as it might appear. For example, the mere fact of an HMRC tax enquiry may not point to the failure of the scheme as a tax mitigation advice if e.g. this possibility has been foreshadowed at the outset (as it often was in the promotion of such schemes) and particularly if the investor receives ongoing assurances that it will be "alright in the end". Note, however, that such assurances will generally only be effective to prevent ‘knowledge’ accruing if they are given by someone other than the defendant original professional advisor (see Williams v Lishman Sidwell Campbell & Price Ltd  EWHC 1322 (QB) where reassurances merely from the defendants were held insufficient).
In summary, any lawyer confronted with bringing or defending a claim by a disgruntled investor against their financial advisor in relation to a failed tax mitigation scheme investment must be alive at an early stage to the issue of limitation, both in terms of primary limitation but more usually s14A "latent damage". There may well be a significant volume of relevant documentary evidence held by the claimant, their accountants and/or the advisor themselves (or the scheme organiser, if they are prepared to cooperate) which is relevant to the date of knowledge, and the scheme may be similar to one which has already been well-publicised as failed. As limitation is usually an "all or nothing" issue, investigatory efforts should be focussed on such evidence at an early stage.
Furthermore, it may often be difficult for an investor who claims to have been so reliant on the promises of significant returns on their investments and/or of indefeasible tax mitigation effectiveness to later claim that they didn’t realise those promises were false at an early stage when the investment plummeted in value and the tax enquiry began to look decidedly dodgy. A difficult line must be trod by claimants seeking to rely on s14A but also to prove reliance in relation to the original advice itself.
1. Though it is not uncommon to find investors who have borrowed at low rates, often from major lenders who had some awareness of the nature of the schemes, to fund the ‘cash’ element of the investment- the potential tax relief (once geared up) being so much greater than any interest or fees payable on the loan.
2. Save in cases of ongoing contractual retainer where the situation is retrievable until some later date (unlikely to apply here), time in the claim in contract (for purposes of s5 Limitation Act 1980) starts running from the last failure of advice i.e. the breach which will inherently be before the investment is made. In tort (for the purposes of s2 LA 1980), damage is incurred when a commercial/financial disadvantage is suffered- but it does not necessarily have to be quantifiable at that point Martin v Brittania Life Limited  Lloyd's Rep. P.N. 412; Shore v Sedgwick Financial Services Ltd  EWCA Civ 863. Note that it is the time of contractual commitment to, rather than date of transfer of funds (which is often slightly later), which is the usual date of damage.
3. It should be noted that s14B LA 1980 provides that, notwithstanding whether the cause of action has yet accrued (i.e. whether there has been ‘damage’) or whether the alternative limitation period under s14A has yet expired, in tortious claims involving negligence there is a longstop limitation date of 15 years from the date (or if there is more than one, the last of those dates) of any act or omission giving rise to the claim – in other words, 15 years from the last date of breach of duty.
4. Which means ‘know with sufficient confidence to justify embarking on the preliminary steps to issuing a claim form’ not ‘know with absolute certainty’: Halford v Brookes  1 WLR 428.
5. ‘Attributable’ means ‘capable of being attributed’ i.e. that there is a real, and not just fanciful, possibility that the act or omission is a possible cause of the damage- it does not need to be a probable cause- Nash v Eli Lilly & Co  1 WLR 782. Nor does the claimant need to be in a position to be able to fully plead their claim: Wilkinson v Ancliff  1 WLR 1352. Finally, by s14A(9), lack of knowledge of whether in law acts or omissions amount to negligence is irrelevant.
6. E.g. the statutory quasi-‘vicarious liability’ provisions under s39(3) FSMA 2000.
7. Whilst the Defendant must raise the issue of limitation, in relation to s14A the Claimant then bears the burden of proving the earliest date when they had knowledge.
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