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Tax advisors defeat professional negligence claim despite failing to warn of EBT scheme risks

Thursday, 24 March, 2016

A firm of solicitors who advised a client to use an employee benefit trusts (EBT) tax avoidance scheme has defeated his claim for damages in professional negligence, brought after the scheme was challenged by HM Revenue & Customs.

The law firm was led by Paul Baxendale-Walker (BW), an expert on the taxation of remuneration trusts. In 1998 his firm was approached by Iain Barker, the owner of a profitable management and business software company, who was looking for a scheme that would allow him to make a partial exit from his shareholding without incurring the associated very large capital gains tax (CGT) charges. His company's own tax advisor, Nigel Hollinshead, referred him to BW.

BW recommended the use of the EBT scheme under which a sub-trust was set up for each participant, who then gifted their shares into the sub-trust. Although the participant and his family would thereafter be barred from receiving any benefits from the trusts, he would be able to take 'deep discount' cash loans from the trusts at a commercial rate of interest, with the interest accumulated and repayable in a lump sum at the end of the loan period. This would entirely avoid the CGT charge on the disposal of his shares. His family could also receive distributions after his death, and the loans could be rolled over to become a debt on his estate, thus reducing its value for inheritance tax purposes.

BW's representative discussed the matter of the scheme's legitimacy with Barker at the time – Barker's notes indicate he was given reassurances that the schemes could not be successfully challenged by HMRC and he also received a written tax opinion from Hollinshead, stating that 'whilst nobody can rule out possible changes to tax law it is difficult to see that the Inland Revenue will be in a strong position to mount any meaningful attack on the use of an EBT as described in this opinion'. The opinion described the EBT as a bona fide, irrevocable, discretionary trust that gave the participants no power to command the trustees: 'Whilst recommendations can be made through declaratory memoranda this is entirely different to circumstances with other tax planning where in a real sense taxpayers maintain substantive control over the direction of transferred assets. It is this line of reasoning which we believe provides the most effective defence to any arguments of the Inland Revenue, based on the line of case law referred to above, that tax avoidance has resulted.'

Barker signed up for the proposed EBT scheme, but HM Revenue & Customs did challenge the EBTs. In 2005 its Special Civil Investigations unit began an inquiry into Barker's tax returns from 1999 onwards on the basis that capital gains relating to the sale of his company had been omitted.

In 2010 HMRC issued a substantial assessment against Barker, on the basis that the trust did not attract the tax benefits that could apply to an EBT, because it permitted his family to benefit after his death. The following year HMRC told him they had opened a COP-9 inquiry on the basis that he had acted fraudulently in making incomplete tax returns.

Ultimately, Barker came to a settlement with HMRC under which he had to pay more than GBP11 million in tax and interest.

He launched a claim against BW for professional negligence. However, this week the England & Wales High Court rejected his claim. Mr Justice Roth agreed that BW were in breach of their duty of care in not giving him an adequate 'general health warning' about the scheme, in that the firm only mentioned the possibility that HMRC might defeat it when he was about to sign the deed of gift. 'The defendants gave extremely confident advice, subject to no real qualification at all, even when Mr Barker and the other shareholders expressly asked them about risks', said Roth J.

However, the judge considered that Barker would have gone ahead with the scheme even if he had been properly apprised of the risks. He came to this conclusion because Barker had admitted he knew the scheme constituted 'aggressive tax avoidance', and also that he had considered taking up an alternative scheme marketed by Deloitte.

Roth accepted that Barker would not have gone ahead with the scheme if he had been given a 'high level' warning that the tax risks were significant. But, he said, BW were not in breach of duty for failing to admit that their advice might be wrong in law. He noted that a series of experienced tax specialists for several years had not interpreted the relevant law in a way that contradicted BW's advice, nor even suggested that it was arguable. 'In my judgment, therefore, this was not a case where it can be said that any competent and careful solicitor of appropriate expertise would have given the high level warning urged on behalf of Mr Barker', said Roth J. 'Accordingly, I conclude that [BW] were not in breach of their duty of care in a manner that caused Mr Barker any loss as claimed in these proceedings.'

He gave judgment against Barker (Barker v Baxendale Walker Solicitors, 2016 EWHC 664 Ch).