Rational Tax Enforcement
The Rt. Hon. The Lord Keith of Kinkel

Tax is not a popular subject except among those who hope to make money out of
advising about it, or selling schemes aimed at avoiding or mitigating its incidence.
However, the series of cases which started with Ramsay v. Inland Revenue
Commissioners! has greatly reduced the number of concerns in the business of
marketing tax avoidance schemes, and so many taxpayers have had their fingers
burnt by the wares that they purchased so hopefully that there can be few
nowadays who are tempted to take the risks involved. The reduction in the higher
marginal rates of tax and the introduction of a 40% marginal rate of capital gains
tax may also operate to the same effect.

The Ramsay series of cases, and particularly Furniss v. Dawson,2 engendered
serious doubts as to whether the principle enunciated in the Duke of Westminster's
cas? had been thrown completely overboard by the House of Lords. It was feared
that in future any act by which a taxpayer so arranged his affairs that he was liable
to pay less tax than he would otherwise have done might be struck down by the
courts. It was felt in some quarters that the House of Lords had turned itself into
an arm of the Inland Revenue dedicated to securing that all taxpayers so arranged
their affairs as to be liable for the maximum amount of tax.

The features that distinguished Furniss v. Dawson from its predecessors were
that the series of transactions there involved were not of a circular self-cancelling
character, but had a commercial object in view,while the interposed step appeared
to have certain definite and inescapable legal consequences. The intermediate
company was on the face of it entitled, as a legal entity distinct from the original
owner of the shares in question, to the proceeds of sale of these shares. It will be
remembered that the scheme entered into involved the shareholders in an
operating company transferring their shares to an Isle of Man subsidiary company
in exchange for shares in the latter, which then sold the operating company shares
on to a purchaser. Everything was carried through in one morning, in pursuance of
an informal, non-contractual arrangement with the purchaser. The object was to

·The Denning Lecture 1989 under the auspices of the Bar Association for Commerce, Finance and
Industry.
1. [1982] A.C. 300.
2. [1984] A.C. 474.

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postpone liability to capital gains tax in reliance on paragraphs 4(2) and 6(1) of
Schedule 7 to the Finance Act 1965. It was held that the disposal by the Isle of
Man company fell to be disregarded for fiscal purposes. Capital gains tax was
accordingly payable as though the shares in the operating company had been
transferred directly to the purchasers and the purchase price had been received by
the taxpayers.

Furniss v. Dawson was followed by a period of doubt as to its true ratio decidendi.
The transfer of the shares to the intermediate company had been held by
Commissioners to be a genuine and not a sham transaction, yet the fiscal
consequences which by the provisions of paragraphs 4 and 6 of Schedule 7 to the
Act of 1965 were to be attached to such a transaction were held not to apply. So it
came to be thought by some that the case rested upon the principle that any-J1ing
done with a view to avoiding or minimising tax upon a contemplated future
transaction fell to be struck down. This view of the case was fostered to some
extent by certain observations of Lord Diplock in I.R. C v. Bunnah Oil Co. Ltd.4 and
by Lord Scarman in Furniss v. Dawson itself. Lord Diplock said:

"It would be disengenuous to suggest, and dangerous on the part of those
who advise on elaborate tax avoidance schemes to assume, that Ramsay's case
did not mark a significant change in the approach of this House in its judicial
role to a pre-ordained series of transactions (whether or not they include the
achievement of a legitimate commercial end) into which there have been
inserted steps which have no commercial purpose apart from the avoidance of
a liability to tax which in the absence of those particular steps would have
been payable. The difference is in approach."

Lord Scarman had appeared to introduce a moral dimension into the matter, by
his reference to determining

"the limit beyond which the safe channel of acceptable tax avoidance shelves
into the dangerous shallows of unacceptable tax evasion."

This supposed principle constituted the high water mark of the Inland
Revenue's argument in the three cases reported under the name of Craven v.
White.6 Lord Oliver said:

"Your Lordships are thus invited ... to construct a general catch-all formula
for rendering ineffective any step undertaken with a view to the avoidance or
minimisation of tax on an anticipated transaction or disposition.,,7

The facts in all three cases presented a more or less close resemblance to those
in Furniss v. Dawson. In each of them assets, in one case land and in the other two
3. [1936] A.C. 1.
4. (1983) 54 T.e. 200, at p.214.
5. Supra n.2, at p.513.
6. [1988] 3 W.L.R. 423.
7. At p.456.

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shares, had been transferred to subsidiary or sister companies in anticipation of a
sale to an outside purchaser and with a view to avoiding or postponing a liability to
tax which would have been incurred on a direct sale. In two of the cases the sale
immediately in contemplation had not come to fruition, but a sale in one case to a
different purchaser and in the other case to the same one had in fact been
completed over a year later. In the third case, Craven v. White itself, two sets of
negotiations were in progress at the time of the transfer to the intermediate
company, and one of them was brought to a successful conclusion by a completed
sale only a short time afterwards. The House of Lords decided unanimously that
tax had been successfully avoided in the first two cases, and by a majority of three
to two, also in the third case.

The most important effect of the case is that it laid to rest the idea that any
transaction which is effected for the purpose of avoiding tax on a contemplated
future transaction is, because it is "planned", necessarily to be treated as being one
with the later transaction and having no independent effect. That proposition was
not supported even by the minority in the House. The rationale of Ramsay v.
Burmah Oil and Furniss v. Dawson was put firmly on the basis of statutory
construction. In regard to the circular, self-cancdling series of transactions which
featured in the first two of these cases, the true effect of them was nil from the
point of view of creating an allowance loss such as the legislation intended to make
deductible in computing chargeable gains. Furniss v. Dawson was explained on the
basis that the two interconnected transactions were equivalent in legal effect to a
tripartite contract, this being the essence of the ratio decidendi contained in the
speech of Lord Brightman. The two transactions were capable of being
realistically treated as one indivisible whole involving only a single disposal for tax
purposes. The intermediate company never acquired control of the operating
company within the meaning of paragraphs 4 and 6 of Schedule 7 to the Act of
1965. Lord Oliver said:

"As the law currently stands, the essentials emerging from Furniss v. Dawson
appear to me to be four in number: (1) that the series of transactions was, at
the time when the intermediate transaction was entered into, pre-ordained in
order to produce a given result; (2) that the transaction had no other purpose
than tax mitigation; (3) that there was at that time no practical likelihood that
the pre-planned events would not take place in the order ordained, so that the
intermediate transaction was not even contemplated as having an indepen-
dent life; and (4) that the pre-ordained events did in fact take place. In these
circumstances the court can be justified in linking the beginning with the end
so as to make the single composite whole to which the fiscal results of the
single composite whole are to be applied."g

8. At pp.462, 463.

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Later he said:

"[I do not] consider that the Ramsay approach, while no doubt applicable to a
much wider variety of transactions than those described in the instant appeals,
requires further exposition or clarification. Its basis is manifest and has been
clearly explained by Lord Wilberforce. What the apellants urge upon your
Lordships is a restatrnent of the approach in -a formula based, as it seems to
me, not upon seeking to identitY the reality of sequential transactions, but
upon a much wider, but at the moment unidentified general principle of
judicial disapprobation of the lawful rearrangement of the subject's affairs
designed to produce a result which is fiscallyadvantageous to him in relation
to a transaction into which he anticipates entering. That is essentially a
legislative exercise and one upon which, in my opinion, your Lordships
should hesitate long before entering.,,9

Lord Templeman, who dissented on the result in Craven v. White but not in the
other two appeals, took the view that if the taxpayer planned to carry out a
transaction which would normally attract tax by combining it with another
transaction solely designed to avoid tax, and the whole scheme was eventually
carried through, then the intermediate transaction in every case fell to be
disregarded for fiscal purposes. It made no difference that the final transaction was
not certain to be completed at the time the intermediate transaction took place, nor
that a considerable interval of time might intervene between them. Craven v. White
was caught because the final stage of the pre-planned scheme actually took place.
In the other two cases the final stage originally planned did not take place. The
eventual disposal was not part of the original plan, so these cases were not caught.

In the result, taxpayers and their advisers must now have a reasonably clear
understanding of the limits of the Ramsay principle and what steps towards tax
avoidance or mitigation they may safely take without incurring liability. It is plainly
highly desirable that the law should be clear in this respect. It remains the law that
artificial transactions which from beginning to end have no other purpose than tax
avoidance have no utility for achieving that purpose. It has also been made clear
that arrangements made with a view to avoiding tax on some genuine transaction
which may be contemplated as likely to be carried through in the future are not
vulnerable to being struck down judicially. It is for Parliament, not the courts, to
set the parameters beyond which tax avoidance may not legitimately and effectively
be carried on.

The Committee on tax enforcement powers of which I was chairman and which
reported in 1983 looked fairly briefly at tax avoidance. It made two
recommendations in this field which were directed at securing that the revenue
departments might more readily gain access to information about what
transactions had actually taken place in the course of a tax avoidance scheme. If a

9. At pAM.

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taxpayer has been advised that such a scheme has resulted in no liability to tax, he
may think there is no need to disclose its existence in his return. One witness
before the Committee said:

"The taxpayer builds a tax-proof castle: if the Inspector could see inside he
would see the weakness in the castle's structure, but the taxpayer does all he
can to make sure that the Inspector never sees inside it."

To meet this sort of case the Committee recommended that there should be
included in the tax return a question on the lines:

"In making this return have you taken the benefit of any doubt about whether
any item ought to be declared, or any relief or deduction allowed? If so give
brief details."

This recommendation was rejected by the Government.
The other relevant recommendation was in the field of legal professional

privilege. A taxpayer is not entitled to keep his affairs confidential in a question
with the revenue departments, and it seemed to the Committee that there was
room for the view that legal professional privilege should not be capable of being
manipulated so as to secure such a result. The Committee had evidence that the
details of tax avoidance schemes were on occasion recorded only in instructions to
counsel to advise, with a view to these details being kept secret from the revenue.
The privilege belongs to the taxpayer, not to the professional adviser, and logically
there seemed much to be said for his being obliged to waive it in particular
circumstances. So the Committee recommended that, subject to stringent
safeguards, the privilege should be capable of being overridden by the court where
the ascertainment of facts necessary to the proper determination of a tax liability
would otherwise be unreasonably impeded. This recommendation was naturally
strongly opposed by the Law Society and other professional bodies, and the
Government has decided to reject it.

These were, however, fairly peripheral aspects of the Committee's report. The
most important aspects were those at the centre of the tax enforcement system,
particularly for income and corporation tax and VAT. In the introduction to the
report the Committee said:

"At an early stage we formed the view that the mechanisms which the Board
ofInland Revenue were striving to operate were in many respects antidiluvian
and quite unsuited to modern conditions."

One of the most unsatisfactory features of the existing system was that every
year about 1.8 million estimated assessments on trading profits were made in the
absence of timely returns, and that in no less than 1.7 million cases use of the
appeal machinery was needed to compel the production of tax returns and
accounts. As regards penalties for late or defective returns, these could only be
exacted on being imposed by the appeal Commissioners and could amount to as

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much as 200 per cent of the tax due for fraud and 100 per cent for neglect. 10 The
Committee proposed the introduction of three categories of default carrying
automatic penalties which would be assessed as tax by the inspector, alwayssubject
to appeal to the Commissioners. The first category, "Default Class A", was to be
civil fraud, being the deliberate omission or understatement of amounts in tax
returns with the dishonest intention of deceiving the revenue and evading tax.
Here the penalty was to be the tax due plus default interest plus a maximum of 100
per cent of the tax underpaid, mitigable to 50 per cent for co-operation in the
investigation. The second category, described as "Default Class B" or "gross
negligence", consisted in the omission or understatement in tax returns of an
amount arithmetically calculated or lesser but repeated omissions or understate-
ments. Here the penalty was to be the tax due plus default interest plus 30 per cent
of the tax underpaid, non-mitigable. The third category, "Default Class C", was to
be any error leading to the omission or understatement in a tax return of any
amount not within Default Classes A or B. The penalty was to be the tax due plus
default interest only.

In February 1986, the Board of the Inland Revenue put out a consultative
document including draft clauses, certain of which would have introduced
automatic penalties on the lines proposed by the Committee, but subject to
modification. In July 1988, a further consultative document was issued which
proposed to drop these clauses and, instead, simply to amend section 95 of the
Taxes Management Act 1970 by removing the obsolete fixed penalty of £50 and
reducing the 200 per cent limit to 100 per cent, which would be fully mitigable.
This contrasts with the new regime for VAT penalties, already introduced by the
Finance Act 1985, which I shall be considering later. It remains accepted,
however, that the income tax penalties should be assessed by the Inspector as
additional tax, subject to appeal to the Commissioners.

One of the most vexatious problems addressed by the Committee related to late
returns of income both by trading and by non-trading taxpayers, and the
non-delivery of accounts. It is this that lies at the heart of the excessive use of the
appeal machinery to compel compliance. At present an income tax return is
required to be completed and sent back within 30 days of its issue, and failure to
do so is technically, but never in practice, subject to penalty. This is obviously a
completely unrealistic requirement in the great majority of cases, and the
Committee recommended that the time limit be increased to three months, with
provision for extension up to six months with the approval of the Inspector, and
subject to automatic penalties for late returns. It was also proposed that trading
taxpayers should be required to submit accounts in support of their tax returns not
later than twelve months after the end of their accounting years, with provision for
gradually reducing this to seven or six months. Where the accounts were not
available when the return was sent in, it was proposed that the profits for the

10. Taxes Management Act 1970, section 95.

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preceding accounting year should be entered. In the latest consultation paper
issued by the Inland Revenue (July 1988), these proposals have all been rejected,
at least at this stage, for non-trading taxpayers and unincorporated traders.

However, in relation to corporation tax Parliament has already enacted, in
sections 82 to 91 of the Finance (No.2) Act 1987, a new system known as Pay and
File. This is not to come into effect until 1992 at the earliest, in order to enable
companies and their accountants to make the necessary preparations, and also
because the Revenue will need to equip itself with new computer facilities in order
to administer the new system. Broadly speaking, the effect of the Pay and File
regime will be that a company will be required to make its own assessment of the
corporation tax due and pay it on the usual due date nine months after the end of
its accounting period. However, no proceedings for collecting the tax can be
instituted, if the company does not pay at that stage, until the Inspector has made
an assessment on the company and thirty days have elapsed from the notice of it.
The company is to have twelve months from the end of its accounting period to
send in its return and accounts. If it fails to do so it will incur an automatic penalty
unless it can show a reasonable excuse for the failure. The penalty will start at
£100 and increase in steps up to £1 ,000 according to the length of the delay and
the number of occasions on which the company has previously been in default,
together with 10 per cent of the unpaid tax if the return is up to two years late and
20 per cent if the delay is over two years. When the final tax liability is settled
interest will be payable to the Revenue, as from the due date for payment of tax, on
any amount by which the payment then made is less than that eventually assessed,
and will be payable by the Revenue to the taxpayer on the amount of any excess
payment, which will itself, of course, be repaid by the Revenue, subject to any
set-off.

The Pay and File regime will include the introduction of a new form of
corporation tax return, the details of which are being worked out between the
Revenue and representatives of companies and the accounting profession. A
considerable amount of attention is given in the July 1988 consultative document
to the appropriate rates of interest on underpayments and overpayments of tax. It is
proposed that all interest should be simple and not compounded and that it should
be paid without deduction of tax and left out of account for all tax purposes. The
rate of interest on overdue tax is proposed to be 2.5 per cent over base rate, and
that on repayments base rate minus 1 per cent.

These changes or proposed changes seem to offer some prospect of bringing
about improved compliance without imposing excessive burdens on taxpayers, and
of reducing the previous excessive reliance on the appeal machinery, though they
do not go so far as the Committee would have liked. It would be tedious and
time-wasting to try and go through many other aspects of the Committee's
recommendations which have been either accepted or rejected by the
Government. However, it is of some interest that there has been acceptance of the
proposal that the Revenue's powers under section 20 of the Taxes Management

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Act 1970 should be enlarged by enabling it to require a taxpayer to answer written
questions, in addition to producing documents called for. There has also been
acceptance that the third parties who can be required to produce documents
should no longer be limited to certain close relatives of the taxpayer together with,
as regards business profits, any person carrying on a business and any company
whether carrying on business or not. The present intention seems to be to make all
third parties subject to the requirement to produce documents, but the prior
approval of an appeal Commissioner will be required, as indeed it will be for all
requests for documents or particulars.

The present state of playas regards the Committee's recommendations on
income and corporation tax appears to be that 28 have been accepted in detail or in
principle, 20 have been accepted with modification, 22 have been rejected and 9
have been reserved for further consideration. Full implementation of the accepted
recommendations cannot, however, be expected until well into the 1990s, since it
depends to a large extent on computerisation of Inland Revenue operations.

In the field of VAT matters have moved much further and faster. The
Committee made 59 recommendations relating to VAT. Of these 38 were
accepted and have been enacted, 10 have been accepted with modifications and
enacted, 9 were rejected and two are still being considered. Of those rejected, five
related to legal professional privilege. Others rejected were concerned with the
publication of the names of offenders, the level of judicial authority for issuing
warrants for VAT searches (it was proposed to raise the level in England and
Wales from magistrate to Circuit Judge), notification of taxpayers before
disclosures to foreign revenue authorities, and jeopardy assessments.

The principal aspect of VAT enforcement with which the Committee found
fault was that almost all failures by the taxpayer, including breaches of regulatory
provisions, were subject to criminal prosecution. This regime had been carried
over from Purchase Tax. Its existence caused much indignation among bodies
such as the National Federation for the Self-Employed. In practice, the number of
defaulters prosecuted was very small. It was estimated that in the autumn of 1982,
out of about one million traders expected to make VAT payments, more than
375,000 were at least one month late and more than 130,000 two months late.
Customs and Excise had insufficient resources to enable more than 16,000 traders
to be included in any prosecution routine at anyone time. In 1980-81, there were
3,767 prosecutions for failure to furnish returns and 739 for failure to pay tax.
There was no provision for payment of interest on overdue tax.

It seemed to the Committee that this was highly unsatisfactory. Not only did
prosecution appear quite unsuited to securing compliance with purely regulatory
requirements, but it was rarely invoked and massive amounts of tax were regularly
outstanding with substantial loss to public revenue. So the Committee proposed
the abolition of the criminal sanction for regulatory matters and the substitution of
civilpenalties, together with the introduction of default interest on underpayments
of tax or overclaims. It also recommended the introduction of two new types of

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"civil default". The first was described as "gross negligence" (the description
"serious misdeclaration" has now been adopted), covering defaults of a large or
persistent character. The test was to be objective, turning on the size of an
understatement or overclaim and whether it was repetitive. The default was to
attract a fixed rate, non-mitigable penalty of 30 per cent of the tax understated or
overclaimed, together with default interest. The second type of default was
described as "civil fraud", defined as an act or omission designed to deceive
Customs and Excise with the object of evading VAT. The penalty was to be 100
per cent of the tax evaded, mitigable down to 50 per cent according to the degree
of co-operation received from the taxpayer during the investigation, together with
default interest. The Committee recommended that all civil penalties and default
interest should be assessed as tax, with a right of appeal to the VAT Tribunal. It
will be seen that this regime closely resembled that proposed for income and
corporation civilpenalties. A further important recommendation was that failure to
notify liability to registration for VAT or the unauthorised issue of VAT invoices
should constitute the civil offence of "gross negligence" attracting the
non-mitigable penalty of 30 per cent of. the tax involved, together with default
interest. It was also proposed that for failure to furnish returns or not paying the
tax in time there should be a new tariff of civil penalties at daily rates with
tax-geared alternatives, starting at the third default in any period of two years, and
a tariff of daily rates for failure to keep records or supply information when
required to do so.

All these recommendations were implemented by sections 13 to 21 of the
Finance Act 1985. The penalties, except that for civil fraud, were made subject to
the defence of reasonable excuse. This was not in the Bill as first published, but
was added by amendment largely due to representations by members of the
Committee. Consideration of this defence now forms a large part of the work of
the VAT Tribunals. All the provisions did not come into effect at once. The
penalty for failure to notifYliability to registration came into force from the date of
the Royal Assent. Customs and Excise regarded this as one of the most important
provisions operationally, since a taxpayer cannot be controlled until he is
registered. However, sustained criticism of the measure was encountered, largely
because the fIXedpenalty of 30 per cent of the tax was considered harsh, and
defaulters were found to be largely ignorant rather than negligent. So amendments
were introduced in the Finance Act 1988, whereby the penalty was reduced to 20
per cent where the delay does not exceed 18 months and 10 per cent where it does
not exceed nine months. Customs and Excise regard the results of the provison as
beneficial. The level of imposition of penalties runs at just over 3 per cent of new
registrations, and the value of penalties to the end of December 1988 amounts to
£16,679,016.

The civil fraud penalty regime did not become operational till the summer of
1987. The policy has been to apply the criminal standard of proof, that of beyond
reasonable doubt, rather than the civil standard of balance of probabilities. By the

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end of 1988, 538 penalties had been assessed. There had been 33 appeals of
which 9 were withdrawn and 24 were still awaiting hearing. The value of penalties
assessed to 31 December 1988 amounts to £2,334,789. The provisions about
default interest and serious misdeclaration penalties were due to be put into effect
in July 1988, but it was decided to defer this until late 1989. So there is as yet no
indication of how this part of the package will work.

The default surcharge provisions were implemented on 1 October 1986, but
surcharges did not start to be assessed until May 1987. The regime appears to
have had considerable success. The percentage of registered traders who are liable
for tax and fail to furnish returns by the due date has fallen from 40 per cent to 17
per cent. This result is thought to be largely due to the widespread advance
publicity given to the measures. By the end of 1988, 1343 appeals against
surcharge assessments had been lodged with VAT Tribunals. Of these 391 had by
then been withdrawn, 203 dismissed and 80 upheld. The average value of tax
arrears outstanding at any time has fallen fairly dramatically over the period, and
Customs and Excise consider that they are well on the way towards halving, by
early 1989, the average arrears outstanding at mid-1985. The reduction so far is
estimated to be nearly £700 million, direcdy related to the implementation of the
Committee's recommendations.

In October 1986, the Government instituted a review of the effects on small
businesses of the 1985 legislation and a number of other matters. One result was
the introduction of a cash accounting system for businesses having an annual
turnover not exceeding £250,000. This means that such businesses account for
VAT on the basis of payments received rather than that of invoices issued, and is
of considerable benefit to them from the point of view of cash flow and automatic
relief for bad debts. Another result of the review was that it was found that the
requirement to keep records for six years rather than three years, a change
recommended by the Committee, did not impose an undue burden on small
businesses. In addition the impact of the penalty provisions was modified in certain
respects, in particular by amending the law so that late registration should not
attract default interest as well as default surcharges.

In all the circumstances the members of the Committee can reasonably feel that
their labours have not been in vain. It is not uncommon for a departmental
Committee or even a Royal Commission to find its report pigeon-holed
indefinitely. In this instance, however, Governmental action has been as speedy as
could reasonably have been expected in the two fields which I have been
discussing. The result in both of them, it may well be thought, is to put in place a
much more rational and more effective system than previously existed. The new
VAT regime is "Nell on the way to being fully operational, although for reasons with
which one can have some sympathy matters are not yet nearly so advanced on the
income and corporation tax front. Although I have not so far specifically
mentioned it, it should not be forgotten that practically all the measures
recommended by the Committee for better procedures, less burdensome and

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oppressive to the citizen, in connection with searches for evidence of fraud,
production of documents and other matters which in the past have caused
considerable friction have been implemented either by legislation or by
administrative action. All this, of course, is not just a cause for self-congratulation
on the part of the Committee. It is to be hoped that it may be seen as a benefit to
the great and conscientious majority of taxpayers, and also, though in different
ways, to the minority which is no~so conscientious.

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