Failure to prevent tax evasion: the corporate offence

Introduction

The offence was given additional impetus in the wake of the leak of the Panama Papers, but it was over a year later, on 30 September 2017, before the offence came into force as part of the Criminal Finances Act 2017.

The offence follows the model established in Section 7 of the UK’s Bribery Act 2010, by holding a corporate to account in circumstances where those “associated” with it have engaged in the criminal facilitation of tax evasion.  A corporate will be liable unless it can show that it had applied reasonable measures to prevent such conduct (even if such measures were not successful).

As with other “failure to prevent” offences, the progress of the Bribery Act offence, and the responses to it, are helpful in identifying the steps that corporates can take in order to demonstrate that they are responsible citizens.

What is the offence?

An offence is committed by a corporate (which includes any body or partnership, whether commercially motivated or not) if:

1. a person who provides services for or on behalf of the corporate criminally facilitates tax evasion by another person; and
2. the corporate did not have reasonable procedures in place to prevent such facilitation.

Whilst the rules depend on essentially two offences - criminal tax evasion and the criminal facilitation of such evasion – there is scope for it to be applied more widely than might be expected.  Firstly, a facilitation offence includes any offence pursuant to which a person is knowingly concerned with tax evasion. Second, and perhaps more significantly, no actual offence need ever be prosecuted. HMRC emphasise that conduct capable of being prosecuted is enough to trigger these rules.

This is important because prosecutions are difficult and time-consuming, even assuming that it is a UK prosecution at all. In addition, HMRC often prefer not to pursue criminal proceedings in exchange for a taxpayer admitting the offence and making a full disclosure.

It is also worth noting that, unlike the Bribery Act, there is no requirement on HMRC to prove that any person intended to obtain or retain business for the corporate. The mere fact that conduct amounting to facilitation of tax evasion has occurred is sufficient.

It is easy to see why tax evasion is a target given its presence in the news.  Even as the leak of the Panama Papers was dominating headlines, ProPublica published a story under the headline “Wall Street Stock Loans Drain $1 Billion a Year From German Taxpayers”, following analysis of confidential documents relating to dividend arbitrage trading.

Germany has been seeking criminal prosecutions for so-called cum/ex dividend arbitrage trading for years.  The ProPublica story focused on simpler cum/cum trades that were tentatively described as illegitimate, if not illegal.  That would surprise few who understand these trades, but the Frankfurt prosecutors reacted to the story by announcing that they had opened a probe into them.  Such trades may not ever be regarded as illegal and the traders are unlikely to be treated as dishonest even if they were.  That does not mean, however, that companies will not face difficult questions.  It is, therefore, a good example of the difficulties that can be faced by companies when the edges of what comprises tax evasion can change in a news cycle.

Who acts “for or on behalf of” a corporation?

A key concern is understanding who a corporate must answer for. This has been one of the principal difficulties that corporates have needed to deal with in implementing the UK Bribery Act.

The rules state that a corporate is responsible for anyone “associated” with it and an associated person will be anyone acting for or on its behalf. 

As is the case for the equivalent Bribery Act offence, this is a broad definition and its application is open to interpretation. In fact, the offence does not prescribe a particular relationship, as it includes any person who performs services for or on behalf of the corporate (albeit only when actually performing services for the corporate).  Accordingly, it will include employees and agents of the corporate but, in reality, the test is ultimately determined, not merely by the relationship between the person and the corporate, but by reference to all relevant circumstances. 

Commonplace arrangements could include contractors, sub-contractors and temporary workers, along with counterparties in joint ventures, consortia or other commercial associations.

HMRC have previously suggested that a person who only takes work as a result of referrals from a corporate might be treated as providing services on behalf of that corporate (particularly where they do so at less than commercial rates).

Where does it apply?

Failure to prevent the facilitation of UK tax evasion can be asserted against any corporate (wherever located) and, whilst failure to prevent the facilitation of foreign tax evasion requires a corporate to have a UK nexus, this is a broad concept. 

It includes not only corporates incorporated or formed in the UK, but corporates with a business establishment in the UK. It also includes any corporate (wherever located) if a step in the facilitation offence takes place in the UK. Given the role of the UK in so much of global commerce, these rules could have a far reach. Indeed, the extra-territorial effect is wider than is the case under the Bribery Act, which requires the corporate to have a business presence in the UK. 

In relation to foreign tax evasion, HMRC have at least emphasised the fact that the offence requires “dual criminality” – namely, the activities in question must amount to a criminal offence in both the foreign jurisdiction and in the UK.  Whilst “tax evasion” offences tend to be widely drawn and similar across jurisdictions, this nonetheless provides some limits to the scope of the offence, particularly in the case of certain foreign strict liability offences.

Who is affected?

The finance industry, of course, remains a key target.  Similarly, advisors and those delivering the “infrastructure” that enables tax evasion to take place (for example, virtual offices, invoicing arrangements and IT systems) are all targeted.

This offence overlaps with the Bribery Act offence given that any transaction involving a corrupt payment will almost inevitably also include tax evasion (not least because such payments will, presumably, not be declared for tax purposes).

This offence potentially applies across a wide range of industries:

• companies with a global reach and those that deal with certain high risk jurisdictions and industries may be subject to scrutiny; and
• tax evasion could be present in any flow of cash or payment arrangement and in respect of any transaction that needs to be accurately reported to a tax authority. 

By way of example, HMRC’s guidance refers to case studies that involve, not just banks and financial service companies, but a car parts maker.

Ultimately, most corporates will need to consider, to some extent, the identity of suppliers and customers, payment methods and supply lines, paying close attention to offshore movements of money.

Case studies

Housebuilder Ltd has 30 sites across the UK where it is building new homes.  A shortage of bricklayers is putting increased pressure on delivering homes on time.  John is a contractor in charge of one of the sites and agrees to pay his bricklayers in cash.

In this case, although a contractor, John may be treated as working on behalf of Housebuilder Co.  On the face of it, John appears to be criminally facilitating tax evasion.  Even if John were unaware of any tax evasion, as a practical matter, corporates need to be live to activities that could facilitate tax evasion, whether intended or not.

Marketplace Inc is a successful US online business matching buyers and sellers and has significant operations in the UK.  One of Marketplace’s staff arranges for payments to a UK seller to be made offshore with the intention that tax will not be paid on that amount.

In this case, it is irrelevant that the company is based in the US given that UK tax is being evaded.

An employee of a German company arranges for invoices to be issued to a business customer in Germany for a higher amount than is paid so that higher tax deductions can be dishonestly claimed.  The invoicing is processed in the UK parent company.

In this case, the fact that German tax is being evaded may be irrelevant if, as a result of processing the invoices in the UK, an act constituting part of the foreign facilitation offence is treated as taking place in the UK.

The defence: prevention procedures

If it can be demonstrated that, despite criminal facilitation having occurred, reasonable procedures are in place, the corporate will not be held liable.

It is worth noting that the UK Bribery Act refers to “adequate procedures”.  Although procedures in respect of the Bribery Act also depend on the circumstances, the reference in these rules to “reasonableness” might suggest a test that will rely more heavily on context – that is, the relevant facts and circumstances.   

The rules also required the Chancellor of the Exchequer to publish guidance about the procedures that corporates can put in place to prevent “associated” persons from committing facilitation offences.

That guidance mirrors the principles which accompany the Bribery Act:

1. Proportionality: reasonable procedures will depend on the nature of a corporate’s activities and, in particular, the level of control that a corporate can exercise over its representatives.  HMRC use the notion of “proximity” to gauge how much control a corporate is expected to exercise.  For example, an employee is more “proximate” than an independent contractor and so would be subject to greater control and oversight.
2. Top level commitment: top level management should be involved and committed to fostering a culture in which facilitation of tax evasion is unacceptable.
3. Risk assessment: what procedures are reasonable will depend on an assessment of the nature and extent of its exposure to the risk of facilitation of tax evasion. This must be “documented and kept under review".
4. Due diligence of those who act on behalf of the corporate (and the corporate’s clients).
5. Communication (including training) with regard to policies and procedures.
6. Monitoring and review of a corporate’s “prevention procedures”.

HMRC have also stated that timely self-reporting of any wrong-doing will be viewed as an indicator that reasonable measures are in place.

This will be familiar territory from the Bribery Act, and for regulated firms following the FCA’s guidance on fostering a culture of compliance.

It will be important for corporates to deal with these rules without unduly hampering their business, and understanding how the equivalent Bribery Act offences have been addressed will allow corporates to focus on the procedures that have proven to be most effective.

At the same time, whilst corporates have learnt much from engaging with the Bribery Act, a corporate cannot simply rely on existing procedures.  It will need to engage seriously with the varying methods of facilitation of tax evasion, potentially cross-jurisdiction, and introduce “reasonable” safeguards.  

Sanctions and Deferred Prosecution Agreements

Where a corporate is liable under this offence, sanctions can include unlimited financial penalties and ancillary orders such as confiscation orders.

HMRC have also stated that Deferred Prosecution Agreements can be used in the same way as they have been used for Bribery Act offences. Such agreements allow prosecution to be suspended for a defined period provided that the organisation meets certain specified conditions. 

As far as a corporate is concerned, they enable reparations to be made for criminal activities without a lengthy trial and, importantly, without the risk of conviction.  Similarly, they allow the authorities to hold corporates to account where there have been compliance failures, but without having to prove definitively that the offence was triggered. 

Although the first Bribery Act deferred prosecution agreement was only entered into on 30 November 2015, they are likely to become increasingly important.  For example, an agreement with Rolls Royce in 2017 followed a 4 year enquiry and resulted in a payment of £497m plus costs by Rolls Royce.

They are also seen by the courts as an effective alternative to prosecution. Even in circumstances where there have been serious and systemic failures, an agreement has been approved where the corporate self-reported, co-operated fully and demonstrated that it was addressing the compliance issues.

Whilst it took some time for the first deferred prosecution agreements to be used in connection with the Bribery Act, they are likely to be an accepted route to addressing the failure to prevent tax evasion from an early stage.   

As such agreements become more frequent, the one note of caution is that, because the consequences of conviction are so severe, corporates might be pressured into accepting a deferred prosecution agreement, even where the basis for applying the offence is doubtful.

Timing

The offence forms part of the Criminal Finances Act 2017, which received royal assent on 27 April 2017.

The offence itself came into force on 30 September 2017, at a time when HMRC expected to obtain significant information from the common reporting standard.

HMRC have stated that they accept that it will take time for corporates to put reasonable measures in place, although they have also noted that they expect there to be “rapid implementation”.

What next for tax?

As far as tax is concerned, this offence is just the beginning.

Companies are required to publish a “Tax Strategy”, codifying their approach to tax.  A special measures regime monitors co-operation with HMRC, and those that exhibit persistent non-cooperation will be flagged as high risk.  Meanwhile, increasing numbers of companies are subject to codes of conduct, whether it is the Banking Code of Conduct or the Framework for Co-operative Compliance.

All of these rules form a tax regulatory framework, putting corporates – and, expressly, the top level management – under pressure to address tax matters directly, and to instil good tax practices as part of the culture of an organisation. 

In addition, while the charge is being led by HMRC, it is only prudent for regulated firms to anticipate the imminent arrival of the FCA, particularly given that other “failure to prevent” offences have been proposed. Indeed, in recent years the FCA has levied sizeable fines for failures by firms to implement adequate anti-bribery and corruption safeguards and controls, deeming such failures indicative of poor systems and control frameworks; and financial crime and anti-money laundering continues to be a core priority theme for the FCA. There is every reason to expect a similar attitude in respect of the failure-to-prevent tax evasion offence.

Corporates need to be able to demonstrate that they are responsible tax citizens. This brings its own uncertainties and challenges, but experience has shown that genuine engagement with the issues, and the implementation of sensible procedures is not only a regulatory necessity, it is good business. The offence of failing to prevent the facilitation of tax evasion represents a considerable stick to ensure compliance, and with the information anticipated from the common reporting standard, HMRC expect to have reason to investigate and enforce.

How to respond

The most effective way of addressing this offence is by starting with existing procedures (for example, anti-bribery and corruption procedures).  Nonetheless, corporates will still need to consider risks of tax evasion as a separate matter in order to ensure that any procedures (including modified existing procedures) are sufficient.

By way of some practical steps:

• Understand your tax risks: where are the risks of tax evasion – is it the type of industry, the countries dealt with, the activities undertaken? Who within the organisation is best placed to identify them – is it your compliance or your tax function?
• Identify the structure of your organisation: who is acting for and on behalf of the organisation and how are they incorporated into the business?
• Consider existing infrastructure: administrative systems (and, in particular, IT) will be crucial to ensuring reasonable procedures are in place.  How can such systems help you (or how can they be adapted to help you) identify and manage the risks of tax evasion?
• Training: develop and deliver comprehensive yet bespoke training to inform staff on the nature and possible methods of tax evasion.  What actions should ring alarm bells, or at the least, trigger a suspicion? Encourage your staff to understand what the new offence means for them on a day-to-day basis. 
• Due diligence: consider the questions to be asked of clients, customers, suppliers and of staff and others who act on behalf of the organisation?
• Leadership involvement: have senior management received a dedicated briefing and do they understand their responsibilities?  If the firm is regulated, who has been allocated the relevant senior management function and, if it has not been allocated, consider whether similar steps need to be taken?
• Monitoring and review: ensure that such procedures are in place and are sophisticated enough/fit-for-purpose.
• Consider the approach to be adopted in the event that weaknesses, or indeed, facilitation of tax evasion is identified. The interests of the organisation are more than likely to diverge from that of the individual perpetrator, and HMRC (and other regulators) will be looking for a prompt response and timely disclosure.
• Internal communication: ensure that your tax specialists and your financial crime and compliance teams liaise in order to identify risks.  Consider how effective your whistleblowing mechanism is, for employees to report their concerns.