We have reported in the past (see here) on when limitation periods begin in negligence actions again tax advisors.
A recent judgment in Evans v PricewaterhouseCoopers LLP [2019] considers the question of when a limitation period runs in circumstances where tax liability is contingent on a future event (in this case the decision of two separate tax authorities).
The facts
The judgment deals with an application for strike out and summary judgment brought on limitation grounds. While the Judge made it clear that she was not able to pre-empt the decision at trial and only needed to consider the question of whether the Claimants had a realistic prospect of resisting the limitation defence, it is interesting in its findings on contingent losses and limitation periods in a tax context.
The Claimants, who were the trustees and beneficiaries of a trust (the "Trust"), brought an action for damages in negligence and breach of statutory duty arising from tax advice given by their accountant, the Defendant.
In 2000 the Claimants wanted to sell shares owned by the Trust to release cash for the First Claimant. The shares had risen in value and as a result Capital Gains Tax was going to fall due on the sale. The Defendant advised the Claimants to adopt a "Round the World" scheme. Under the scheme, the Trust would be resident for part of the tax year in a jurisdiction that did not tax capital gains and during which the shares would be sold. Later in the year they would move the Trust back to the UK. The idea was that pursuant to the terms of double taxation treaties, there would be no, or very little, tax payable on the gains.
The Defendant sought advice from a QC who advised on the scheme using Mauritius as the overseas jurisdiction. The Defendant relayed that advice to the Claimants but suggested that Canada should be used rather than Mauritius to reduce the "smell factor" in the transaction.
The Claimants allege the Defendant was negligent as there was one key difference in the tax treaties the UK had with each of Mauritius and Canada. The treaty with Mauritius had an objective criterion to comply with to ensure the sale was taxed in Mauritius. The treaty with Canada, on the other hand, provided that the competent authorities (i.e. the Inland Revenue, now HMRC, and the Canada Revenue Agency ("CRA")) should determine by mutual agreement where the trust was resident and which authority should tax the gain.
The scheme was implemented on the basis of the Defendant's advice. On 5 April 2001 the Royal Trust Corporation of Canada ("TRCC") was appointed in place of the Defendant, on 9 August 2001 the Trust's shares were sold, and on 18 December 2001 the TRCC resigned and the Claimants were re-appointed as trustees.
In April 2005 HMRC opened an enquiry into the tax return of the First Claimant. On 17 December 2013 the CRA wrote to HMRC to the effect that (i) the Trust was not resident in Canada for tax purposes from 6 April to 18 December 2001, and (ii) in any event the UK could tax the gain realised by the Trust on the sale of the shares. On 25 March 2014, HMRC issued a closure notice to the First Claimant showing a tax liability of almost £2 million on the capital gains on the sale of the shares.
On 29 November 2016 the First Claimant entered into a settlement with HMRC and on 14 December 2016 the Claimants commenced proceedings against the Defendant.
The Defendant applied for Strike Out and Summary Judgment on the basis that the claim was barred by limitation. The Judge had to consider whether the Claimants had a realistic prospect of resisting the limitation defence.
Tax negligence and limitation periods
The general rule in negligence is that a six year limitation period runs from the date when a negligent act causes loss. When loss occurs is not always obvious in tax claims.
There are normally two categories to consider when a claimant enters into a transaction in reliance on negligent advice:
- "No transaction" cases - where the claimant would not have entered into the transaction but for the negligence. It is necessary to consider the position of the claimant having entered into the transaction and compare that with his position had he not entered into the transaction to establish at what stage his position was worse off having entered into the transaction.
- "Wrong transaction" cases - where the claimant would have entered into a different transaction but for the negligence. The damage is normally deemed to have been suffered on entering the transaction, even if a precise quantification is not initially possible. However, Evans v PricewaterhouseCoopers LLP shows that there are exceptions when the tax liability is contingent (see further below).
Section 14A of the Limitation Act 1980 provides an extension in instances where the primary six year limitation period has expired. It allows claimants to bring a claim three years from the date on which the claimant had the knowledge required to bring an action and a right to do so. Thankfully for tax advisors there is also a longstop: no claim can be brought in respect of a breach of duty that occurred more than 15 years before the date proceedings were issued, even if no damage had arisen from the breach of that duty.
While these latter two points were considered in the judgment, the key question the court had to determine was when the damage had been caused (i.e. when the 6 year limitation period began to run).
(For further details on the rules on limitation in tax negligence claims, see here.)
How were the rules applied?
The Defendant argued that at the very latest the loss accrued on 9 August 2001 when the shares were sold. It was at this point, they said, that the Claimants' position changed. This is a typical "wrong transaction" case where losses are deemed to occur when the transaction is entered into.
The Claimants disagreed. They said that there was no damage until HMRC issued its closure notice on 25 March 2014 or, at the earliest, when CRA wrote to HMRC on 17 December 2013. They argued it was a case of purely contingent liability and drew on Law Society v Sephton & Co (a firm) [2006] 2 AC. Sephton was a claim by the SRA against a solicitor's auditors for damages from claims made by former clients under the Solicitors Compensation Fund after the auditors failed to detect the solicitor was misappropriating funds. It was held damage was contingent on the former clients making claims and accrued when each and every claim was made.
While the Judge acknowledged that this case was a "wrong transaction" case, she agreed with the Claimants. She said in typical "wrong transaction" cases loss occurs on entering the transaction because the claimant acquires the wrong package on entering into the transaction, even if the extent of that loss is not immediately clear. For example:
- Pegasus Management Holdings SCA v Ernst & Young [2010] EWCA Civ 181 - The Claimant acquired a company which was not in the form that would deliver the benefits sought on the basis of the Defendant's negligent advice. The Claimant was put in a "commercially disadvantageous straightjacket" incapable of cure so the damage accrued when they acquired the company.
- Halsall v Champion Consulting Ltd [2017] EWHC 1079 (QB) – The damage accrued when the Claimant adopted the wrong tax avoidance scheme and acquired a company. At this point the scheme was "incapable of cure". See here for more details.
- Shore v Sedgwick Financial Services Ltd [2008] EWCA Civ 863 - The Claimant was negligently advised to transfer his benefits to a riskier pension scheme instead of a safe investment as sought. Even though there was a possibility that he would be better off by being exposed to the risk, the transaction meant that the Claimant had obtained a bundle of rights from the outset of the transaction that were "less advantageous to him".
The Judge said that this was not a typical "wrong transaction" case as "nothing was acquired" except for taking on a risk that the two revenue authorities would decide that tax was owed to the UK rather than Canada, i.e. a pure contingency case. Loss accrued only once the CRA sent its letter to HMRC in 2013 as this was when the risk of loss became a reality.
Comment
It is worth remembering that this judgment was for an application for strike-out and summary judgment so the Judge only had to decide whether the Claimants had a realistic prospect of resisting the limitation defence, and had to take the Claimants' case at its highest. It may be that at trial, with the benefit of evidence and disclosure, the judge comes to a different conclusion.
However, the case makes it clear that the classification of cases as "wrong transactions" is not always determinative. Careful thought needs to go into whether a tax liability is contingent on another event occurring, or whether the wrong package has been acquired with detrimental effects simply by virtue of entering into a transaction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
