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The Panama Papers leak from one of the world’s largest offshore law firms has led to a hardening of attitudes towards tax avoiders – and that arguably includes many lawyers, who are deemed complicit in the actions of their clients. Diana Bentley looks at how the landscape has changed.
It’s a given that lawyers should be keenly focused on how they can best serve their clients and advance their interests. Now, it seems, law firms – especially those involved in private client and tax planning work – must devote considerably more time and energy to best protect themselves. With money laundering and tax evasion laws burgeoning, public attitudes to tax planning becoming more hostile, and greater scrutiny of tax avoidance schemes by HM Revenue & Customs (HMRC), lawyers are facing the increased risk of prosecution and reputational damage.
Monty Raphael QC, special counsel at Peters & Peters, says the shift in attitude towards lawyers has been significant. ‘Regulators and law enforcement have long regarded lawyers as gatekeepers of the financial probity of society. In the UK, for example, those law firms in the “regulated sector” are under an obligation to report suspicious transactions. Notwithstanding their contribution to the 400,000 suspicious-activity reports filed annually, billions in criminal funds reach the UK each year. Lawyers are themselves increasingly falling under suspicion as witting or unwitting accomplices in white-collar crime. From being regarded as “gatekeepers” of the financial system, lawyers are now suspected of being “enablers” of financial crime.’ Such suspicions include involvement in aggressive tax avoidance.
In the current climate, law firms must constantly reappraise their practices and be alive to any impropriety in relation to tax avoidance
Raphael ascribes this shift in attitude to the recent revelations in the Panama Papers (documents including lawyer-client information leaked from the Panamanian law firm Mossack Fonseca) and Paradise Papers (documents disclosing offshore investments allegedly hacked from the international law firm Appleby), compounded by the perceived failure of lawyers and other gatekeepers to prevent the Russian and Azerbaijani ‘Laundromat’ scandal, a complex money-laundering operation that used several UK-based companies.
Publicity surrounding large multinationals that pay little tax in the UK despite their large turnovers here has also fuelled public anger over the use of tax laws to significantly reduce the tax burdens of individuals and corporations. ‘There’s a sense of public outrage about this; words like “scheme” and “trusts” now have negative connotations,’ says Ed Powles, a partner at private client law specialists Maurice Turnor Gardner. While Powles argues that the criticism of tax planning is not always focused or accurate, the suspicion and disapproval now falling on lawyers who work in this arena mean they must engage more proactively with the subject.
Although clients may be increasingly worried about illegality, many have already grown more conservative in the ordering of their tax affairs. ‘The current environment will no doubt change some clients’ attitudes to taxation, but the days when clients sought advice on how to reduce their tax bill by any legal means possible, no matter how close to the wind the arrangements might have sailed, are gone,’ says Stuart Adams, associate at Mishcon de Reya and a member of the Private Client Section committee. ‘Over the last decade or so, clients have become keener to ensure that they’re tax-compliant. As the double prospect of international tax information exchange and data leaks increases, so the risk of personal reputational damage has also become increasingly important to them.’
While tax avoidance (as opposed to tax evasion) is generally considered to be legitimate, various initiatives introduced over the last decade have eroded the use of more ambitious avoidance schemes, remarks Adams. ‘Over the years, HMRC has relied upon targeted anti-avoidance rules, litigation and publicity to stamp out aggressive tax avoidance that defeats the intention of parliament. Those strategies have been supplemented by disclosure of tax avoidance schemes, follower notices and accelerated payment notices.’
Avoidance schemes successfully challenged by HMRC can result in investors being left with huge tax liabilities. By way of example, Adams points to film investment schemes devised to take advantage of tax breaks offered by the government to encourage investment in the production of films made in the UK. ‘HMRC has successfully challenged a number of these schemes on the basis that they seek to achieve an aim parliament did not intend. Many investors in these schemes have now been left with huge tax liabilities, not to mention costs associated in taking up the schemes and defending them before the courts,’ he says.
In the aftermath of such challenges brought by HMRC, firms can face the possibility of claims for negligent advice. Recently, in Barker v Baxendale Walker Solicitors & others  EWCA Civ 2056, the Court of Appeal ruled that a firm was negligent in not providing a client with a warning about the possible dangers of a tax scheme set up to avoid capital gains tax and inheritance tax through use of an offshore trust. Ten years after the scheme was established, its validity was challenged by HMRC and the client was forced to pay £11.29m in tax and interest.
While the High Court found it was not a case in which a competent solicitor would have given a specific warning, the Court of Appeal held that the solicitor should have pointed out that there was a significant risk that his view of the situation could be wrong.
In the current climate therefore, firms must constantly reappraise their practices and be alive to any impropriety in relation to tax avoidance, says Powles. ‘It’s more important than ever that law firms are careful to ensure that the facilitation of tax evasion does not happen through, say, a rogue member of staff who may help facilitate it for a client.’ Firms must be mindful as to the outcome of any tax planning advice they give, particularly in cases where there is a lack of clarity in the legislation, which may lead to schemes being scrutinised through litigation. ‘Good tax planning, now more than ever, is about working with the rules as they are intended to be used,’ he declares.
Other regulation in this area – both national and international – has noticeably increased and law firms must stay abreast of this ever-evolving regulatory landscape. On an international level, the Common Reporting Standard (CRS) is an information standard for the automatic exchange of tax and financial information, developed by the Organisation for Economic Co-operation and Development. Approved on 15 July 2014, it is designed to help combat tax evasion globally and now has over 83 national signatories (including Panama) committed to its implementation. In the UK, the General Anti-Abuse Rule (GAAR) has been in force since 7 July 2017 and applies to abusive or aggressive tax arrangements. Under its provisions, HMRC can impose a ‘just and reasonable’ tax liability – or one that would have accorded with the intent of parliament – for such arrangements.
Most recently, the Criminal Finances Act 2017 (CFA 2017) came into force on 30 September 2017 in the UK. It creates two new criminal offences: the failure to prevent the facilitation of tax evasion in the UK, and the failure to prevent non-UK tax evasion. ‘Relevant bodies’ – that is, corporate entities and partnerships – are liable for the actions of their staff, agents or anyone else (known as ‘associated persons’) who performs services for or on their behalf. The two defences available are that the relevant body had reasonable preventative procedures in place, or that it was unreasonable to expect it to do so. Those guilty of the offences can face unlimited fines and reputational damage. Directors and senior managers may also be subject to civil claims – for example, relating to the mismanagement of the relevant body.
Penalties imposed for transgressing such new regulations are sobering, says Adams. ‘If the GAAR advisory panel finds an arrangement to be “abusive” – that is, one that can’t be regarded as reasonable in relation to the tax provisions – the tax advantages of the arrangements are counteracted by making adjustments, and there can be penalties of up to 60 per cent of the counteracted tax, and sanctions for serial tax avoiders, including penalties, publication of names and withdrawal of access to certain reliefs.’
The CFA 2017 in particular represents a deep cultural change, Powles believes. ‘Its requirements must now be built into how firms operate. I’ve done a 20-page report for my firm on the subject. We’re doing training on the CFA 2017 and tax evasion at the moment through lunchtime seminars. We have to ask ourselves if, as a firm, we’re being careful enough about identifying tax evasion.
‘Some law firms have higher-risk clients than others, but it’s important for all firms to have robust whistle blowing processes in place,’ Powles continues. ‘In many firms – mine included – work is often done in teams which, in theory, reduces the risk of having one person go “off-track”. Even where that’s the case, it’s important that set procedures are in place so that if someone is uncomfortable with a matter, they can report their concerns to specified individuals in the firm.’
Raphael draws attention to other significant regulation that came into force last year which focuses on ‘complicit or negligent professional enablers’. From April 2017, HM Treasury Office of Financial Sanctions Implementation (OFSI) has had the power to levy heavy monetary penalties for breaches of financial sanctions. In OFSI’s view, anyone who acts on behalf of or advises another as part of their job is a ‘professional facilitator’ and, depending on their conduct once a potential breach is discovered, they may be treated as colluding.
There is also the extra burden for lawyers and other regulated persons imposed by the implementation of the EU Fourth Anti-Money Laundering Directive, in force from June 2017. This coincides with the EU’s Supranational Risk Assessment Report, which identifies lawyers and other professionals as an ongoing source of money laundering and terrorist financing risk by misinterpreting their reporting obligations and the doctrine of legal professional privilege. From August 2017, too, lawyers have an obligation to report knowledge or suspicion of breaches of EU financial sanctions.
With the shift in attitudes towards lawyers’ involvement in tax avoidance being prompted in large part by the release of the Panama and Paradise Papers, the protection of data has become even more crucial for firms.
The cybersecurity risks faced by organisations – including law firms – are constantly evolving, and they must keep abreast of new ways of combatting the threat. The National Cyber Security Centre and the National Crime Agency’s 2016/17 report provides a good summary of the current cyberthreats to the UK, says Timothy Hill, the Law Society’s technology law policy adviser.
While the sophistication and capabilities of security systems vary hugely from firm to firm, Hill urges that everyone should take a holistic approach that encompasses physical, personnel and information security. ‘Firms should take both technical and organisational measures to ensure the confidentiality, integrity and availability of their information assets. What’s appropriate will vary according to the nature of the information assets and data to be protected; the processes and procedures of the firm; and its people,’ he remarks, ‘but for many smaller firms, the recently relaunched Cyber Essentials Scheme may be a good starting point.’ Gaining certification under the scheme may help firms reassure their clients that they are taking cybersecurity and their confidential information seriously, says Hill.
Hill also points out that forthcoming regulation will impose greater burdens on firms in relation to data security. ‘The EU General Data Protection Regulation (GDPR), which comes into force in EU member states – including the UK – on 25 May 2018, will impose additional obligations: first, in the reporting of cybersecurity breaches involving personal data; and second, in the level of fines that could potentially be imposed.’ For the foreseeable future, Hill predicts, the GDPR will drive developments in data protection.
‘Whatever the expense of having high-grade security systems, it will be less than having a data breach. This isn’t an area in which it’s sensible to economise.’
At the same time, what has especially angered some lawyers – Powles and Adams included – over the Paradise Papers has been the media focus on the tax arrangements of some high-profile individuals, rather than the criminal use of information and internal breaches of confidentiality. ‘Firms are susceptible to external hackers, but also to leaks from people like disgruntled employees,’ notes Powles. ‘You can’t protect your information 100 per cent, and while you can do your best to protect against external data security breaches, preventing internal breaches may be harder to do. Defending yourself against these can go all the way back to things like recruitment and your dealings with third parties.’
Chris Scott, partner at Schillings and an expert in reputation management, agrees. ‘We advise clients – especially families who work with private client firms – to hold all their advisers to the highest standards, and do due diligence on all people they work with, like accountants and the people in their own teams who control access to their data.’ Many firms, Scott reports, use a mixture of in-house teams and external advisers to manage their data and its security. ‘External advisers are important to independently test your security systems. And firms should remember that whatever the expense of having high-grade security systems, it will be less than having a data breach. This isn’t an area in which it’s sensible to economise.’ A major concern for clients, if a breach occurs, is not just that their legitimate tax planning arrangements may be frowned upon, but their law firm’s security systems have failed.
Scott urges firms to keep clients actively informed about what measures they are taking to keep their data secure. ‘A key thing now, as never before, is client confidence.’ Another crucial issue is learning how to avoid data hacks and leaks, and how to react to them if the worst happens. Firms must have response and crisis management plans in place. ‘If a breach is discovered, firms must determine rapidly what is going on and adapt to it as fast as possible. You need to have your defences prepped and ready, and be prepared to tell your clients exactly what you are doing about the breach and the level of risk they have been exposed to.’
Powles predicts that in the coming years, clients and their advisers will have to remain fixed on genuine tax planning strategies, and that there may be more crackdowns on artificial schemes. ‘There’s been a huge volume of laws introduced in the last five years, which will have a dramatic impact on mainstream tax evasion. The use of overseas jurisdictions to hide money is dwindling. I think many people in the field would like to pause and see how well regulation, like the CRS, is working. The reality is that we can expect to see more national and international regulation.’
Scott says lawyers and clients will have to carefully consider how transparent they should be in their tax planning. ‘Clients are entitled to receive advice that’s confidential and to defend that confidentiality, but there is an element of reality involved, and it’s not always going to be possible to avoid scrutiny in an increasingly transparent society, either by regulatory change or unauthorised disclosure. You have to ask yourself this: if outside parties find out about your tax affairs, how do you think you would look to them, and would you be comfortable with their perception of you?’
Meanwhile, many lawyers will be following with interest the legal action Appleby is now taking in the wake of the Paradise Papers leak, seeking damages from the Guardian and the BBC, and the return of documents. This may help put data and privacy issues back on the table, and alter the balance in the media attention currently weighing against lawyers.