HMRC wins on non-notification of £110m tax avoidance scheme

HMRC has won a landmark Alchemy case against a tax avoidance scheme promoter who failed to meet the Disclosure of Tax Avoidance Scheme (DOTAS) rules in a tribunal ruling that could lead to the recovery of £110m

A first tier tribunal (FTT) found in HMRC’s favour in a case brought against scheme promoter Root2 for failing to report a mass-marketed tax avoidance scheme, known as Alchemy, to the tax authority. [The Commissioners for Her Majesty’s Revenue and Customs and Root2tax Ltd, Root3tax Ltd (in liquidation) [2017] UKFTT 0696 TC06115]

The scheme aimed to extract profits from owner-managed companies in the form of winnings from betting on the stock market, which the scheme aimed to ensure would be tax free, rather than in the form of taxable employment income.

The FTT was given the explanation that under the scheme, an individual enters into a spread bet contract with a counterparty, an established spread-betting business at arm’s length, though aware that it is entering into a pre-conceived arrangement. The bet relates to the performance of a basket of hedge funds over a given period: if the funds rise in value to a stated level or above by the end of the period, the user wins, and if not he loses the bet.

The user also enters into a hedging contract, commonly a call spread option (CSO), with the same counterparty. The outcome of the CSO is also dependent on the performance of the same basket of hedge funds, but in reverse: thus if the user wins on the spread bet he is certain to lose on the CSO, and vice versa. The spread bet and the CSO are arranged so that they mature at the same time.

Subsequently the employer or employee benefit trust (EBT) agrees to assume the CSO by way of novation. At this stage, usually a few days after the user has entered into the two contracts, when the period remaining to maturity is relatively long and the outcome of the two contracts is uncertain, it is expected that the spread bet will have a modest positive value in the user’s hands, and the CSO a modest negative value. Thus by relieving him of the burden of the CSO, for no payment, the employer or the EBT has conferred an employment-related benefit on the user, which he declares and on which he pays the appropriate tax.

Nothing more happens until the contracts mature, typically a few months later. Ideally, from his perspective, the user will have won on the spread bet, and the employer or EBT will have lost on the CSO. Thus the employer or EBT makes a payment to the counterparty, which in turn makes a payment of about the same amount to the user. In this case, and if the scheme works as intended, the user will have received a significant sum which, as betting winnings, is not taxable; he will have suffered tax, if at all, only on the much smaller value of the benefit to him of being relieved of the CSO.

HMRC brought the case against Root2 under DOTAS rules, which require promoters to tell HMRC about tax avoidance schemes they design and sell, arguing to the tribunal that the Alchemy scheme was notifiable. When asked about this, the respondents had denied this was the case.

One element of HMRC’s argument centred on detailed analysis of the outcomes of users of Alchemy.  This showed that in many cases the scheme had worked as intended: the user had won the spread bet, and the company or EBT had been obliged to pay the counterparty. However, HMRC also discovered that on many occasions when the user had lost the spread bet and the company or EBT had correspondingly won on the hedging contract the exercise had been repeated, in some instances several times, until the desired outcome was achieved.

The tribunal judge described much of the evidence of Blair Forsyth, a director of Root2, as ‘disingenuous, if not evasive’, as Forsyth sought to argue that his company was not providing advice on participation the scheme but on the tax consequences, despite evidence of webinars promoting the scheme.

The judge said: ‘Taken at face value, it would lead to the conclusion that a succession of individuals, who had happened on the idea of taking simultaneous or near simultaneous spread bets and hedging contracts and whose employers, or EBTs of which they were beneficiaries, had fortuitously offered to relieve them of the CSOs, had chosen to instruct one or other of the respondents to advise on the tax consequences of their doing so, and that the respondents’ sole part was to provide that advice, albeit refining the scheme in the process.’

Instead, the judge said there was no doubt that ‘if the respondents did not devise the Alchemy scheme they played a leading part in refining it to the point at which it could be marketed’.  He accepted Forsyth’s explanation that the CSO represented a hedge on the bet, but dismissed his explanation of why that hedge was then immediately passed on to a third party as ‘incomprehensible’.

The judge agreed with HMRC’s view that the Alchemy scheme is a standardised tax product, as ‘even a cursory perusal of the documents shows a recurring pattern with little variation, apart from dates, names, amounts and similar details, from one iteration to another.’

Thus the FTT agreed with HMRC that the promoter did not abide by the DOTAS rules and had failed to disclose the scheme. There is no right of appeal against the tribunal decision.

Penny Ciniewicz, director general of HMRC’s customer compliance group, said: ‘This is a great victory that sends a clear message to tax avoidance scheme promoters that we will pursue you if you don’t play by the rules.

‘Most tax avoidance schemes don’t work. The DOTAS rules ensure that HMRC is notified of schemes so that we can investigate and challenge them.’

HMRC says it will seek to impose a substantial penalty on the promoter for failure to disclose the scheme.

The Commissioners for Her Majesty’s Revenue and Customs and Root2tax Ltd, Root3tax Ltd (in liquidation) [2017] UKFTT 0696 TC06115 is here.

Report by Pat Sweet

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