Making sense of tax risk

Written by: Richard Willsher Posted: 13/09/2017

tax risk illoAn increase in regulation has made life far more complicated for directors and NEDs – so just how can they navigate safely through the tax compliance minefield? 

The saying goes that there are only two things in life you can be sure of: death and taxes. In the current environment, you might want to add an addendum to this: tax risk is intensifying. 

Companies, funds, their directors and non-executive directors (NEDs) are facing increased responsibilities to comply and report to tax authorities. The penalties for non-compliance have stiffened significantly and the outlook is for closer scrutiny and greater reputational risk. This is all piling pressure on decision makers within businesses in the Channel Islands.

On 1 September 2009, hot on the heels of the financial crisis, HMRC’s Liechtenstein Disclosure Facility (LDF) came into force. It was effectively an amnesty to encourage those who were evading tax in the UK by routing their affairs through the Alpine principality, to come clean and pay up. It was the first of several such disclosure facilities to be put in place by the UK tax authority. 

On 31 December 2015, these were all closed and replaced by the Worldwide Disclosure Facility (WDF), which until 30 September 2018, HMRC states, ‘will be the final chance to come forward before we use CRS data and toughen our approach to offshore non-compliance’.

‘CRS data’ refers to the Common Reporting Standard (CRS) for the automatic exchange of financial institutions’ client information, which was approved by the Organisation for Economic Co-operation and Development (OECD) in July 2014.

This will further ratchet up the fight against tax evasion and follows on from the Foreign Account Tax Compliance Act (FATCA), the US legislation dating from 2010 that required foreign financial institutions to report on the accounts of American account holders, either through their own tax authorities or directly to the US Internal Revenue Service (IRS). 

Navigating the maze

The sum of these measures illustrates the scale of tax risk and disclosure responsibility that businesses and their directors now face. It’s labyrinthine and far from straightforward.

“Tax risk has become more onerous. And it’s going to get even more onerous as other pieces of legislation take effect,” explains Harry Lawson, Senior Tax Consultant at Equiom Solutions.

“As well as the WDF, the Requirement to Correct [RTC] puts an onus on businesses to ensure that their clients’ tax reporting is up to date, and also runs until 30 September 2018. It’s an opportunity to put their tax affairs in order and is aimed at the fiduciary industry with responsibility for trusts and others in the UK that are generating an income which has yet to be reported to HMRC.”

The picture is one of ever-more-demanding tax compliance. “The trend over the past few years is for an increase in the tax and morality debate,” says Debbie Payne, Director at PwC in the Channel Islands. “There’s now a huge amount of law. You need to understand what the laws are, what your compliance risks are and what procedures you need to put in place to protect your business from those risks.”

This means businesses need to have policies and procedures in place that reflect the requirements of the global kaleidoscope of tax legislation. This can affect any business, but is particularly true of those that manage clients’ money or hold accounts for them, such as banks, investment funds and private equity structures. 

And along with the increased regulation, the penalties for non-compliance are increasing. “Penalties for non-compliance post-RTC are quite draconian,” says Lawson, a former HMRC staffer. “100 per cent of the tax is a minimum. There may also be asset-based penalties of 10 per cent of the assets involved.”

What’s more, as directors and NEDs bear ultimate responsibility for the tax compliance of the firms for whom they work, they could also face severe sanctions. “They could face fines, professional challenges, and the regulatory authorities could ban them from practicing,” says Moore Stephens Associate Director Hazel Johnson, who specialises in tax planning advice for high-net-worth individuals. “And then, if they’re involved in lawbreaking, they could face criminal prosecution.”

Johnson goes on to explain what they should do to prepare themselves. “Directors and NEDs need to be fully aware of what tax compliance obligations they face and what internal systems are in place to monitor these, as well as Know Your Customer [KYC] requirements. They need to keep themselves up to date with changes that have gone on in the regulatory environment. 

“They need to stay in contact with people who are working with clients to ensure that they’re keeping up with clients’ needs in the regulatory environment and that they can keep up with reporting.” 

Johnson adds: “And they need to keep an eye on the professional bodies, such as trust administrators, so that they keep themselves up to date with latest best practice as well.”

Who’d be a NED?

Changes in tax legislation have altered the role of directors and NEDs. There’s now clearly a requirement for a greater degree of professionalism in the field of tax.

“You can outsource your compliance obligations and administrative tasks to a fund administrator; what you can’t outsource is your responsibility,” says Payne. “You can hedge yourself commercially, but if anything does go wrong it’s the directors that would be held responsible when it comes to enforcement proceedings.” 

But while some potential directors and NEDs are thinking twice about taking on such responsibilities and risks, there are now more people who see this job as a long-term career. 

“They take on a small number of appointments and expect to be paid properly for them,” Payne says. “We have groups of such people in the Channel Islands who now do this, and who have much more infrastructure and support around them. A different type of director is coming through, rather than those that perform such roles on an ad hoc basis. They look at it as a real business proposition.”

Lawson stresses the importance of research before taking on a directorial role. “Directors and NEDs need to think carefully about the roles that they’re going into. While most will already do this anyway, they need to do their research very well before taking on the job. They need to look into the background of any fiduciary entity or other business. They need to know about what’s behind that entity, find out as much as they can about it. 

“What they need to do is undertake their own due diligence into the role they’re going to take. They might start by asking whether the entity is regulated or needs to be regulated. That would be my first port of call. The less information you can find out about an operation, the more worried you should be.”

Reputation, reputation, reputation

Overarching the risks associated with tax compliance itself is reputational risk. Tax authorities have adopted a more aggressive, investigatory approach to tax gathering and this includes naming and shaming non-compliant businesses and individuals. Adverse publicity is now a tool in the armoury of the tax collectors, who increasingly gather their intelligence from each other to assist them in their enquiries.

Weighing it all up, it seems pretty clear that there’s only likely to be one direction of travel – no wonder then that tax experts say the intensity of tax risk is going to worsen in the future. 

“The risks have been around for a number of years,” says Payne. “What we’re seeing is a greater willingness among tax authorities in different countries to ask questions and to take a tougher line in investigation and enforcement.” 

However, there’s another imponderable waiting in the wings. Lawson concludes by saying: “Beyond the next year or two, when we know what’s in the pipeline, the big unknown is Brexit. The islands’ interests with the EU are served by the UK, but they don’t know what their position will be when the UK leaves.” 

That may be a matter for another day, but Brexit looks likely to heap further tax complications and risk onto an increasingly complex maze of tax regulation and compliance.

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