One of the core attractions of settling a disagreement with HMRC is to put an end to the inherent uncertainty that surrounds any dispute. But what if HMRC seek to pull out of a settlement agreement after the event?
That is what HMRC is seeking to do in the case of GE v HMRC  EWHC 2121 (Ch). HMRC's basic position is that it should not be bound by its agreement with General Electric because the company did not disclose the full picture when it entered into the agreement and associated clearance application.
The GE case is still at a preliminary stage – the facts are complex, the full trial is yet to take place, and none of HMRC's allegations have been proven. But the case highlights some important issues for taxpayers:
- The certainty offered by a settlement may be undermined if the taxpayer does not disclose relevant material facts.
- The parties need to be very clear about what they saying (and what they are not saying) are the relevant facts – there should be no ambiguity. This is especially true of things which are said in meetings, where there is often more scope for misunderstanding.
- If possible, the parties should consider submitting a written summary of all the representations which have been relied on in entering into the agreement.
Facts in GE
The UK anti-arbitrage rules are designed to prevent tax avoidance through the exploitation of the tax treatment of hybrid entities in different jurisdictions. Put simply, a hybrid entity is taxed as a distinct entity in one jurisdiction, but treated as transparent in a different jurisdiction.
GE approached HMRC in 2005 for clearance in relation to a number of transactions and sought confirmation that the anti-arbitrage rules did not apply. One of these transactions concerned the 2004 investment in an Australian subsidiary by GE's UK entities. In late 2005, GE entered into two agreements with HMRC: a settlement agreement, concerning existing transactions, including the Australian investment, and a clearance agreement, concerning the ongoing treatment of various GE activities.
Following several years of discussions beginning in 2011, HMRC purported to rescind the settlement agreement in 2018 on the basis of alleged material misstatements of fact and a failure to provide adequate disclosure. HMRC are now seeking a declaration from the High Court that the settlement agreement has been validly rescinded. The High Court recently heard a number of preliminary points as part of an application by HMRC to amend its pleadings.
In simplified terms, the points of contention were:
1. Whether GE had represented to HMRC that the main purposes of the Australian investment – being funded by loans and held by the UK subgroup of GE – were all genuinely commercial; or alternatively that obtaining a tax advantage was not a main purpose.
2. Whether GE had represented to HMRC that, in the absence of the presence of a hybrid entity in the transactions, GE UK would have nevertheless borrowed in the UK to fund the Australian investment. The parties disagree about whether this is the correct test to apply, but in essence HMRC's argument here was that it was induced to enter into the settlement agreement because GE had said that, if one applied HMRC's view of the law, the facts were such that there was no relevant UK tax advantage.
3. Whether HMRC were entitled to add an allegation to their pleadings that GE had fraudulently represented that it had disclosed all relevant facts and matters to HMRC in connection with the settlement agreement.
4. Whether HMRC were entitled to argue that the settlement agreement was a contract of "utmost good faith", which requires full disclosure of all relevant matters.
The first two issues above were decided in GE's favour. The court ruled that HMRC had no real prospect of successfully establishing that GE had represented that obtaining a UK tax advantage was not a main purpose (see 1. above). Because of the passage of time, HMRC were inevitably relying on inferences to be drawn from contemporaneous documents, and those documents did not go so far as HMRC alleged.
In respect of the hybrid entity representation (at 2. above), the court agreed with HMRC that remarks made at a meeting with HMRC (minuted by the solicitors at the meeting) could be construed as representing that – on the assumption that HMRC were correct to ask whether hybridity of the debt was the determining point – the UK subgroup would have borrowed to buy even without the hybrid opportunity. However, subsequent documents made it clear that HMRC were not persuaded of this, which meant that HMRC had no real prospect of establishing at trial that they were induced to enter the settlement agreement by such a representation.
HMRC make a number of allegations about fraudulent conduct, which are denied by GE. The judge has allowed these points to proceed to trial but made no finding as to their validity.
HMRC also argued that the settlement agreement was a contract subject to duty of utmost good faith. This would impose an obligation on the parties to disclose all relevant facts. The argument relied on principles – which were given in the context of a judicial review claim against the Revenue in R v IRC, ex parte MFK Underwriting – that a taxpayer seeking clearance from HMRC needs to place all cards face up on the table in order for HMRC to be bound. HMRC argued that a taxpayer, who seeks to enter into a settlement agreement with HMRC in the context of a clearance application, should be under the same duty. GE argues that a compromise agreement – that is one that constitutes the settlement of a dispute by mutual concession – is not a contract of utmost good faith.
The judge has allowed this question to proceed to trial on the basis that it would be better to decide upon it after hearing all of the evidence and arguments at the trial. We will need to wait to see whether the courts are willing to expand the "utmost good faith" requirement to certain settlement agreements with HMRC. If they do, it could significantly broaden HMRC's scope for pulling out of agreed settlements after the event where new information allegedly comes to light.
Most corporates are committed to paying the right amount of tax, so settling a dispute is not about getting one over on HMRC, but rather a means of establishing what is the right amount of tax. Nevertheless, parties will wish to advocate their position as part of the negotiations.
This is not a problem when it comes to the purely legal points, but, when dealing with the facts, care must be taken. Putting forward a positive interpretation of the facts is to be expected, but what if this leads HMRC to misunderstand the true position? Arguably this is HMRC's problem but, as GE illustrates, there comes a point where a misunderstanding could provide grounds for HMRC to argue that there was a misrepresentation. At that point, any certainty achieved by a settlement is at risk of unravelling.
The same is true when it comes to deciding which facts are relevant. Clearly, evidence that supports the taxpayer's view will be relevant – but so is the unhelpful stuff. Taxpayers will have certain obligations to disclose these facts anyway, but in other cases there may be a sound argument that disclosure is not required (or possibly HMRC have not asked). In this situation, there may be a temptation to err on the side of disclosing the required minimum in order not to derail any settlement and to encourage the best settlement terms, but if it leads to HMRC later on challenging the agreement the parties can find themselves, as GE has done, back where they started – arguing about the tax, perhaps many years after the event.
The position in relation to disclosure is perhaps more salient than ever, given the extensive third-party information powers HMRC have at their disposal and the level of co-operation that now exists between tax authorities in different jurisdictions. There is a lot of information out there that will come to light, whether the taxpayer volunteers it or not.
This is not to suggest taxpayers should not actively look after their interests in any negotiation with HMRC – of course they should (and HMRC will certainly look after theirs). But always bear in mind a core objective of the settlement is finality – there should be no room for either side to argue later on that it was somehow misled into entering the settlement.