Practice note: DOTAS – HMRC’S early warning system

What is DOTAS?

The Finance Act 2004 introduced an early warning system in respect of tax avoidance schemes. The objective is to give HMRC earlier and better intelligence on avoidance schemes, in order that they can take action earlier than would otherwise be the case. The Disclosure of Tax Avoidance Schemes (DOTAS) is that early warning system.

There are two different disclosure regimes, one for VAT and one for direct taxes and National Insurance contributions.

Direct taxes

The DOTAS regime covers Income Tax, Corporation Tax, Capital Gains Tax, Stamp Duty Land Tax, Inheritance Tax, Annual Tax on Enveloped Dwellings and National Insurance contributions.

Under DOTAS certain people must provide information to HMRC about avoidance schemes within five days of the schemes being made available or implemented. Usually the person providing the information will be the promoter of the scheme (the person who designs or markets the scheme). However, users of a scheme must also inform HMRC.

The legislation imposes a number of tests to determine if disclosure is required. Briefly these are:

Are there arrangements (i.e. a scheme) or proposals for arrangements?
If there are is that scheme expected to provide a tax advantage?
Is getting a tax advantage expected to be one of the main benefits?
Does the scheme fall within one of a number of descriptions (called ‘hallmarks’)?

There are seven hallmarks aimed at new and innovative schemes, marketed schemes and targeting specific schemes (for example, loss schemes).

Promoters must provide the Scheme Reference Number (SRN) that HMRC gives them. The user must then declare the SRN on each return affected.

Promoters may be liable for a penalty for failure to disclose such arrangements to HMRC.

Indirect taxes

The disclosure regime for VAT is limited to two broad categories – listed schemes and hallmarked schemes.

Listed schemes are specific schemes (there are currently 10) that are defined in the disclosure legislation. If a taxpayer is registered for VAT in the UK and involved in a listed scheme they must notify HMRC unless the annual turnover, or group turnover if applicable, is below £600,000.

Hallmarked schemes are schemes that include or are associated with a ‘hallmark’ of avoidance defined in the legislation. A disclosure is not necessary, however, if:

a third party, such as the scheme promoter, has voluntarily disclosed the scheme to HMRC and provided the taxpayer with the Voluntary Registration Scheme (VRS) reference number;
the taxpayer or the group concerned has an annual turnover below £10 million (the turnover threshold).

Failure to disclose a scheme may be liable to a penalty as follows:

15% of the VAT saved for ‘listed schemes;’
Up to £5,000 for ‘hallmarked schemes.’

Failing to give registration numbers to clients will expose the promoter concerned or other person concerned to a penalty of £5,000 per client. Users of the scheme who fail to show SRNs on the affected returns will be liable to an initial penalty of £100 rising to £500 for subsequent failures.

Who is a promoter?

A person may be a promoter if, in the course of providing services relating to tax services they:

are to any extent responsible for the design of a scheme;
make a firm approach to another person with a view to making a scheme available for implementation by that person or others;
make a scheme available for implementation by others; or
organise or manage the implementation of a scheme.

Both UK and non-UK based promoters are subject to the disclosure rules but they only apply to the extent that the scheme enables or is expected to enable a UK tax advantage to be obtained.

The hallmarks

(A) Confidentiality.

Arrangements are prescribed as falling into this hallmark if any element of the arrangements give rise to the tax advantage expected to be obtained and it might reasonably be expected that a promoter would wish the way in which that element of those arrangements secures, or might secure, a tax advantage to be kept confidential from any other promoter at any time following the material date; or
The promoter would, but for the requirements of the Regulations, wish to keep the way in which the element of these arrangements that secures, or might secure, the tax advantage confidential from HMRC at any time following the material date, and a reason for doing so is to facilitate repeated or continued use of the same element, or substantially the same element, in the future.

(B) Premium fee

The ‘premium fee’ hallmark

Arrangements are hallmarked if it ‘might reasonably be expected’ that a hypothetical promoter of the same or a similar scheme would, in the absence of the disclosure requirements, be able to obtain a ‘premium fee’ from ‘a person experienced in receiving services of the type provided’. The intention is to limit this hallmark to marketed schemes aimed at large corporations.

(C ) Tax loss schemes

This hallmark looks at the objective behind the scheme and targets those where:

The promoter expects the same arrangements, or substantially the same arrangements, to be implemented by two or more individuals; and
An informed observer, after studying the details, would conclude that the main benefit expected to arise to the individuals was the provision of tax losses which would then be used to reduce their liabilities to income tax or capital gains tax.

D) Leasing schemes

This hallmark is aimed at schemes involving the leasing of plant and machinery. An overriding condition is that there must either be a promoter involved or, if it is an in-house scheme, the expected tax advantage is to be obtained by a large business.

Other conditions which have to be met for the scheme to be hallmarked are:

the arrangements must include a ‘plant or machinery lease’ which is not a ‘short-term’ lease;
the ‘relevant value condition’ is met; and
one of three ‘additional conditions’ is met.

The relevant value condition is satisfied if either the cost to the lessor (or the market value, if lower) of any asset forming part of the plant or machinery is £10m or more; or the aggregate cost (or market value as appropriate) of all the assets is £25m or more.

The first condition is satisfied if one of the parties to a lease comprised in the arrangements would have a right to claim capital allowances in respect of the plant or machinery; and one of the other parties is not within the charge to corporation tax.

The second condition is that the lessor’s risk of non-payment of the lease rentals by the lessee is limited by the provision of money or a money debt, whether expressed in sterling or some other currency.

The third condition is satisfied if the arrangements are designed to include either sale and finance leaseback or a lease and finance leaseback.

E) Employment Income

A scheme will be prescribed under this hallmark if:

Conditions 1 and 2 are met and Condition 3 is not met; or
Conditions 1, 2 and 3 are met and at least one of Conditions 4 and 5 is met

Condition 1 will be met if the arrangements involve at least one of the following:

a relevant third person taking a relevant step under ITEPA 2003, s. 554B (earmarking of money or assets);
any person taking a relevant step under ITEPA 2003, s. 554C (payment of sums or transfer of assets) or 554D (making assets available); or
B taking a step under ITEPA 2003, s. 554Z18 (Earmarking) or 554Z19 (Provision of security).

Condition 2 is met if the main benefit, or one of the main benefits, of the arrangements is that an amount that would otherwise count as employment income is reduced or eliminated;

Condition 3 is met if, by reason of at least one of ITEPA 2003, s. 554E to 554X ( exclusion for steps under certain schemes such as SIPS).

Condition 4 is met if the arrangements involve one or more contrived or abnormal steps without which a reduction or elimination of employment income would not be obtained.

Condition 5 is met if the arrangements involve a relevant step being treated as taking place and ITEPA 2003, Pt. 7A, Ch. 2 (treatment of relevant steps where employment income provided by third parties) applies.

Conclusion

The DOTAS provisions are one of the main weapons in HMRC’s unceasing campaign against what they consider to be the ‘unacceptable’ side of tax planning. The provisions are highly technical and expert advice is essential for promoters and taxpayers who may be affected by them.

Levy and Levy – the tax investigations and resolution specialists in London and Tunbridge Wells