As the government sounds the death knell of a raft of tax avoidance schemes and the Proceeds of Crime Act 2002 bestows on lawyers a duty to report suspicions of evasion, Linda Tsang discusses solicitors' concerns that such regulation threatens professional privilege

Death and taxes are said to be the only certainties in life - and under two successive Labour governments, there is also the pre-budget report from the Chancellor that exercises tax advisers every year.

The continuing battle between the Inland Revenue and tax advisers - one to raise revenue and the other to reduce tax liability - had the law firm Bircham Dyson Bell claiming a victory last month when the Inland Revenue accepted a tax-saving scheme that reduces the value of an estate for inheritance tax purposes (see [2003] Gazette, 23 October, 8).

Under the scheme, clients are able to benefit from lower taxation by a lease of chattels being granted to secure their continued enjoyment and the chattels themselves being gifted.

This reduces the value of the chattels in the estate of the donor.

Nicholas Brown, the private client partner involved in the scheme, says: 'I advised that the clients should consider a "shearing scheme" to reduce the taxable value of the house and chattels.' The two schemes were established in 1989, and the Inland Revenue reviewed these schemes only recently, as is standard practice.

Mr Brown adds: 'There had always been a doubt whether a shearing scheme would work in relation to chattels, but there was greater confidence that a scheme in relation to the house would be effective.

This proved to be the case when in 1998, the House of Lords approved such schemes in the well-known case concerning Lady Ingram's estate (see Ingram v Commissioners of Inland Revenue [2000] 1 AC 293, HL(E)).

The shearing scheme is no longer effective for land, thanks to anti-avoidance legislation following that case.'

With Mr Brown's scheme, the revenue accepted that chattels worth approximately 1.5 million were valued for inheritance tax purposes at less than 20,000.

The estate paid less than 8,000 rather than 600,000.

But this case was not standard, and Mr Brown warns: 'There is no point in saving inheritance tax at 40% only to pay capital gains tax at 40% on the creation of the lease, so the chattels have to be well chosen to avoid this.'

He adds: 'For capital gains tax reasons, the chattels should be ones that are likely to stay in the family, rather than being sold following the death.

And the chattels have to be valuable - 500,000 or more is a "ball-park" figure.'

That case was just another chapter in the long-running saga of wealthy individuals trying to avoid tax legitimately while the Inland Revenue tries to close any loopholes that their advisers devise.

Suzanne Marriott, a partner in the private capital department at City law firm Charles Russell, says: 'The Ingram loophole was closed by anti-avoidance legislation, but we were aware that this was likely to happen, but a more recent scheme, known as Eversden [which was a tax-saving scheme relating to gifting the family home to a trust for a spouse (see Inland Revenue Commissioners v Eversden and another [2003] EWCA Civ 668)] was closed earlier this year with no warning at all.

Advisers are now looking at 'son of Eversden' schemes, which may also arouse the Inland Revenue's interest.'

With the sudden closure of the Eversden loophole, tax advisers are becoming more aware of regulation by ambush.

But other possible targets are being highlighted.

More recently, reports in the press that the Chancellor may look at imposing capital gains tax on all sales of residential property - that is, getting rid of the exemption for principal private residences - has had clients ringing their advisers for possible schemes to avoid that 40% charge.

Ms Marriott adds: 'The boom in property prices means that many more people are coming within the 255,000 inheritance tax band, so the family home is becoming the target for raising revenue - but that is likely to cause problems politically.'

Lawyers and accountants have also become the target of the government in other areas, in particular with suspicions of tax evasion falling under the duty to report in section 330 of the Proceeds of Crime Act 2002.

Failure to report knowledge or suspicions to the National Criminal Intelligence Service (NCIS) carries a maximum 14-year prison sentence.

Both lawyers and accountants see this as having the most immediate impact, and the recent divorce case of P v P (Ancillary Relief: Proceeds of Crime) [2003] Gazette, 30 October, 33, has also highlighted this issue.

In this case, Dame Elizabeth Butler-Sloss heard arguments on behalf of both applicant and respondent as well as NCIS, the Inland Revenue, the Law Society and the Bar Council.

The husband in question was thought to have assets of about 19 million.

The wife's advisers were also concerned that, if he had evaded tax, the Inland Revenue might attempt to collect back tax from assets awarded to the wife, in which case she would not have received what was intended.

However, Dame Elizabeth ruled that solicitors must report any suspicion of irregularity to NCIS, but can, in certain circumstances, reveal the report to their clients.

John Rhodes, head of the private client department at City law firm Macfarlanes, voices the consensus of concern about the scope of the Act and other legislation which is in the pipeline in relation to the area of taxation.

He says: 'Both the EU Savings Tax Directive and the UK's latest anti-money laundering legislation pose difficulties for professional advisers in their relationship with clients.

Both apparently provide protection to a professional who reports a client of whom he is suspicious.

Neither, however, makes clear how loss to a client is protected in the courts of another jurisdiction where the client decides to take action and where the law on this point may be different.'

Mr Rhodes adds: 'The fact the Act has no de minimis limits may result in NCIS being swamped with comparatively trivial reports.

Secondly, once taxpayers realise that their accountants have no choice but to report any intentional past tax default as tax evasion (as only legal professional privilege is preserved by the Act), they will probably become much more reticent to discuss such matters.

The net result will be less opportunity for the accountants to advise clients how to put things right.'

He concludes: 'It will be some time before the full impact of this works through, but governments may yet regret this attack on professional privilege.

It may lead to some short-term gains in tax collection, but at the cost of destabilising professionals' traditional role in encouraging compliance.'

The increasing amount of regulation and restriction of tax avoidance manoeuvrability seems inevitable given the economic boom times of the recent years.

Ms Marriott says: 'In boom times, people are making money and don't want to pay too much tax, and in hard times there is less money so they want to hang on to it.

'People are getting more sophisticated in their use of private client lawyers and accountants - the two professions work in co-operation and sometimes in competition with each other.'

Martyn Gowar, a partner in the tax and private capital department at City law firm Lawrence Graham, highlights the problem that all tax advisers have - uncertainty.

He says: 'There is the current review about domicile which the government is consulting on, but any changes may not appear until the Finance Bill in 2005.

That uncertainty makes it difficult to advise clients.

The area that most advisers expect to be changed is inheritance tax, which, up until now, the government has only marginally fiddled with.'

Mr Gowar is bullish about advising on private capital and taxation.

He says: 'London is the world capital in international tax planning.

The Americans can't escape Uncle Sam and the Internal Revenue Service, so London dominates the market for overseas clients, who see that the financial and legal and banking systems all work and that London can provide the best advice.

'So we are all fighting in the battle to bring business to London.

It's like the Premiership which has a small number of quality teams - that competition means we bring the best out of each other.'

Linda Tsang is a freelance journalist