Currently, it is a constitutional principle that tax should be imposed only by legislation. Also, case law says that, within bounds imposed by law, a taxpayer is free to arrange his commercial affairs as he pleases, and if his ingenuity reduces the resulting tax bill, this cannot be challenged, even if the results are not popular with other taxpayers or HMRC.

The CTC represents a significant departure from normal tax practice. A bank signing up to the CTC has to:

The rationale for targeting banks as opposed to, say, large companies, is their unique position in being payers of significant amounts of tax. They also have a customer base to whom tax avoidance products can be sold and a capital base which can be used to facilitate tax avoidance transactions by others.

Non-UK banks operating in the UK and other entities carrying on banking activities in the UK will also be asked to sign the CTC.

Signing the CTC will be voluntary (although failure to sign will be taken into account by HMRC in assessing the relevant bank’s risk status and is likely to result in greater scrutiny by HMRC). There is no formal sanction for non-compliance following signature. Instead, pressure will be put on the board or other senior officers to comply, and reports might be made to professional bodies in appropriate cases of non-compliance.

If this does not work to achieve the change in behaviour and attitude to tax planning which HMRC is seeking, the consultation raises the possibility that other deterrent measures, such as requiring a statement in the accounts that the CTC has been complied with or an audit of compliance, might be imposed in the future. In addition, HMRC will report to Parliament on compliance, including the number of banks signed up to the CTC (although not, it would seem, the names of those which have not).

The CTC has three sections: governance, HMRC relationship and tax planning.

The governance section requires a signatory bank to have a tax governance regime signed off at a senior level (for which the board or “equivalent senior officers” will be accountable). This includes a formal process for approval of tax products, with senior management sign-off if the business unit and tax department disagree, and a requirement to operate in an open and transparent way with HMRC.

The relationship section requires the bank to work co-operatively and openly with HMRC on identifying and resolving issues, including disclosing cases where there are uncertainties in the tax treatment. Similar arrangements will already be in place at many banks: most will have a tax governance policy imposed at board level, and will already be operating in a more open manner with HMRC.

The requirement to have a formal approval process for tax products may require changes in process but, in general, it is not thought that these two sections will present particular difficulties to banks asked to sign the CTC.

However, the section on tax planning (and the guidance on it given in the consultation) is likely to give more concerns, in that it will raise issues for banks on how they conduct their business and maintain their position against competitors. The guiding principle is that tax planning should only be used to support genuine commercial activity.

Where the tax planning is on the bank’s own account, transactions should not be structured in a way which has a tax result that is inconsistent with the economic result, except where this is due to specific legislation. If the mismatch is the result of legislation, the bank must reasonably believe that the transaction is structured in such a way that gives a tax result which is not “contrary to the intentions of Parliament”.

Where a bank is promoting a product to a customer, it must do so only where the bank reasonably believes that the tax result of the arrangement is not contrary to the intentions of Parliament. A bank may finance an arrangement provided that it does not promote it. Employee pay packages should be structured so that proper (as far as HMRC is concerned) amounts of tax and national insurance contributions are paid.

No commentary is given on how to discern Parliament’s intention; there are examples of what constitutes tax avoidance in the consultation, but these are not given in sufficient detail to determine which head of the test HMRC thinks applies, and there is no commentary on why it considers that the transactions are not in line with what Parliament intends: “it is usually self-evident that a tax result is contrary to the intention”, seems to be the approach.

In the Appendix, the test is framed as “the law was clearly not written with the objective of allowing these outcomes” but in the case of, say, a new investment product which is not specifically within any existing legislative provisions, it is difficult to see how this test could be applied.

In cases of difficulty, the CTC requires that the matter is discussed in advance with HMRC, but this will, at the very least, have timing implications for transactions. If a transaction is undertaken which later is identified as possibly contravening the CTC, immediate notice must be given to HMRC.

In practice, it is not thought that there should be difficulties for banks in accepting the governance and HMRC relationship elements of the proposals; banks should be prepared to have an open discussion with HMRC about transactions they have undertaken, and if there is any desire to be economical with an explanation in discussing a structure with HMRC after the event, this should be a sufficient warning that the taxpayer should not be undertaking the transaction in any event. However, the CTC raises some issues:

While, particularly in the current economic climate, it may be difficult for banks to justify not signing up to a CTC, the broadness of the scope of the tax planning restriction seems to leave little scope for even the most ordinary tax planning. A CTC which contains the governance and HMRC relationship proposals, together with a tax planning section which prohibits extremes of tax avoidance, would seem a more balanced approach.

A code of practice on taxation for banks, http://customs.hmrc.gov.uk/channelsPortalWebApp/channelsPortalWebApp.portal?_nfpb=true&_pageLabel=pageLibrary_ConsultationDocuments&propertyType=document&columns=1&id=HMCE_PROD1_029639. The consultation ends on 29 September 2009.