A brief guide to making a claim in respect of negligent tax advice

Many businesses rely on professionals to guide them through the complex, and often highly technical, tax legislation and case law. Unfortunately, receiving incorrect advice from a professional is more common than many people realise, with mistakes often leading to substantial and unexpected liabilities, penalties, and business disruption.

Bringing a professional negligence claim against an adviser, however, can help to recover some of the losses caused by incorrect advice. Here, we provide a brief guide to making professional negligence claims for tax advice, including what constitutes negligent advice, what businesses can do when faced with unexpected tax liabilities, and how legal teams will pursue professional negligence claims.

What constitutes negligent tax advice?

Negligent advice is advice that was incorrect when it was given because the adviser in some way failed to act to a reasonable standard, and that incorrect advice caused loss. This loss is not always immediately apparent. In tax, for example, it can take months, if not years, for negligent advice to come to light.

A particularly common area for mistakes and negligent advice is value-added tax (VAT) treatment.
 
The UK’s VAT rules are complex. Most goods or services are supplied at the standard rate of 20%. But many supplies are exempt from VAT, or the VAT on the supply is charged at the zero-rate or at the reduced rate.
 
Negligent advice can often occur when a business is told that its supplies are exempt from VAT, or zero or reduced rated, only to discover later that the exemption/ zero or reduced rate does not apply. This business can then be liable for a significant VAT bill from HMRC covering the years in which VAT went unpaid, as well as statutory interest and penalties.

How is negligent tax advice discovered?

Many advisers are subject to professional codes of conduct that require them to inform their clients when they identify an error in the advice that they have given.

Negligent tax advice may also be discovered when a business switches to a different tax adviser, who spots the issue after reviewing the business’s current tax position.

In any event, it is always worth spotting errors or discrepancies before HMRC does. Once HMRC has opened an enquiry or other investigation, a business may have lost the opportunity to voluntarily disclose the mistake. Unprompted or voluntary disclosures are important in mitigating any statutory penalties.

What is the difference between breach of contract and professional negligence?

There are two ways in which businesses can claim against advisers for negligent advice that has caused loss. Whether both options are available will depend on a case’s specific circumstances, including the point at which the loss was discovered.

1. Breach of contract. Most tax advisers conduct professional services under the auspices of a written engagement letter that sets out the scope of work. If the adviser provides incorrect advice, he/ she may be in breach of an express or implied contractual term requiring them to exercise reasonable skill and care. Even clauses that limit liability cannot always protect an adviser from a claim, particularly if they are found to be unreasonable. Indeed, such clauses are often successfully challenged in courts.
2. Professional negligence. This is known as a claim ‘in tort’, which concerns a breach of legal duties that one party owes to the other. A business may have a claim in tort if the adviser owed a duty of care that was subsequently breached and caused a recoverable loss. When examining whether a professional negligence claim is valid, the courts will consider the relationship between the adviser and the client, the client’s reliance on the advice, how the advice was communicated, and whether the adviser assumed responsibility for the work.

What losses can I recover?

Losses that can be claimed from an adviser are often limited to those that are directly caused by the negligent advice, and that are foreseeable when the advice was given.

For example, a business is incorrectly advised that its supplies qualify for a VAT exemption. Consequently, it does not charge VAT on such supplies for several years. That business may be able to recover penalties and interest levied by HMRC, as these are arguably a direct result of that advice. It may also be able to claim the VAT itself as a loss because the business may have lost the ability to charge its customer the VAT output tax, being an amount equal to the business’ VAT liability.

How will my legal team pursue a professional negligence claim?

• Immediate containment and tax review. When a client approaches us with concerns about a potential unexpected tax liability, our first step is to contain the issue and protect our client from further losses and penalties. This includes our tax experts reviewing the original tax advice and deciding whether a voluntary protective disclosure to HMRC is required.
• Assessing the claim’s merits. Once we’ve reviewed the original tax advice, we will decide whether the facts of the case are strong enough to make a professional negligence claim. This will include examining the scope of the adviser’s engagement, whether they breached their duties, and whether any limitation periods have been exceeded. We also check whether the adviser has professional indemnity insurance, as insurers must be placed on notice to avoid prejudicing coverage.
• Pre-Action Protocol. Before issuing legal proceedings against the tax adviser, we must follow what is known as the Pre-Action Protocol for Professional Negligence. This involves sending a Preliminary Notice to the adviser, in which we notify them of the potential claim and request that their insurers be informed. 
• Standstill Agreement. At this point, we may also seek a Standstill Agreement with the adviser to pause the limitation period and so protect the business from running out of time to bring the claim. This is particularly important where it has been decided to make a voluntary disclosure to HMRC to ascertain whether HMRC agree that there is a tax liability and, if so, to what extent. It may be many months before HMRC and the taxpayer agree the correct tax treatment and/ or its quantum. 
• Letter of Claim. This is followed by a detailed Letter of Claim, which sets out the claim’s background and legal basis, as well as the losses to be recovered. We will work with tax specialists to draft the Letter of Claim. Once the adviser has received this, they should issue a Letter of Response.
• Settlement or litigation. The courts will usually expect both parties to engage in mediation or another method of alternative dispute resolution following the pre-action stage. If the parties cannot agree a settlement, the claim proceeds to the courts.

What about claims under tax indemnities?

Where the tax liability is that of a company (‘Target’) that has been subject to a change of control - such as on its sale - the Buyer may have a claim against the Seller for the Target’s increased tax liability if the Seller gave a tax indemnity to the Buyer in respect of the Target’s historical tax liabilities. 

If the Buyer’s claim were successful, the Seller would be required to make a payment under the tax indemnity to the Buyer. If the liability had arisen from the negligent advice from the Target’s tax adviser, the Buyer would be prudent to ensure that the Target made a claim against the adviser and possibly require a Standstill Agreement between the adviser and the Target. 

At the same time, the Buyer would want to make a claim against the Seller under the tax indemnity. To ensure limitation periods on that contractual claim did not expire, the Buyer might also wish to agree a separate Standstill Agreement with the Seller. 

The Buyer will need to consider the Conduct of Claim provisions in the Share Purchase Agreement, which may require involving the Seller in the decision as to whether the Target should make a voluntary disclosure to HMRC and/ or how the Target should appeal against the tax liability. The Seller’s rights of conduct in Share Purchase Agreements do not, however, usually go as far as requiring the Target to pursue a claim in negligence against the Target’s tax adviser. That is a matter for the Target and the Buyer to decide.

Given some of the legal difficulties in professional negligence claims, such as evidence, causation, quantification of loss and contributory negligence, it may be a better solution for the Buyer to make a claim against the Seller for the tax in accordance with its rights under the tax indemnity. This is a particularly attractive option because, unless express words to the contrary have been included in the indemnity, a claim under an indemnity or covenant does not require the Buyer to mitigate its loss. The Buyer, therefore, does not have to require the Target to pursue a claim against the tax adviser. The Buyer can usually recover the liability from the Seller on a pound for pound basis. In short, it may be easier from a legal point of view for the Buyer to pursue the Seller, rather than for the Target to pursue the adviser.

What should I do if I have been given incorrect tax advice?

Act quickly. Time limits for bringing breach of contract and/ or professional negligence claims are strictly enforced. Reviewing the situation as soon as possible is critical to ensuring that you can bring a claim in time, protecting your position, and avoiding unrecoverable losses.

Working with both tax and professional negligence specialists at the earliest possible opportunity is vital, as they can assess the validity of your previous tax advice, quantify any potential losses, and preserve your position with both HMRC and any insurers.

Our Tax and Commercial Dispute Resolution teams work closely to assess potential liabilities, advise on voluntary disclosures and the merits of a claim against a previous adviser, pursue claims against advisers, and handle complex disputes arising from corporate transactions.