Nadhim Zahawi – It could have been a lot worse

The former Chancellor and present Chairman of the Conservative Party, Nadhim Zahawi, may be feeling somewhat sore over the public screening of his seven-figure tax settlement with HM Revenue & Customs (‘HMRC’), but it could have been a lot worse.

According to reports last week, Zahawi agreed to pay around £5 million to HMRC for a historic error in his tax return, of which £1 million related to penalty issued by HMRC for so-called ‘careless’ behaviour.

The tax, penalty and around £300,000 – £500,000 of interest for late payment arose from the sale of Zahawi’s shares in YouGov, a company which Zahawi co-founded over two decades ago and sold for tens of millions in 2018.

Zahawi’s statement over the weekend said that he settled his tax position with HMRC on the basis that an allocation of the original founder shares in YouGov, which were issued to a Gibraltar company owned by his father, actually belonged to Zahawi himself; the result being Zahawi should have paid capital gains tax on the sale of those shares which would have generated around £27 million of cash proceeds.

Without knowing all the detail, the basis of the settlement sounds unusual in my view and experience, and it’s unclear to me why HMRC had any concern over the allocation of the original founder shares – unless, for example, there was a clerical error in the share register which suggested a different position to that originally declared on Zahawi’s submitted tax return.  This is probably for another day.

The most interesting aspect of this very public HMRC settlement is the penalty of 30%, which appears to be a favourable result for Zahawi and his advisors in the circumstances we know about, even if it amounted 10,000 times more than a fixed penalty notice for not wearing a seatbelt in a moving car.

Zahawi said in his statement that he reached the settlement with HMRC on the basis that he has made a “careless but not deliberate” error – this is very purposeful language which specifically relates to the tax legislation on penalties.

When HMRC are determining penalties, it is based on the behaviour of the taxpayer in relation to the tax underpayment.  The penalty rate is then applied to the additional tax due because of the error in the tax return.

Firstly, the penalty rate can be reduced if the taxpayer comes forward themselves and the quality of the disclosure provided to HMRC – this is referred to as a ‘prompted’ disclosure.

There are then three categories of behaviour to determine the penalty rate – ‘careless/lack of reasonable care’, ‘deliberate’ and ‘deliberate and concealed’.

Zahawi’s statement was firm that his situation came into the ‘careless’ category, where the maximum penalty is 30% – but there is more to this.

Firstly, penalty rate could have been feasibly brought down to zero where the disclosure is unprompted; therefore the 30% penalty issued to Zahawi strongly suggests that HMRC were already investigating Zahawi’s affairs before the error was discovered, and so this matter appears to be a ‘prompted’ disclosure.

‘Careless’ behaviour means that the taxpayer failed to take reasonable care in relation to their tax affairs and can be likened to ‘negligence’.  Yes – there is a degree of subjectivity around this and HMRC are broadly looking at what the taxpayer did or failed to do and whether the reasonable taxpayer would have acted the same or differently.

Applying this to what we know about Zahawi’s circumstances – HMRC seem to have accepted that the error relating to the original allocation of the YouGov shares, was careless and he had filed his tax return on the basis he believed to be correct at the time.  A reasonable taxpayer would have acted in the same way, not knowing, or believing that those YouGov shares allocated to Zahawi’s father’s company were beneficially owned by Zahawi himself.

So, we have an ‘prompted’ and ‘careless’ situation which puts the penalty range for this matter into the 25%-30% range, but there is one final element to reach the final penalty rate – could this error relate to an ‘offshore’ matter?

There is question over whether Zahawi has a connection to an offshore trust structure, known as Balshore Investments (‘Balshore’), based in Gibraltar – Zahawi has strongly denied this but there are references to Balshore in the historic publicly filed accounts of YouGov. Zahawi’s weekend statement stated that HMRC agreed that Zahawi had not set up Balshore and is not a beneficiary of the structure.

But we understand that the YouGov shares in question, which HMRC successfully contended were beneficially owned by Zahawi, were originally allocated to Balshore (a company owned by father).

For the purposes of determining the offshore penalty rate, Gibraltar is a ‘Category 2’ territory which can enhance the penalty by 150% – taking the range to 37.5%-45%.

However, HMRC can apply additional penalties of up to 200% for offshore matters known as ‘requirement to correct’ (‘RTC’).  It is possible that Zahawi’s settlement fell just outside the timeframe for RTC, but it is apparent that any link to Balshore Investments could have been serious for determining the penalty rate, as well as the overall public sensitivity around this.

The amounts concerned are significant – a transaction which involved a sale of shares generating £27 million of cash proceeds, a resulting tax liability of £3.7 million, plus interest and penalties of over £1 million.  In the circumstances, a 30% penalty is a good result, despite the eye-watering overall cost and how this has unfortunately played out in the public domain.