In addition to the emotional upheaval, divorce brings a level of financial scrutiny that most high net worth individuals (HNWIs) and ultra high net worth individuals (UHNWIs) spend their lives trying to avoid.
Providing full and frank disclosure is a strict requirement of the family courts in England and Wales once financial remedy proceedings are issued. There is a misconception that full and frank disclosure only benefits the financially weaker party, but it is also in the interest of the financially stronger party to obtain a settlement which is impervious to attack. In this second instalment in our wealth and marriage series, we discuss the importance of full and frank disclosure within divorce proceedings.
Full and Frank Disclosure
When the court is asked to look at the division of assets on divorce it will look at all relevant factors when making its decision. For example, it will consider the length of the marriage, the financial circumstances of each party (including earning potential and financial responsibilities, plus the wider resources available to the parties, which may extend beyond the assets in which they have a legal/beneficial interest), the needs of any dependents that they may have, the standard of living enjoyed before the breakdown of the relationship.
The court will determine the outcome of the case, and will order a financial settlement on the basis of these factors on whether a party has a sharing claim, or a needs based claim (needs based claims trump sharing claims) and will have regard to what is a fair outcome.
In order to carry out this process, the court requires “full and frank disclosure”—i.e. full, clear and accurate details of complete transparency on both parties’ worldwide resources, income and liabilities, however they are held. Assets that are legally owned in either or both parties’ names must of course be disclosed—but so must any assets in which a party has a beneficial interest. Trust structures, company structures and offshore assets are not exempt, and if a party does not provide full disclosure of their interest in any of these or similar assets, the court can make disclosure orders against third parties (such as trustees, company directors or banks) for them to provide the disclosure that the court considers it needs in order to determine the financial proceedings.
Full and frank disclosure is initially provided by way of a “Form E” and via responses to any questions raised in respect of that document. It is, however, an ongoing obligation throughout the proceedings—and the Form E also obliges parties to disclose any changes in their financial position during the previous 12 months (as a minimum) and looking forward.
The duty to provide full and frank disclosure is a strict obligation. Failure to comply frequently results in parties being criticised by the court (and can lead the court to draw adverse inferences against parties who fail to comply with their disclosure obligations). Because of the discretion that each judge has in determining the correct financial award to a party, criticism (including for non-disclosure which can be considered as dishonesty) by the court is to be avoided.
Perhaps more importantly, if it later transpires that a party has failed to comply with their disclosure obligations, this can be used as a reason to overturn the initial settlement award and re-open the financial proceedings.
Below, we look at some commonly overlooked issues within the disclosure process, from a tax perspective.
Over the years, HM Revenue & Customs (HMRC) has taken a more aggressive stance against tax non-compliance.
Due to the complexity of their affairs, HNWIs/UHNWIs have become a particularly lucrative target. HMRC has a special unit to collect tax from HNWIs, who are those with assets of 20 million pounds ($26 million) or more. A 2016 National Audit Report suggested that at the time, HMRC was running a formal enquiry on around a third of high net worth taxpayers, with an average of four issues being examined per taxpayer, and with several thousand enquiries having been open for over three years.
HMRC’s increased use of dedicated HNWIs/UHNWIs taskforces and measures (such as unexplained wealth orders) make it clear that HMRC’s interest in the tax affairs of HNWIs/UHNWIs is unlikely to end anytime soon.
Given this, it is possible that many HNWIs/UHNWIs may find themselves the subject of an HMRC investigation during their divorce. The reasons for this are wide-ranging, from a routine compliance check to involvement in a historic tax avoidance scheme which is subject to ongoing litigation.
Enquiries bring uncertainty. In circumstances where the taxpayer is unsuccessful in their argument and HMRC is owed money, the tax, together with any late payment interest and penalties, may give rise to a significant liability.
However, despite the uncertainty (which the family courts understand), it is essential to disclose any potential liability. Not only is this required by the court, but it will also be factored into any settlement ordered.
Traditionally, it has been difficult for HMRC to find information about assets held offshore. To counteract this, HMRC had previously adopted the use of disclosure facilities which encouraged taxpayers to come clean in return for some form of favourable treatment.
In 2018, HMRC started to receive information under the Common Reporting Standard which requires certain institutions such as banks, trust providers and insurance companies to disclose customer information to the relevant tax authorities—obviating the need for HMRC to show any leniency to those who came forward in respect of previously undeclared assets and income.
Where information is disclosed as part of full and frank disclosure in financial proceedings in connection with a divorce, as a general rule HMRC is not entitled to it (see below) but, as will be discussed in the final article in this series, once the financial settlement has been determined, the transfer or disposal of assets not previously disclosed may cause HMRC to revisit information that has been previously shared.
During the course of providing disclosure within divorce proceedings, many professionals (including some who are not part of the individual’s team of advisers) will review the individual’s financial affairs. This may include judges, former spouses, experts and representatives on both sides (not just lawyers but also any shadow experts they appoint to consider disclosure—such as forensic accountants or company valuers). Some of these experts may have duties to report (without informing anyone first) any irregularities that they uncover—this includes current, potential and historic tax irregularities. It is therefore imperative that advice is taken at the earliest opportunity to ensure complying with full and frank disclosure does not produce any unforeseen issues.
Historically, the family courts have not wanted to be involved in reporting tax irregularities to HMRC. This is to encourage full and frank disclosure, which the courts see as the priority. However, in circumstances where information in the family courts may well be of assistance to HMRC’s understanding of a person’s financial position, it is no surprise that HMRC has sought to convince the court to deliver up documentation and information about a taxpayer.
The most noted example of this is HMRC v Charman and Another  EWHC 1448(Fam). In this case, a financial award of approximately 40 million pounds was made to the wife from the marital assets. The husband’s residency status was in issue, which had an impact on whether he was subject to U.K. tax, and within which periods of time.
HMRC raised assessments against the husband for circa 11.5 million pounds’ worth of tax, which he appealed. As part of the investigation, HMRC asked both the husband and wife for copies of documentation from the divorce proceedings, including transcripts, witness statements and supporting evidence. The wife agreed to disclose the information but the husband refused—requiring HMRC to issue a formal application to the court. The judge had discretion to order the documents to be disclosed.
The judge identified that there was on one hand a public interest in taxpayers paying the correct amount of tax, but on the other hand there was a public interest in parties making full and frank disclosure in financial proceedings, which would be discouraged if information could be disclosed to HMRC.
It was held that as a general rule documents and other evidence produced in financial proceedings are not disclosable to third parties outside the proceedings except in rare and exceptional circumstances and with permission from the court. A key factor in the judge’s decision-making was that the husband was the subject of a routine tax assessment and there was no suggestion that he was involved in tax evasion or any criminal behaviour.
However, despite the court’s reluctance in this case, the veil of privacy may well be lifted subject to the facts of a particular case.
Taxpayers should also be mindful of relying on information shared confidentially within family proceedings as part of any tax investigation, as they may lose their right to privacy in relation to all documentation and not just those relied upon.
Depending on the level of complexity of assets or income streams within a case (which for HNWIs and UHNWIs is usually high), experts are likely to be involved in order to assist the court with its understanding of the value of the marital resources. While the court has streamlined the volume of experts involved by encouraging that the parties appoint a single joint expert, in many cases either or both of the parties will have their own shadow expert advising in the background on the single joint expert’s report.
Experts are frequently accountants, business valuers or others who are strictly regulated within their professions and have reporting duties to HMRC. They may feel that they require historic information or a deeper level of disclosure than is initially provided in order to provide the advice that is required of them by the court. Parties must be aware of the potential implications and risks of this: any expert worth their fee is likely to uncover tax irregularities and may be required to report their findings.
Accordingly, if there is anything that you are worried about—no matter how far in the distant past or future —it is essential that you seek advice on this and seek to rectify it. Not only is it crucial that your family lawyer knows about this before any expert is appointed, but it is also imperative that tax advice is sought so that corrective steps can be taken as appropriate.
In some cases, the wrath of former spouses/partners should not be ignored. Whatever the motivation (and however misplaced it may be), your former spouse/partner may hold information that is of interest to HMRC.
With emotions running high, a former spouse/partner may be tempted to report any believed wrongdoing to HMRC. Alternatively, they may be aware of or discover offshore assets abroad that you have not disclosed for tax purposes that they wish to benefit from as part of any financial settlement.
Many believe that there is something to be gained from notifying HMRC of your spouse/partner’s assets and liabilities. However, in reality it will most likely lead to reduced assets (or increased liabilities) which will impact the level of settlement (or this can prejudice the ability of the wrongdoer to generate an income in the future, e.g. if they are Financial Conduct Authority regulated). Furthermore, if certain arrangements arose prior to the breakdown of the marriage, it is possible that both spouses/partners may be the subject of a tax investigation.
Whilst many HNWIs/UHNWIs are uneasy about saying too much, honesty really is the best policy.
Those who may have been tempted previously to conceal assets should be aware that the consequences of doing so may extend beyond the confines of the family courts.
- Be aware of the highly discretionary powers of family court judges to make orders in respect of worldwide resources, depending on the specific set of facts.
- Speak to your family law and tax advisors to identify any taxation issues that you may have—consider whether any disclosures need to be made.
- Seek updates as to the status of any ongoing enquiry, prospects of success and likely tax liability (including any and all interest and penalties).
- Review the tax position of any offshore assets and income.
- Consider whether any disclosures need to be made.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Morag Ofili and Daisy Minns Shearer are Senior Associates with Harbottle & Lewis.