Corporates involved in complex tax disputes will be aware that HMRC is adopting an increasingly forensic approach to investigations. In this environment, it is very often critical for corporates to conduct their own internal investigations in order to properly respond to an enquiry by HMRC.
The issue of privilege in internal investigations was brought into sharp focus last year by the decision in Serious Fraud Office (SFO) v Eurasian Natural Resources Corporation Ltd (ENRC)  EWHC 1017. In that judgment, the High Court drew a distinction between civil and criminal litigation, denying a claim for litigation privilege in relation to documents produced by lawyers and forensic accountants during an internal investigation into fraud and bribery conducted against the backdrop of a criminal investigation by the SFO. The decision has significantly reduced the ability of corporates to claim privilege over notes of witness interviews carried out as part of an internal investigation where criminal proceedings are not yet in contemplation. It has also created uncertainty as to the scope of litigation privilege, creating difficulties for corporate taxpayers undertaking internal fact-finding exercises in the face of an HMRC investigation.
However, corporates involved in tax disputes can take some comfort from the recent and important decision of the High Court in Bilta (UK) Ltd (in liquidation) (Bilta) & Ors v Royal Bank of Scotland plc (RBS) and Mercuria Energy Europe Trading Ltd  EWHC 3535. In this case, Sir Geoffrey Vos had the opportunity to consider the conclusions reached in SFO v ENRC in an application brought by Bilta against RBS for disclosure of certain documents, including interview notes. The relevant documents were generated during an internal investigation conducted by RBS’s external lawyers pursuant to HMRC’s communications that it believed RBS knew or should have known of a VAT carousel fraud and had, therefore, over claimed c.£86m in VAT. The judge dismissed the application, holding that litigation privilege did attach to the documents in question.
The facts in Bilta
The substantive claim brought by Bilta arose out of an alleged missing trader intra-community fraud involving carbon credits which took place during 2009. The claimants claimed that in executing the alleged fraudulent trades, RBS and Mercuria were wilfully blind to what was an obvious fraud. HMRC began to investigate RBS’s role in the fraud in 2009. In 2010, HMRC wrote to RBS stating that it estimated c.£90m of input tax to be at risk, but did not state that it was alleging any dishonesty by RBS. For the next two years RBS cooperated with HMRC’s investigation, in accordance with its statutory obligations as a taxpayer and its own codes of practice.
In March 2012, HMRC wrote to RBS stating that there might be grounds to deny RBS’s right to recover input VAT in respect of the carbon credits purchases because RBS should have known that the purchases were connected with fraud (‘HMRC’s letter’). HMRC did not commit itself to making an assessment and asked RBS to set out its views.
Upon receiving the letter, RBS retained solicitors and began an investigation. In a meeting with HMRC in May 2012, RBS stated that its reason for attendance was to understand HMRC’s position with a view to determining what it needed to do to stop HMRC from issuing an assessment. Nevertheless, HMRC issued a protective assessment in September 2012, but remained open to receiving RBS’s views.
In December 2013, RBS supplied a draft report to HMRC, which alluded to interviews which RBS had carried out as part of the Investigation. RBS’s solicitors sent the final report to HMRC in January 2014, but did not provide interview transcripts. RBS appealed against HMRC’s protective assessment in October 2014.
The claimants issued a claim form in June 2015, claiming compensation for dishonest assistance and compensation in respect of fraudulent trading. In September 2017, the claimants applied for disclosure of documents held by RBS relating to the Investigation, including the interview transcripts. RBS resisted the application on the grounds of litigation privilege. RBS had provided the claimants with a copy of the final report prepared by its lawyers but refused disclosure of any of the documents created on or after the date of HMRC’s communication on the basis that such documents were subject to litigation privilege.
The test for litigation privilege
The test for litigation privilege was articulated by the Court of Appeal in Three Rivers District Council v Governor & Company of the Bank of England (No 6)  1 AC 610. For a communication to attract litigation privilege:
• litigation must be in progress or in contemplation;
• the communication must have been made for the sole or dominant purpose of conducting that litigation; and
• the litigation must be adversarial, not investigative or inquisitorial.
The parties agreed that the relevant documents were created when adversarial litigation with HMRC was in contemplation (being a threatened assessment for over-claimed VAT). Accordingly, the issue in dispute was whether the documents were made for the sole or dominant purpose of conducting that litigation.
The claimants argued that the documents were prepared for the purposes of the investigation and, pursuant to RBS’s obligations as a taxpayer and under its own codes of practices and not for the dominant purpose of litigation. They asserted that the dominant purposes of the investigation were to gather information, to supply a complete set of facts to HMRC and to dissuade HMRC from issuing an assessment. In support of his submissions, counsel for the claimants relied on the approach taken in SFO v ENRC.
RBS asserted that it carried out the investigation (including the interviews) to discharge its obligation to provide HMRC with accurate information and to ensure that it could meet its disclosure obligations in the contemplated litigation with HMRC. Counsel for RBS argued that HMRC’s letter signalled a change away from an investigation towards a dispute, and was akin to a letter before claim. Consequently, any action which RBS took following receipt of this letter, including action to dissuade HMRC from issuing an assessment, was inseparable from its wider purpose of conducting litigation.
Dismissing Bilta’s application, the judge held that the documents, including the interview notes, were subject to litigation privilege. Whilst paying ‘due and proper regard’ to the decision in SFO v ENRC, the judge did not consider it to be determinative. Rather, he emphasised that what is the sole or dominant purpose of a document is always a question of fact, and the court must take a realistic, and commercial view of the facts. Applying the principles of litigation privilege to the facts, Sir Geoffrey Vos found:
• HMRC’s letter and the statement that it had sufficient grounds to deny RBS’s right to recover input VAT marked a change in the status of the matter from an investigation to a dispute.
• RBS’s appointment of specialist external solicitors following receipt of HMRC’s letter indicated that it anticipated a claim and intended to defend it; otherwise, it would not have gone to the trouble of incurring significant legal fees.
• The subsidiary purposes of the investigation (i.e. to dissuade HMRC from making an assessment and provide information to HMRC under RBS’s duties as a taxpayer) ‘should be subsumed under the overarching purpose’ of engaging in litigation to defeat the assessment. The judge took account of the Court of Appeal finding in Re Highgrade Traders  BCLC 151 that litigation privilege can extend to advice on whether or not to litigate.
• The relationship between a corporate taxpayer and HMRC is different to that between ordinary parties to civil litigation.
• RBS believed that the purpose of its investigation was to allow it to prepare for litigation which it genuinely anticipated, including the inseparable purpose of avoiding the litigation if possible. Therefore there was no need for the documents to grapple with the multiple purposes for which they were created (per Rawlinson & Hunter Trustees SA v Akers  4 All ER 627).
The judge therefore concluded that the relevant documents were made for the sole or dominant purpose of the litigation against HMRC and protected by litigation privilege.
In the current environment, where it is important for corporates to engage collaboratively with HMRC for both risk and reputational reasons, it is helpful that the judge recognised that the ‘ostensibly collaborative’ nature of RBS’s interactions with HMRC did not preclude the relevant documents being made for the dominant purpose of litigation. In doing so, the judge has given some comfort to corporates undertaking internal investigations pursuant to scrutiny by HMRC.
It is also helpful that the judge did not accept, as a general legal principle, Andrews J’s dicta that litigation privilege does not extend to documents created for the purpose of trying to settle a dispute or persuade an opposing party. Rather, the judge considered the purpose of ‘fending off the assessment was just part of the continuum that formed the road to litigation’.
The judge distinguished RBS’s interactions with HMRC as a ‘very different context’ to that of ENRC and the SFO. Indeed, there are several distinguishing factors which are worth noting and which may assist a taxpayer, in the context of an HMRC investigation, to ensure that interview notes or other documents recording findings of facts which are produced during an internal investigation are protected by litigation privilege:
1. Communications analogous to pre-action correspondence: HMRC’s letter communicating its view that it had sufficient grounds to deny input tax, and seeking a response from RBS, was considered to be a ‘watershed moment’, marking a change in status from an investigation to a tax dispute. The judge regarded the report prepared by RBS’s external lawyers to be ‘a close comparable to a response to a letter before claim’.
2. Evidence and record keeping: the judge accepted that the evidence relied on by RBS, which included contemporaneous correspondence and evidence from RBS’s UK head of indirect tax and the in-house solicitor with conduct of the matter, was ‘quite sufficient’ to discharge the burden of proof. In contrast, the supporting evidence submitted by ENRC was impaired by the fact that it was not given by ENRC’s employees or solicitors contemporaneously involved in the various internal investigations. Companies should therefore keep contemporaneous records of their reasons for conducting internal investigations, in particular where they do so in anticipation of tax litigation.
3. External lawyers: within weeks of the receipt of HMRC’s letter, RBS instructed external lawyers specialising in tax litigation. The judge considered this to be a strong suggestion that RBS anticipated a claim and was ‘gearing up to defend it’. Corporates involved in a dispute with HMRC should therefore always consider instructing external counsel during the early stages of a tax dispute.
The decisions in Bilta and in SFO v ENRC were first instance decisions. The Court of Appeal is due to hear the appeal of ENRC in July 2018, and it is hoped that its judgment will resolve the inconsistencies and clarify the scope of litigation privilege. For now, those involved in tax disputes should take comfort that documents generated during an internal investigation should often be protected by litigation privilege, subject to the particular facts in each case.
*A version of this expert insight first appeared in Tax Journal on 08 March 2018