It has been almost a year since news broke that HMRC had opened its first investigations into the corporate criminal offences contained in Part 3 of the Criminal Finances Act 2017 (CFA), and over two years since the CFA came into effect.
The fact that there have been no announced prosecutions (or deferred prosecution or settlement agreements) under the legislation should not deter businesses in the franchise sector from reviewing their CFA risk and acting accordingly. With the Government guidance emphasising ongoing monitoring and review, now is also a good time for businesses in the franchise sector to revisit risk profile and existing procedures to ensure they are still appropriate and effective.
Criminal Finances Act 2017 and the franchise sector
The CFA created two criminal offences (detailed below) that can only be committed by a corporate entity or partnership (“relevant body”), punishable by an unlimited fine. The CFA offence of the “failure to prevent the facilitation of UK tax evasion” is committed if:
- A third party taxpayer commits a tax evasion offence – e.g. they dishonestly evade VAT; and
- An “associated person” (see below) of the relevant body facilitates (i.e. assists) that tax evasion – e.g. through dishonestly engaging in false invoicing.
A similar yet separate offence concerns the evasion of foreign tax, although this is subject to additional conditions including the requirement for a sufficient UK-connection.
The offences are broadly drafted. They are not confined to businesses in the financial, accountancy and legal services sectors. In principle, it does not matter where the relevant body is incorporated or formed. Involvement, or knowledge, of the relevant body or their staff and senior management to the criminality is not required.
However, a defence is available if the relevant body proves that, at the time of the facilitation, it had in place such prevention procedures that were “reasonable in all the circumstances” to expect the body to have in place. HMRC has published guidance, along with other industry bodies (though no franchise sector specific guidance has yet been produced).
As with the similar Bribery Act 2010 offence of “failure to prevent” bribery, the CFA provides a significant stick to encourage businesses to monitor and take responsibility for the actions of those operating under their name.
Why the focus on franchising?
There are potentially many parties involved in an ongoing franchise relationship:
- Franchisor business and other entities within the franchisor group
- Franchisee / sub-franchisee businesses (usually a limited company, so a separate legal person)
- Principal / guarantor (individual owner of the franchisee business)
- Directors/employees of the franchisee business
- Customers, agents and other subcontractors of the franchisee business
This means that tax evasion by any one actor in the franchise arrangement could potentially see CFA liability for the franchisor, if there is also facilitation of that tax evasion by an associated person of the franchisor.
This isn’t to say that there may be other areas of CFA risk for a franchisor business, but the franchising relationship is potentially fertile ground for risk, particularly if a franchise network is complex and involves casual or cash transactions by franchisees.
The franchisor & franchisee relationship - associated persons?
As the reader would expect, associated person includes employees and agents of the franchisor, when acting in that capacity. It is clear from the HMRC guidance that what employees do in their spare time “on a frolic of their own” falls outside of that association. So far, so clear.
However, associated person also includes any other person who performs services “for or on behalf of” the relevant body, whilst acting in that capacity. This is a difficult definition to apply in practice, not least identifying the parameters of the association to understand when someone might be acting in or outside that capacity.
The extent to which a separate franchisee business and others involved in operating the franchisee business could be associated persons of the franchisor is fraught with difficulty. Specific points for franchisors to consider would be:
- The parties to and terms of the franchise agreement between the franchisor and franchisee
- Evaluation of all the circumstances, not just the contractual label applied (or not applied) to the nature of the relationship – consider what happens in practice
- Are there any situations where the franchisee could act as agent or sub-contractor of the franchisor – i.e. distributing goods or fulfilling services on behalf of the franchisor, to customers of the franchisor?
- To what extent can the franchisor exert control (or does the franchisor have visibility) over the actors in the franchise arrangement?
Effective prevention requires identification, evaluation and measurement of risk in the first instance, and renewed assessment on an ongoing basis. It is no surprise that HMRC guidance therefore lists a “risk assessment” as the first principle. Franchisors should also identify persons who could be “associated” with them for the purposes of the CFA. As we’ve noted above, this may be challenging.
The results of the risk assessment will help inform the franchisor of appropriate and proportionate procedures to address risks identified. We have seen changes to diligence / on boarding procedures, staff training on new policies and amendments to contracts to address areas of risk. Two years on, now is a good time to revisit risk profile and existing prevention procedures and make proportionate changes. Has the franchise network expanded into new geographical areas, for instance?
It should be borne in mind that prevention procedures deal primarily with the risk of criminal liability under the CFA (criminal facilitation of tax evasion by associated persons of the relevant body). There is a broader question for businesses about risk of criminality in more remote or indirect circumstances; even if outside of liability under the CFA, regulatory scrutiny and reputational damage may still ensue.