The scope of HMRC’s powers in relation to raising discovery assessments outside of the normal enquiry window has been a contentious issue in recent years and a number of cases seem to have eroded the position of the taxpayer (see our earlier blog post for example).

A recent First-Tier Tribunal case, J Hicks v HMRC, seems to have taken a more reasonable approach and may therefore give hope to taxpayers for a more balanced approach in the future.

The taxpayer in this case took part in a tax avoidance scheme which was marketed by a firm specialising in such schemes.  The scheme in question was marketed at derivatives traders, which the taxpayer was.  Having taken part in the scheme it was reported on his 2008/09 tax return, with the relevant avoidance scheme reference included.  He had losses carried forward, which he claimed on his 2009/10 and 2010/11 returns, which were both filed in late January before the filing deadlines for each year.

HMRC opened a standard enquiry into the 2008/09 return, and this enquiry was ongoing when the later tax returns were filed.  However, HMRC did not open enquiries into 2009/10 or 2010/11.

In March 2015, HMRC issued discovery assessments for 2009/10 and 2010/11, which Mr Hicks appealed.  HMRC argued they could issue an assessment under either TMA 1970, s29(4), that the insufficiency was a result of careless behaviour, or under TMA 1970, s29(5) that a hypothetical officer could not have been aware of the deficiency within the normal time limits.

The tribunal found that a hypothetical officer should have had enough information by the end of the normal window to raise an enquiry, with the Judge noting that, “I do not consider that subsection (5) allows or is intended to allow HMRC to issue assessments which ignore the normal time limits while they spend further time in polishing a justifiable assessment as at the closure of the enquiry window into a knockout case.”

He also points out that these rules should not be seen as giving HMRC “carte blanche […] to omit to open an enquiry—whether intentionally or by omission—and then simply rely on subsection (5) in every case to issue assessments which would otherwise be out of time. The statutory time limits for assessments are a critically important safeguard for the taxpayer, just as the onus of disclosure on the taxpayer, and the duty not to act carelessly or deliberately, are a protection for HMRC where those limits are not met.”

It is interesting to note the Judge acknowledging that taxpayers deserve rights and safeguards from HMRC, particularly in light of HMRC’s continued attempts to obtain ever greater powers.

Looking at the matter of carelessness, the Tribunal found that reliance on the scheme provider for information included in the return was not careless, nor is the use of a tax avoidance scheme automatically careless.  The key point was whether careless behaviour led to the deficiency of tax.  In this case, it was found not to be careless.

The taxpayer’s appeal therefore allowed.

Another week and another case involving a failed tax avoidance scheme.

This time, perhaps more worryingly, HMRC were arguing that the return was submitted fraudulently or negligently by the taxpayer and therefore sought the extra penalties that would be due in such circumstances. This shows a new aspect of the targeting of anti-avoidance schemes and suggests users of schemes could expect the costs of failure to rise higher, whether in penalties or fees for defending them.

Ultimately, the taxpayer won in this case. Of particular interest was the fact that the Tribunal found that relying on the advice of a trusted accountant was helpful in suggesting that he had not acted negligently. It appears the courts confirm that obtaining suitable professional advice is worth paying for in the long run!

Mr Bayliss participated in a scheme marketed by Montpelier Tax Consultants (Montpelier). The scheme involved a Contract for Differences (CFD) and was sold as generating a £539,000 capital loss for Mr Baylis in 2006–07. It was agreed by all the parties that the scheme had failed and additional tax was due, however the taxpayer appealed against penalties raised by HMRC on the basis that ther return was submitted fraudulently or negligently.

The Tribunal determined that in accordance with established case law, in order to prove fraud HMRC had to prove that the appellant did not have an honest belief in the correctness of the return. The Tribunal was persuaded on the basis of the evidence and facts that Mr Bayliss did believe that his tax return was correct and so there was no fraudulent behaviour.

On the question of negligence, the Tribunal felt that the correct test was that set out in Blyth v Birmingham Waterworks Co (1856), that of ‘the omission to do something which a reasonable man, guided upon those considerations which ordinarily regulate the conduct of human affairs, would do, or doing something which a prudent and reasonable man would not do’. They also considered the test in Anderson (decʼd) [2009], ‘to consider what a reasonable taxpayer, exercising reasonable diligence in the completion and submission of the return, would have done’.

HMRC used a number points to support their argument that Mr Baylis was negligent, including that:

  1. the transaction did not stand up to commercial scrutiny and the appellant failed to check the commercial reality;
  2. the appellant had not kept copies of the documentation, whereas a reasonable person would have done so;
  3. It was a complex financial transaction and the appellant should have obtained proper independent financial advice, but he relied on informal advice.

The Tribunal agreed with HMRC that some of the taxpayer’s behaviour could have been deemed to be careless, but on balance found that HMRC had not done enough to prove that the appellant was negligent in filing an incorrect return.

Interestingly, they felt that relying on his accountant was helpful in this respect, stating “We are persuaded that the appellant relied fully on Mr Mall, a chartered accountant on whom he had relied for a number of years, and on what he believed (based on Mr Mallʼs recommendation) to be Montpelierʼs expertise.”

The tribunal allowed the appeal on the basis that HMRC had not proven that Mr Bayliss acted fraudulently or negligently in submitting an incorrect return.

Those (like me!) who appreciate the significance of the above headline will be thinking ‘Tax is Fun’ and ‘This is Fascinating’.  For the rest I challenge you to struggle on to the end.

The case (Brain Disorders Research Limited Partnership – TC4510) is interesting because the complex, highly cogent, judgement goes through the arrangements as a whole.  Then the Court decides that overall they do not make commercial sense (on the grounds that 6 ≠ 99).  As a result, the Court strikes down the whole structure as a “sham”, and hence ineffective from a tax perspective.  This is oversimplification, of course, but in this case the First Tier Tribunal have struck to the heart of a manufactured tax avoidance scheme by destroying it as having crucial aspects which meant the whole scheme effectively amounted to a sham.

Where does the case leave us?

Analysis of the detailed judgement is interesting in itself, as will be the question of whether the case is appealed to a higher court.

For the moment though, in looking at the commercial picture and looking at steps obviously inserted for tax purposes the First Tier tribunal could be said to be adopting an approach on the lines of ‘Ramsay Robust’.  Those of you familiar with the classic anti-avoidance case of CIR v Ramsay will know that it analysed tax planning schemes and then surgically excised steps inserted just for tax planning purposes and then re-analysed the result.

It seems to me the Brain Disorders judgement follows similar principles, but, in simile, perhaps by using a large axe rather than a scalpel!  It does though leave interesting (and relevant) thoughts, especially as in terms of the claim, the underlying scientific research seemed to be accepted by the Courts to be genuine and cutting edge.  The issue was whether the price had been artificially inflated.  Effectively, therefore it leaves open the question for future commercial planners of what makes the tax axe fall?  All of us need to use the tax system.  You can’t opt out!  How do we know we are not ‘abusing’ it?

In the case, the fact that (blatantly) 6 ≠ 99 was a key determinant, and understandable in may people’s eyes as an inherent misrepresentation.  Where though is the cut off?  Where 6 moves and then tends to approach 99?  Does ‘abuse’ stop at 12 or 50 or where?  Surely there cannot be a ‘fixed’ level?  As is clear from my insurance quotes, in a free market, there seems to be little that approaches a fixed price.  It depends upon the precise terms of the contract, plus the expertise and reputation of the provider.  There must therefore be a range of values which would be acceptable and thus ‘non-abusive’?  Crucially though, how is this ‘non-abusive’ range to be determined in advance by advisors?

The Court’s technical analysis and indeed the scheme details are highly complex, but essentially (to use the round numbers adopted in the case) the higher rate taxpayers investing in the scheme sought to claim 99 or 96 of interest/scientific research allowances, for true research expenditure that was actually being sub-contracted out for 6.

HMRC convinced the Court that it was never remotely considered (or even possible) for the investors to undertake the research themselves, in the Partnership Structure established.  This was believed, to be because of the bank borrowings and lack of relevant resources for the Partnership Structure meant that it would be problematic in raising the finance to undertake the research itself.  As a result, the Courts held it was thus inevitable that the research would be subcontracted to the true scientific experts at the agreed price of 6.  Thus it was ‘false wording’ in the documentation to suggest that 99 (or indeed any amount other than 6) was to be paid to procure the research.

The Court judged;

“Most of the money movements related entirely to the borrowing arrangements and had nothing to do with genuine royalties derived from scientific research”.

It went on;

“Everything in relation to the refund of capital expenditure should the research project be abandoned was uncommercial”.

The FTT held that the scheme was a sham.  It was based on the premise that the recipient of the borrowed/invested funds may undertake the relevant scientific research.

A previous case, Tower M Cashback, showed that the price paid had to represent fair value for allowances to be available.  A valuation exercise was undertaken by the designers of the Scheme to show that a number of “traditional” researchers in institutions or universities would have charged 99 or 100 for the work.  However, the Courts criticised this exercise as being effectively a self-fulfilling prophecy, undertaken in a hurry by a party associated with those involved through past work, and not actually comparing like with like.  The Courts also pointed out that a genuine commercial arrangement would have made the most of the quote of 6 from Australian leaders in the relevant brain research.  Any true commercial investors would have been unlikely to do anything other than go for that price, rather than committing to 99 or 100 created via the inflated borrowing.

The internal un-commerciality of the finance arrangements was apparent by the fact that some of the quotes compared US $ prices to AUS $ prices without ‘noticing’ the 22% currency exchange difference existing at the time.

The First Tier Tribunal was scathing:-

“We agree that there was a sham in this case [None] of the parties or indeed the investing partners were intended to be deceived into thinking that the possible aim of sub-contracting was just one of two realistic possibilities. Of course it was known that it was the only conceivable way of proceeding.  [Hence] the alternative contractual provision, suggesting that [the Partnership Structure] might itself conduct the research was false. The significance of the false claim was that, had it been deleted in accordance with reality, it could not possibly have been suggested that [the Partnership Structure] was ever to pay more than 6, let alone 99 or 96, in order to procure the scientific research. The falsely worded clause was therefore the foundation of the Partnership’s claim for vastly excessive capital allowances, and this is why we decide to strike it down as being a sham.  The [HMRC] counsel was slightly more hesitant in describing the whole pricing of the scientific research in the Schedule to the top-level contract, sub-dividing the total expenditure and allocating elements of it to each step and stage in the research, as a sham. We are not so hesitant. By sub-dividing the alleged expenditure of 99 or 96 in this way, inserting all this elaborate nonsense into the Schedule, it becomes clear that the critical drafting of [the Partnership Structure] clause is not just some mistaken reference to one irrelevant possibility. The Schedule shines the light on the fact that the whole fiction is indeed intended, and that it is indeed the foundation of the Partnership’s claim. [My emphasis].

Comments please on whether you feel my idea of ‘Ramsay Robust’ makes sense and what needs to be done to aid commercial certainty.  Obviously everyone needs to act in accordance with tax law.  Similarly commercial enterprise needs to know tax consequences of their actions.

The courts continue to find in favour of HMRC in cases involving avoidance schemes, with the most recent example being Vaccine Research Limited Partnership and another v CRC at the Upper Tribunal.

With so many cases going against such scheme providers, questions are raised as to whether the various new powers that HMRC is seeking on avoidance and other matters are really necessary?  Perhaps using the existing HMRC powers to more effectively challenge such schemes is all that is really needed.

Vaccine Research Limited Partnership and another v CRC

The case in question concerned an R&D avoidance scheme, with a partnership being established in Jersey. The taxpayer partnership entered into an agreement whereby it paid another entity, Numology Ltd, £193m to purportedly carry out research and development (R&D).

Numology paid a very small proportion of this (£14m) to a subcontractor, PepTCell, who actually undertook the work and then contributed £86m to the taxpayer business itself.  The partners claimed for a loss of £193m in respect of R&D capital allowances.

The Upper Tribunal unheld the First-Tier Tribunal’s decision, finding that the funds were put into an artificial loop and effectively only the £14m paid to the subcontractor was genuinely incurred for R&D.  The Tribunal noted that the FTT was right to conclude “that Numology Ltd’s contribution represented funds put into a loop as part of a tax avoidance scheme, and [was] not in reality spent on research and development”.

The evidence of recent case law suggests that the existing provisions available to HMRC are sufficient to close down avoidance schemes and yet they continue to seek new powers in the name of cracking down on tax avoidance.  It is concerning that HMRC continue to amass new powers, such as attempting to take funds directly from bank accounts and issuing non-appealable tax demands, on the premise that they are needed when it appears that they are not.  Please feel free to share your own thoughts below.

In the recent Autumn Statement, George Osbourne announced several governmental counter-avoidance measures that confirm that the net is closing in on those who subscribe to tax avoidance schemes. A failed tax avoidance scheme marketed by Consulting Overseas Limited has been identified by a recent First-Tier Tribunal case of Boyle v HMRC. HMRC has vowed to pursue all other subscribers to the same scheme that Mr Boyle was involved with and will also target others who have used similar schemes to avoid tax.

Mr Boyle was a contractor who originally worked for a company called Sandfield Systems Limited (SSL) and subsequently worked for Sandfield Consultants Limited (SCL) when a significant fall in his income was noticed by HMRC. It is important to note that Sandfield Consultants Limited (SCL) was a company registered in the Isle of Man. The director of SSL was also the director of SCL and Consulting Overseas Limited (COL) which marketed the tax avoidance scheme. The scheme was marketed by COL to the employees as a remuneration package that could achieve income tax and national insurance contributions (NICs) savings.

The FTT found the conclusions of HMRC’s investigation to be correct. The significant fall in Mr Boyle’s income was explained by the fact that about 2/3 of the income generated by the taxpayer was withheld and then paid to him by way of a ‘loan’ made in Romanian, Byelorussian or Uzebekistani currency. When Mr Boyle entered into a contract of employment with SCL it was agreed that he would be paid a salary but he would also participate in the ‘soft currency loan scheme’ arranged by SCL to receive the remainder of his salary. All employees of SCL used the foreign broker Credex International SA, when taking out the loans in question. It was the currency trades organised by Credex that turned the earnings into what the scheme claimed to be “non-taxable foreign exchange gains”.

The FTT found that the loans were not genuine and also found no evidence to prove that the foreign currency ever existed or that Credex was a genuine dealer independent of SCL. Notably the FTT ruled that the monies which were allegedly paid to Mr Boyle as loans in foreign currency constituted emolument from employment/earnings under s.173 ITEPA 2003. Furthermore, according to s.188(1)(b), as the ‘loans’ that were made were essentially written off, the amount written off is deemed to be treated as earnings from employment for that year and therefore should have been subject to income tax and NICs. They also ruled that Mr Boyle was aware that the loans were a means of receiving his income to avoid tax.

The FTT also stated that even if they were wrong to state that the loans were emoluments of his employment, Mr Boyle should be liable to tax under the transfer of assets provisions so there would not be any further grounds for appeal. The numerous appeals raised by Mr Boyle including his claim that he was entitled to credit for income tax which ought to have been deducted by SCL, were rejected in their entirety. It was found that Mr Boyle was liable to income tax for the years 2001/02, 2002/03 and 2003/04 in respect of monies he received as employment income.

This case demonstrates that efforts to avoid tax using offshore vehicles are being increasingly targeted in the crackdown against tax avoidance. This case also suggests that schemes where employees receive ‘loans’ as a form of payment are also being treated with suspicion. It is estimated that more than 15,000 people have used schemes similar to Mr Boyle and that the pursuit of the outstanding tax and national insurance contributions associated with these schemes will amount to over £400 million.

With the courts continuing to find against avoidance schemes, and the host of new regulations designed to increase the pressure on such schemes, the viability of such schemes is seriously called into question. Genuine tax planning, rather than convoluted schemes, appears to be the way forward and Eaves and Co are here to help.