HMRC Fail in Toothless Attack

HMRC use Eric Morecombe tactics according to judge. “Playing all the notes but not necessarily in the right order”

HMRC use Eric Morecombe tactics according to judge.
“Playing all the notes but not necessarily in the right order”

Readers of our blogs will know we are always interested in cases analysing the extent of HMRC powers and how they should be used. The recent case of Raymond Tooth and the Commissioners for Her Majesty’s Revenue and Customs demonstrates (again) that HMRC powers are not infinite. It also brings out some highly topical points:

1) In Raymond Tooth the taxpayer filed a tax claim which HMRC later decided to challenge. They had though missed their normal time limit on raising an enquiry, so had to raise a ‘discovery assessment’.

2) The definition of a ‘discovery’ made by HMRC is confirmed to be very wide in scope and may include “a change of opinion or correction of an oversight” by the Inspector of Taxes raising the discovery assessment.

3) The general points in Cotter are good law and emphasise the requirements for good disclosure by taxpayers and a clear explanation of how they have computed their self-assessment.

4) The burden is on HMRC to demonstrate that their extended time limits for assessments under ‘discovery’ may be used only where they are saying that the loss of tax was brought about ‘deliberately’. Deliberately means intentionally or knowingly (Duckitt v Farrand).

5) All praise to John Brookes (Tribunal Judge in this case). He basically eviscerated the HMRC case. He said with regard to the issue of extended time limits,

“In my judgment this [assessment] cannot be right. The deliberate (or indeed careless) conduct necessary to enable the issue of a discovery assessment and extend the time limits for doing so must involve more than the completion of a tax return which, in itself, is a deliberate act. As a person completing a return must do so intentionally or knowingly, and can hardly do so accidentally, HMRC’s argument effectively eliminates any distinction between ‘careless’ and ‘deliberate’…[their] attempt to argue otherwise, saying that if the wrong figures were entered in the right boxes it might be careless but if the right figures were entered in the wrong boxes it would be deliberate, was somewhat reminiscent of, and about as convincing as, Eric Morecambe’s riposte to Andre Previn about “playing all the notes, but not necessarily in the right order.”

6) The case can also be linked to current concerns about ‘Making Tax Digital’ (MTD).

Evidence was presented about the problems created by a computer glitch on how the alleged loss claim should be shown. The computer system adopted was a respectable one, approved by HMRC. However, apparently it would not cope with the proposed claim. The advice given to the taxpayer – to fit in with electronic filing, was thus to use a computer ‘work around’. As most people with appreciate, this is quite a common suggested solution, because computer programming is never perfect. The work around meant the loss claim went in the ‘wrong’ data input box, but the taxpayer described this in the ‘white space’ on the Return and the final answer came to what he believed was the correct net tax liability. Despite this, HMRC when they wished to dispute the loss claim, accused him of ‘deliberately’ causing an underpayment of tax. Whilst HMRC lost in this case, it is easy to imagine the dangers of accidental non-compliance caused by seeking to meet tight computer deadlines for making tax digital. Then it appears from cases such as this that such computer errors may be seen as something more sinister by HMRC. I believe this emphasises the risks of making such a system compulsory, before it is thoroughly field tested and people are familiar with it.

I am pleased to see that most commentary from the profession seems to agree with this line.

There is an interesting contrast in the apparent view of HMRC on a balanced system, in that the proposals suggest taxpayers are to be given a compulsory deadline for compliance every three months, whereas if they get it wrong HMRC should be entitled to a time limit of 20 years to challenge it.

Compliance is a delicate flower, worth preserving. If the proposals are brought in, how many businesses will simply drop off the radar if they get behind for a couple of returns and then fear they have neither the time nor resources to catch up again?

Do people believe the MTD and new penalty proposals are fair? If not please lobby to try to get them amended. If computer filing is going to be so popular, as claimed by HMRC, there should be no need for compulsion. Penalties should be levied on people committing deliberate wrongdoing, not mere bystanders.

Negligence, Private Residence Relief and Penalties

In the recent case of J Day & A Dalgety, two taxpayers had sold three properties that they owned together. The case concerned negligence and penalties for carelessness, as they did not include any details of capital gains relating to the property sales on their returns.  They argued that this was because the gains were below the annual exemption and therefore did not realise that they needed to be included.

One of the taxpayers also claimed that one of the houses sold was their only or main residence and that Private Residence Relief (PRR) should have been available.

HMRC raised discovery assessments and levied penalties for carelessness on both taxpayers, which they appealed.

The First-tier Tribunal agreed that the taxpayers had been careless in not including details on the returns.  The taxpayers made a number of errors in their calculations, including attempting to deduct mortgage fees, claiming they were deductible under TCGA 1992, s 38(1)(c).  However, the tribunal found that such costs were not included in the list of “incidental costs” in s 38(2) and were therefore not allowable.

In terms of the PRR claim, the tribunal found that the first taxpayer had not lived in the property with any degree of permanence or continuity as required by the relevant case law (Goodwin v Curtis [1998] STC 475).  No notice had been given to HMRC or to his employers that he had moved house and no invoices were addressed to him at the property.

The Tribunal dismissed the taxpayers’ appeals, agreeing with HMRC that both taxpayers had been negligent in preparing their tax returns by not including details of the property disposals.

It is important to ensure that proper care is taken with filing self-assessment tax returns and all relevant sources of income or gains are included where required in order to mitigate the risk of penalties.    Eaves and Co would be happy to assist if you or your clients have any concerns.

Taxpayers Hunted and Lynched

The Blog this week could be described as dark tales from the Brothers Grimm entitled “What happens to those who ignore HM Revenue and Customs…”

Do not be too scared!  Whilst the Brothers Grimm tales tend to have awful endings – as do the stories of the poor souls in the cases described in the Blog – they are the ones who have ignored the warnings and neglected dealing with HMRC with due and proper respect.  For years many seem to get away with it.  However, the final conclusion seems inevitable to Observers.  Neglect means ignoring that invariably the Mills of God (and HMRC) may grind slowly, but they grind exceedingly fine.  It is prudent to take professional advice before the sack of corn representing your life is thrown down the hopper into the grinding wheel.

Looking at likely outcomes those who take advice from their properly qualified professional advisors generally come out far better.  Prior neglect will cost – often significantly – but making disclosure and then negotiating a fair deal makes personal and economic sense.  Just compare getting matters settled to being sent to jail or having your assets seized under the Proceeds of Crime Act, let alone the miserable anticipation of waiting for it to happen.

3 recently reported cases exemplify the lesson.  Stephen Douce only declared a low household income, where in fact he was earning far more.  The under-declarations resulted in a loss to HMRC of VAT, income tax, NIC and tax credits.  He was sent to jail.

Mr Lynch was discovered to have failed to declare a particular source of income.  The Courts held that the degree of suspicion was sufficient for there to be ‘discovery’ under S29 TMA 1970 and for procedures to be taken under the Proceeds of Crime Act, reflecting gains obtained illicitly over the preceding 20 year period.  Unexplained deposits and credit card payments from unexplained sources amounted to sufficient evidence of undeclared income.  The tax assessments stood.

The Hunt case shows financial irregularities can have other long term consequences.  Again, taking proper advice regarding prompt disclosure may well have helped Mr Hunt, a Financial Advisor, avoid having his new business tainted because he was deemed not to be a ‘fit and proper person’ under FSMA regulations.  He lost in court, even though he argued his original criminal conviction ought to be ‘spent’ because it took place in 1993 so was over 20 years ago.

The advice to clients is take proper advice and then act promptly.  Ignore HM Revenue and Customs at your peril!  The alternative consequences are likely to be costly and last most of a lifetime.

If you need further advice call us; 01704 548698 or 0113 2443502.

Fishing for A Commercial Rationale – Avoidance Motive in A Fisher, S Fisher, P Fisher  v HMRC

A recent case was heard at the First-Tier Tribunal regarding the conflict between commercial decisions and tax avoidance motives (A Fisher, S Fisher, P Fisher  v HMRC).  It can clearly be seen that legally reducing a tax liability could be a commercially sensible decision, but it was previously assumed that this would not be enough to override the anti-avoidance provisions that apply where there is a tax avoidance motive.

The case in question involved a family bookmaking business, who took the decision to move the business to Gibraltar in the 1999/2000 take year, in order to obtain more favourable treatment regarding betting duties than applied in the UK.

HMRC took issue with this and challenged the, under the anti-avoidance provisions on the transfer of assets abroad.  They raised assessments charging income tax the years 2000/01 to 2007/08 under the rules in force during those years.

The taxpayers appealed claiming that there was no avoidance as they had moved the business to Gibraltar as a commercial decision in order to compete with other bookmakers.  Saving tax was therefore a side effect and not the reason for relocating.

The First-tier Tribunal did not agree, finding that the transfer would not have gone ahead if it were not for the lower betting duty in Gibraltar.  This did not conflict with the decision to move being made for sound commercial reasons, however this did not prevent there being a tax avoidance motive.

The taxpayers made a further argument regarding the EU rights of freedom of establishment and freedom of movement of capital applied, but the tribunal determined that the rules were not relevant for movements between the UK and Gibraltar.  They did, however, apply to one family member who was an Irish national.

The taxpayers also made a claim that HMRC’s assessments were not valid, under the discovery provisions in TMA 1970, s 29, as the tax officer should have been aware of the relevant information as a result of responses to their enquiries.  The tribunal agreed that the conditions for making a discovery assessment were not satisfied for 2005/06 and 2006/07.  The appeals for the remaining years were dismissed.

Whilst the Tribunal confirmed that a tax avoidance motive could also be part of a commercial decision, it is clear that the anti-avoidance provisions are drafted widely enough to catch such situations.  This is because the existence of commercial reasoning does not overrule the fact that there was a tax avoidance motive as well which was inextricably linked.

Discovery Allowed by Tribunal – N Pattullo v HMRC

The question of what constitutes a discovery remains an area of ambiguity, although recent cases tended to have sided with HMRC’s view that virtually anything can be considered a discovery.

A further recent case was heard on the subject in N Pattullo v HMRC (TC03958), although the decision in the case is unlikely to be too controversial or unexpected, especially considering the case involved an avoidance scheme.  In the current climate, the courts are tending to be reluctant to favour taxpayers in cases where they have used an avoidance scheme.

Mr Pattullo participated in a scheme which generated capital losses of around £2.6m which he reported on his 2003/04 tax return.  HMRC concluded that he had participated in an avoidance scheme and issued a notice under TMA 1970, s.20(1) requesting relevant documents.  The taxpayer did not comply with this request and instead sought a judicial review to revoke the notice, but this request was dismissed by the Court of Session in 2009.

In the meantime, the Court of Appeal had found in favour of HMRC in the case of J Drummond v CRC (2009) which involved a similar second-hand insurance policy scheme.  Therefore, HMRC raised a discovery assessment for £835.400 as they were now satisfied that his original return was incorrect.

The taxpayer appealed, arguing that there had been no discovery as no new information had come to light.  The Tribunal found that the decision in Drummond v CRC constituted a discovery as it converted a “suspicion” of an underpayment of tax into a “positive view”.  It was doubtful that a hypothetical officer would have been aware of these avoidance schemes before the Drummond case was heard.

The taxpayer made a final attempt to protect his position by arguing that the grounds of his appeal should be amended to argue that the original avoidance scheme actually worked.  This was again dismissed by the tribunal who felt that, bearing in mind there were a number of appeals on similar schemes to Drummond pending, he was trying to jump on a “bandwagon” allowing other taxpayers to argue his case for him.  They felt the amendment was too vague and dismissed the appeal.

The final decision will likely not be a surprise to many, but does highlight the current attitude of the courts to the use of such avoidance schemes, and the wide definition of “discovery” that HMRC are using.

Discovery and Negligence Considered Again – Sanderson v CRC

The question of what constitutes a ‘discovery’ continues to cause disagreements between HMRC and taxpayers.  A further case on the matter was recently heard by the Upper Tier Tribunal.  Interestingly, the question of negligence on the taxpayer’s part was also considered.

Facts

The taxpayer appealed against the First-tier Tribunal’s decision to uphold a ‘discovery’ assessment.   HMRC were also cross-appealing one part of that decision.

Mr Sanderson filed his 1998/99 tax return in February 2003. He claimed losses of around £2m to set against a chargeable gain of £1.8m.

These losses arose as a result of an avoidance scheme in which he had participated, claiming the benefit of Trust Fund losses in the Castle Trust scheme under TCGA 1992, s. 71(2). Some limited additional information in relation to this claim was given in the ‘additional information’ box on the return.

HMRC had been investigating the Castle Trust scheme since 1999 through the Special Compliance Office and Special Investigations Section. In July 1999, HMRC had a list of the users of the scheme, but Mr Sanderson’s return was not submitted until 2003.  By that point the scheme was found to be ineffective, and its capital losses were reduced to nil. Mr Sanderson was informed of this by the scheme promoter in January 2004.  On contacting his accountants he was advised to do nothing.

In late 2004 the Inspector became aware that Mr Sanderson’s return had been filed and raised a discovery assessment in January 2005. The normal enquiry window for the return had closed on 30 April 2004 which all parties agreed.

The First-tier Tribunal (FTT) had found that there had been a ‘discovery’ by HMRC and that an officer could not reasonably have been expected, on the information made available to him, to have been aware of the insufficiency.  However they determined that the insufficiency of tax was not attributable to negligent conduct on the part of the taxpayer or anyone acting for him.

Both the Taxpayer and HMRC were appealing against the decisions against them in the FTT.

Decision

The taxpayer claimed HMRC knew about his participation in the scheme before he submitted his return and as they had decided the Castle Trust scheme was not effective before he filed, they should have been aware of tax insufficiency before the enquiry window closed.

The Upper Tribunal found that the return did not contain enough information to make an HMRC officer aware that there was a tax insufficiency by itself, despite the fact that it would have alerted a hypothetical official to the fact the taxpayer was taking part in the scheme.

The discovery assessment was therefore valid, and Mr Sanderson’s appeal was dismissed.

However, on the question of negligence, the Upper Tribunal found in favour of the taxpayer.  They did not accept HMRC’s contention that the taxpayer’s adviser was negligent in advising to do nothing further on discovering that the Castle Trust scheme was ineffective.  Interestingly, the judge noted there was “no statutory provision imposing an obligation on a taxpayer to tell HMRC about something in a filed return that he subsequently finds to be erroneous.”

New Discovery Ruling Found in Taxpayer’s Favour – M Freeman v HMRC

The case law surrounding the grounds on which HMRC can raise Discovery assessments continues to develop, and a further case on the matter was recently heard in favour of the taxpayer.  In another recent case (Smith v HMRC), the Tribunal found that HMRC could still raise a discovery where post had not been opened due to staff illness and HMRC effectively changing their minds, despite having the facts available.

A further case, M Freeman v HMRC, appears to provide taxpayers with slightly more comfort than that particular case; the tribunal perhaps looked on the taxpayer more favourably due to the lack of an avoidance motive in the latest case?

Background

In 1997 Mr Freeman exchanged shares in a trading company for loan notes, with the company having received clearance from HMRC that TCGA 1992, s.135 applied.

In 2000 HMRC opened an enquiry into the return and in the course of the enquiry, the loan note documentation was provided to HMRC.  An HMRC Technical Inspector stated “I agree that the facts point to this being a non-qualifying corporate bond”.

Mr Freeman redeemed two tranches of the loan note in 1998/99 and 1999/2000. He redeemed a final tranche in 2002/03 and claimed taper relief on the basis that the loan note was a non-QCB.

In 2005, HMRC subsequently became aware that the loan notes were in fact QCBs (a fact that the taxpayer also accepted), while looking into the affairs of another taxpayer who held the same loan notes.  HMRC therefore raised a discovery assessment in 2007 in relation to Mr Freeman’s 2002/03 tax return, as the enquiry window had closed.

Mr Freeman appealed against the assessment on the basis that HMRC could reasonably have been expected to be aware of an insufficiency in the tax return, based on the information provided.

Decision

The Tribunal found that, whilst the disclosure in the 2002/03 return was not complete, the provision of the loan note instrument in 2000 did constitute information provided in writing to the Board on behalf of the taxpayer.  If the hypothetical officer had considered the loan note provided, he could reasonably have been expected to be aware of the insufficiency of tax.

The conditions for raising a discovery assessment were therefore not satisfied, and the taxpayer’s appeal was allowed.

It will therefore be interesting to see if this case has implications for future cases on Discovery, and could prove useful in cases where information was provided in earlier tax years.

Cotter, Discoveries and Reasonable Excuse

Further to previous posts, we are now aware that the Supreme Court heard HMRC’s appeal against the Court of Appeal verdict in HMRC v Cotter on 3 October 2013.  Whilst we await judgement, it seems a good time to review recent developments in terms of HMRC policy.

A recent First-Tier tribunal case on reasonable excuse found against the taxpayer, raising some interesting points on what constitutes ‘reasonable’.

The case, Rennie Smith & Co v HMRC, concerned filing of P35s and whether a reasonable excuse existed for the failure to file.

The appellants are a firm of Chartered Accountants in Scotland, but they failed to file their own P35 by the due date.  They appealed the penalty on the basis that they had logged on to the online filing system but had not filed due to an HMRC system ‘error’.  They argued that HMRC had acted unreasonably by delaying issuing a warning notice and penalty until 4 months after the deadline in addition to their confusion over whether the P35 had actually been filed.

The tribunal agreed with HMRC that the return was not submitted and that in the absence of records showing any technical faults, the error therefore lay with the taxpayer.

It is interesting that this was not found to be a reasonable excuse, however in other recent cases, it has been inferred that HMRC not monitoring their post is reasonable!  In the case of Smith v HMRC, HMRC were entitled to raise a discovery assessment outside of the enquiry window, despite the fact that the enquiry was only not opened in time due to the extended sick leave of the inspector, with no one apparently dealing with his post.

In light of Cotter and Smith, it is interesting to note the disparity between reasonable HMRC practice and the expectations placed on taxpayers.  We await the judgment on the Cotter appeal with interest and will provide an update once published.

Mr A Omar v HMRC – What qualifies as a Disclosure on a tax return?

HMRC raised discovery assessments on Mr Omar in relation to the transfer of properties in 2005 and 2006 to a FURBS (Unapproved Pensions Scheme).

Mr Omar said HMRC had enough information from the relative tax returns to understand what had happened in 2005 and 2006.  Therefore he claimed that “discovery” assessments could not be raised by them.

Mr Omar had written some narrative about transactions in the relevant tax returns but the Tribunal held:-

  • His entries did not disclose who were members of the FURBS
  • The entries contained no detail about the potential tax treatment of the transfers
  • They did not disclose who the properties were allocated in within the FURBS

Mr Omar lost the case because his disclosures were not detailed enough.

Not a New Discovery

In 2005/06 and 2006/07 three taxpayers created  losses using a tax avoidance scheme.  The taxpayers then claimed the losses against capital gains on their self-assessment tax returns.

The taxpayers included sufficient information regarding the transactions in the additional information section of the tax returns.  As required, the tax returns also revealed the scheme’s Reference Number under the disclosure of tax avoidance scheme (DOTAS) rules.

The scheme in question was subsequently found to be ineffective.

HMRC did not open an enquiry into the taxpayers return in time and therefore instead made a discovery assessment in respect of the gains.

The taxpayers appealed.

The tribunal found that the discovery assessments were not valid.  The judge said that while HMRC had made a discovery within TMA 1970 s.29(1), the taxpayers were protected from the discovery assessment by virtue of TMA 1970 s29(5) as they had provided adequate information to allow the assessments to have been made in time.

The judge stated that ‘no officer could have missed the point that an artificial tax avoidance scheme had been implemented’ and it seemed ‘perfectly obvious’ that no one had ‘even looked at the returns’.

The case highlights the importance of disclosing sufficient additional information in the ‘white space’ of a tax return to protect against a future discovery assessment.