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.

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.”

The statutory rules that specify the maximum penalties which can be levied by HMRC according to certain types of conduct ranging from negligent behaviour to deliberate and concealed are familiar. However, the rules in force prior to April 2008 allowed HMRC to take an approach of giving abatements and mitigations for various categories of conduct such as abatements for disclosure, cooperation and seriousness.

A recent case (Dr J Kohal) has been heard by the First-tier tribunal (FTT), finding that they were not obliged to follow the approach taken by HMRC. Instead, the judge advised that the FTT should take an overall view of the appropriate penalty for the offence in question according to the law.

In this case, Dr Kohal had declared that he had no income for 2003/04 on his tax return when in fact he had worked and received bank deposits of nearly £80,000. HMRC concluded that the taxpayer had been negligent in completing the return and imposed a penalty of 60%. Before the penalty was imposed, HMRC gave abatements of 20% for seriousness and 20% for cooperation to reduce the penalty from the 100% maximum charge to 60%. Following the instruction by the judge to ensure that the most appropriate penalty was levied, the FTT ignored the abatements given by HMRC and agreed that the 60% penalty imposed was too high for negligent conduct. The FTT ruled that the penalty should be reduced to 45%.

Whilst the case related to legislation that has now been out of date for a number of years, this case serves as a reminder of how the tribunals serve as a buffer to protect the taxpayer from the occasional heavy hand of HMRC. More importantly, this case demonstrates the fact that HMRC practice is not the law, and taxpayers should seek to challenge when they disagree with HMRC’s interpretation.