The case law surrounding the grounds on which HMRC can raise Discovery Assessments continues to develop. We have recently written on the Discovery Powers of HMRC and the evidence suggests that the future of HMRC’s powers of Discovery in favour or against the taxpayer is uncertain. In Smith v HMRC the scope for discovery appeared to have been widened but the tribunal ruled that the conditions for a discovery to be raised were insufficient in a further recent case of Freeman v HMRC.
Smith v HMRC
In this case, Mr Smith had participated in a marketed tax avoidance scheme in 2000/01 with a purpose to create a tax deductible capital loss. The normal enquiry window on 31 January 2003 closed without any enquiries into the tax return being opened.
The taxpayer appealed against HMRC’s raising of a discovery assessment in 2006 saying that the failure to open an enquiry was HMRC’s mistake and the discovery assessment was invalid under TMA 1970 s.29. It was also found that HMRC had spotted the issue back in 2002, before the closure of the enquiry window but the reason why an enquiry wasn’t opened was due to the extended sick leave of the inspector and the fact that no-one was opening his post in his absence.
HMRC contended that a discovery had been made as there were chargeable gains which ought to have been assessed to capital gains tax. They also said that the discovery hurdle was a low one; it covered a mere change of mind as to either facts or law. They also felt that the tribunal should consider what the notional officer could have been reasonably expected to be aware of at 31 January 2003 when the enquiry window closed.
The tribunal agreed with HMRC. They held that the discovery conditions of TMA 1970 s.29 (1) was not a strict one. The discovery assessment raised and imposition of capital gains tax against Mr Smith was therefore upheld.
Freeman v HMRC
In 1997 Mr Freeman exchanged shares in a trading company for loan notes, with the company having received clearance from HMRC. In 2000 HMRC opened an enquiry into the return and in the course of the enquiry, the loan note documentation was provided to HMRC. In 2005, HMRC became aware that the loan notes were in fact QCBs. HMRC therefore raised a discovery assessment in 2007 in relation to Mr Freeman’s 2002/03 tax return as the enquiry window had closed.
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 on behalf of the taxpayer. They also considered that the officer could reasonably have been expected to be aware of the insufficiency of tax if the loan notes had been considered fully. The conditions for raising a discovery assessment were therefore not satisfied and the appeal against the Discovery Assessment was allowed.
The contrast between this case and the Smith case is interesting as the Tribunal did not appear to suggest that HMRC merely changing their mind was sufficient for a ‘discovery’ to have been made. At present, taxpayers lack clarity on exactly what constitutes a discovery and the varying Tribunal cases appear to further muddy the waters.