The decision in the recent First-tier tribunal case of Smith v HMRC appears to have tipped the balance of discovery in HMRC’s favour and may have far reaching consequences for taxpayers achieving certainty on their returns.
The Case
In the tax year 2000/01 the taxpayer, Mr Smith, participated in a marketed tax avoidance scheme, the purpose of which was to create a tax deductible capital loss. The case of Drummond v R&C Commrs (2009) ruled that the scheme, which involved the acquisition and disposal of second hand insurance bonds, did not work.
The taxpayer submitted his 2000/01 self-assessment tax return on time. In the return the taxpayer included two ‘white space’ disclosures outlining the transactions involved in the scheme. The return showed nil income and a capital loss on redemption of the bonds.
The normal enquiry window (TMA 1970, s.9A) closed on 31 January 2003, with HMRC not opening an enquiry into the return.
On 29 November 2006, HMRC raised a discovery assessment imposing capital gains tax on the taxpayer.
Taxpayer’s Argument
The taxpayer appealed against this assessment on the grounds that there had been no ‘discovery’ and the enquiry window had long since closed therefore there was no legal basis for the assessment.
During the document discovery exercise it was found that HMRC had spotted the issue back in 2002, before the close of the enquiry window. It transpired that the only reason an enquiry was not opened was due to the extended sick leave of the inspector, with no one apparently dealing with his post.
The taxpayer argued therefore that the failure to open an enquiry was HMRC’s mistake. No new information had come to light and there had been no concealment. Thus the discovery assessment was not valid within TMA 1970 s.29.
HMRC’s Argument
HMRC contended that a ‘discovery’ had been made as there were ‘chargeable gains which ought to have been assessed to capital gains tax’. They said that the discovery hurdle was an exceptionally low one; it covered a mere change of mind as to either facts or law. They felt that the tribunal should consider what the notional officer could have been reasonably expected to be aware of at 31 January 2003 on the basis only of the information listed in TMA 1970, s.29(6).
The Decision
The tribunal agreed with HMRC. They held that the ‘discovery’ condition of TMA 1970 s.29(1) was not a strict one. They said that a discovery assessment could be made merely where the original officer of HMRC changed their mind or where a different officer took a contrasting view.
This decision appears to contradict the verdict in R&C Commrs v Charlton (2013).
However the tribunal felt there were two distinguishing factors:
- The DOTAS scheme (or similar) was not in place (as with Charlton) therefore there was no clear identification of an avoidance scheme and methods for dealing with them, and
- The decision in Drummond was still several years away as at 31 January 2003, and HMRC’s technical department were still ruminating on whether the scheme worked, and were still doing so a year later.
Therefore even if the notional HMRC officer could have spoken to the technical specialists, he could not have been reasonably expected to be aware, on the basis of the information available to him, of the insufficiency.
In Charlton, the case of Drummond had already been decided and HMRC were aware of the insufficiency.
The effect of this decision is that it appears to widen the discovery net.
This will likely have the biggest impact on complicated schemes, as it suggests HMRC no longer has to stick to the enquiry window to make an assessment, particularly if a technical decision is yet to be reached.