Discovery Challenged Successfully By Mr Tooth

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Discovery Challenged Successfully By Mr Tooth

At the start of an investigation HMRC will want to broaden their investigation, you will want to keep it as narrow as possible.

HMRC have smelt a rat and that’s triggered their interest, but just the start – they’ll quickly want to go wider than just the bad odour; they’ll want find out where the bad air is coming from – sure – but they’ll also want to peak in your photo albums, shake your piggy banks and view your browser history.

Should you let them do this?


While HMRC want to broaden the investigation you’ll want to narrow it down. So you’ll want to find out why the investigation has been started and then give them the information they need (and are legally entitled to see) to bring the investigation to an end. So they smell a rat, you explain where that smell comes from and give them the evidence required to show them that there has been no loss of tax to them. Then they have no reason to continue the investigation.

This conflict – with HMRC wanting to broaden the search and taxpayers wanting to keep it narrow – is a common scenario at the start of small investigations – particularly if there is not a great deal of evidence to hand. This is often known as ‘fishing’.

One of the tools HMRC has to broaden the search is discovery. Making a discovery gives HMRC much greater powers. But what is a discovery. HMRC are very quick to say they’ve made a discovery (because they want the extra power) but they are sometimes incorrect to make these amassments because the statutory criteria is not met.

If HMRC says that they’ve made a discovery, you should consider challenging it.

Here’s an example of somebody who did – with success. Keith Gordon reports in Taxation magazine, 1 May 2018.

The honest tooth

Keith Gordon considers a recent Upper Tribunal case which revisits the question as to when a discovery assessment is valid

What is the issue?

HMRC’s discovery assessment powers should reflect a remedy of last resort, limited to those cases where broadly it was not appropriate to expect HMRC to have been able to identify the possible tax risk during the enquiry window.

What does it mean to me?

As the Tooth case demonstrates, there are additional protections given to taxpayers which mean that HMRC have to overcome certain hurdles before a discovery assessment will be valid.

What can I take away?

If you or a client faces a discovery assessment, it is worth checking whether or not the statutory conditions are met. If in doubt, ask, because there is no point paying tax unnecessarily.

The arrival of Self Assessment more than 20 years ago meant that most challenges by (what is now) HMRC into a taxpayer’s income tax, capital gains tax or corporation tax position should be undertaken through the statutory enquiry mechanism. Consequently, HMRC’s discovery assessment powers should reflect a remedy of last resort, limited to those cases where broadly it was not appropriate to expect HMRC to have been able to identify the possible tax risk during the enquiry window (or, in cases where an enquiry was opened, during the enquiry itself).

There are no special rules applying in cases involving so-called tax avoidance, although the advent of the rules requiring early notification of tax avoidance arrangements (‘DOTAS’) back in 2004 (and its expansion in 2006) should have meant that it would be even easier for HMRC to identify potential enquiry cases in time. Nevertheless, for reasons that appear to be a combination of inappropriately drastic staffing cuts and institutional disorganisation, it was precisely in many of those types of avoidance case where timely enquiries were not opened and HMRC have been seeking to remedy the situation by playing catch-up through the use of their discovery assessment powers.

Hot on the heels of a defeat in one such case in the First-tier Tribunal (Hicks v HMRC [2018] UKFTT 22 (TC)), HMRC were hoping for better luck in their appeal in the case of HMRC v Tooth [2018] UKUT 38 (TCC).

Facts of the case

In the 2008/09 tax year, Mr Tooth participated in a tax avoidance arrangement which was designed to give rise to employment income losses, such losses to be set off against other taxable income enjoyed by the taxpayer. As did many other participants of that scheme (and similar arrangements), Mr Tooth sought to use the carry-back rules so as to set off the losses against the income of the previous tax year (i.e. 2007/08).

The pro forma 2007/08 tax return included a space for later years’ losses to be claimed and, as the loss had by been suffered by the time that the return was submitted, Mr Tooth duly made the claim.

Many readers will recall the case of HMRC v Cotter [2013] UKSC 69 where the Supreme Court had to decide the precise procedural consequences of such carry-back claims. The Supreme Court concluded that the claims do not constitute part of the earlier year’s tax return, even if they are legitimately referred to and included on the tax return form for that earlier year. In other words, there is a difference between the ‘tax return’ as that term is understood for some purposes within the Taxes Management Act 1970 and the tax return form, being the set of papers that might colloquially be considered to constitute the tax return.

An associated question that arose in Cotter was how to give effect to the carry-back claim, when so included on the tax return form. It was generally accepted that relief could be obtained pretty quickly (and that was the purpose of including it on the earlier year’s form), but different views existed as to whether it reduced the self assessment calculation for that earlier year or merely provided a credit against the liability arising under SA. This debate was also resolved by Cotter which concluded that the claim gave rise to a ‘free-standing credit’. (Technically, the argument was conceded by Mr Cotter and therefore the Supreme Court did not formally decide the matter, although it agreed that the concession had been rightly made.)

Mr Tooth’s 2007/08 tax return, however, was submitted long before the Cotter case came to Court and Mr Tooth had been advised that the relief should be effected through the earlier year’s self assessment calculation. The difficulty was that HMRC’s forms did not permit such an approach (as they had been prepared in accordance with the view which eventually prevailed in Cotter). Mr Tooth was therefore required to improvise, but included a ‘white space’ note in the tax return explaining that he had treated the loss as an in-year partnership loss specifically to ensure that the self assessment figure reflected the reduction to which he believed to he was entitled.

In October 2014, HMRC issued a discovery assessment to recover the tax that Mr Tooth had underpaid in his 2007/08 self assessment. As this assessment was made more than six years after the tax year to which it related, HMRC were required to demonstrate that Mr Tooth’s under-assessment was attributable to deliberate conduct by him or a person acting on his behalf.

The First-tier had rejected HMRC’s contentions quite comprehensively. HMRC duly appealed to the Upper Tribunal, where the case came before Mr Justice Marcus Smith and Judge Charles Hellier.

The Tribunal’s decision

The Tribunal considered the argument put forward by HMRC. They had argued that Mr Tooth’s tax return had been submitted deliberately (an assertion which I do not think anyone would challenge). They also pointed out that Mr Tooth’s under assessment arose because his tax return contained an error (a point which I shall revisit further below). Consequently, according to HMRC, the under assessment as a result of a deliberate act by Mr Tooth (i.e. the deliberate submission of his tax return).

Although the argument follows the literal wording of the legislation, it clearly makes a mockery of the fact that the deliberate conduct test was meant to limit HMRC’s assessment opportunities after six years to the most serious of cases, a point which the Tribunal readily acknowledged. As the Tribunal further noted, using the phrase ‘self-evidently’, the mere completion of a tax return cannot of itself be the deliberate conduct intended by Parliament: ‘the deliberation must relate to the inaccuracy, not merely the completion and submission of the document’.

Of course, the inclusion of an inaccurate figure could be deliberate. But, as the Tribunal continued, it is not necessarily so. In particular, an allegation of deliberately bringing about a tax loss is a serious one, tantamount to an allegation of fraud. Given that Mr Tooth had taken steps to draw the point to HMRC’s attention, the Tribunal concluded that Mr Tooth’s conduct did not entitle HMRC to assess out of time.

Full text from Keith Gordon on the Taxation website here:

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