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HMRC victory in Supreme Court Cotter battle

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12th Nov 2013
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HMRC has won an important ruling in the Supreme Court which could see it recover £500m in avoided tax.

The Supreme Court found that a taxpayer must perform a calculation of the amount of tax due itself, rather than leave that calculation to HMRC, in order to retain possession of funds under dispute.

The unanimous ruling in Cotter v Commissioners for HMRC [2013] UKSC 69 means HMRC is entitled to enforce payment of a tax debt and withhold tax relief arising from a tax avoidance scheme while it is investigating.

Jason Collins, a tax expert at law firm Pinsent Masons, said: “HMRC has for many years been taking steps to remove the ability for taxpayers to keep possession of the cash during a dispute about tax avoidance.

“As the disputes are lengthy, in some cases lasting a decade or more, even if the taxpayer has to pay the tax at the end of the process with statutory interest, the cash flow advantage of keeping possession of the cash in the meantime can of itself be quite attractive.”

On 31 October 2008 Maurice Cotter filed a tax return for 2007/2008 which made no claim for loss relief in the return, and let HMRC calculate his tax for the year which amounted to income and CGT of £211,927.77.

The following January, Cotter’s accountant submitted a provisional loss relief claim showing employment-related losses of £710,000 for 2008/09 and asserting that no further tax was due because of this.

HMRC opened an enquiry into the loss claim under the Taxes Management Act, however, it claimed the unpaid tax for 2007/08 through the county court, ignoring the loss claim that they were enquiring into.

In June 2009, HMRC issued proceedings in the county court seeking recovery of £203,243 which was the income tax and CGT for 2007/08 and the first payment of account for 2008/09.

Cotter appealed on two grounds:

  • His loss for 2008/09 covered the amount owed for the previous year
  • The county court did not have the jurisdiction to hear the dispute

The High Court found that Cotter was not entitled to rely on his claim for loss relief as a defence to HMRC’s claim, but Cotter’s appeal was upheld by the Court of Appeal and eventually made its way to the Supreme Court.

However in its judgment, the Supreme Court overturned the earlier decision by the Court of Appeal and found in favour of HMRC.

The judges said that the central question was whether HMRC was right to have carried out its enquiry, which allowed for postponement of the relief until the end of the enquiry. In their judgment they said that HMRC may correct the tax return if it disagrees with the relief claim, and if the taxpayer then rejects the amendment, HMRC can launch an enquiry.

As the loss claim for 2008/09 was not made “in a return”, the department was right to proceed to recovery through the courts.

HMRC welcomed the decision as a “significant deterrent” against the cash flow advantages which might otherwise be open to users of personal tax avoidance schemes.

It added around 200 users of the Cotter scheme will be caught by the Supreme Court decision, leading to a saving of up to £500m for similar cases.

However, Collins said the verdict was a deft bit of judicial engineering: “Whilst a sizeable victory for HMRC in this case, it does leave open the possibility that taxpayers engaged in avoidance are still able to retain the possession of the cash if they carry out their own tax calculations.

“HMRC has in recent years consulted on amending its rules to take the 'cash flow advantage' away - including an aborted attempt to exact heavy penalties for failed planning. Whilst that initiative was put on the back burner, HMRC is now pushing to impose penalties if taxpayers do not give the cash back where related litigation goes against them at any stage of appeal in the courts and the scheme is ultimately found not to work.”

Replies (3)

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David Winch
By David Winch
12th Nov 2013 13:12

Two points

I think there are two key points in the Supreme Court judgment.

To quote from the judgment:

"Income tax is an annual tax, and liability to such tax is calculated in relation to a particular tax year" and the particular relief claimed had an effect equivalent to setting a loss in year 2 against income / gains in year 1 - but did not actually affect the tax due in year 1.

So the taxpayer's liability for 2007/08, which initially had been calculated without giving effect to any relief for a loss in 2008/09, was correct and HMRC could sue for the tax shown as due by that (correct) calculation.  HMRC were not obliged to wait for the outcome of the loss relief claim to be determined (which might generate a repayment which could settle some or all of the outstanding tax).

Had the taxpayer initially submitted a tax calculation for 2007/08 which included the relief claimed for the loss incurred in 2008/09 then HMRC would have to have accepted THAT tax calculation as correct until it had been determined to be incorrect.  But in this case the taxpayer had not submitted a tax calculation for 2007/08 and so HMRC performed their own calculation (which did not reflect any relief for the loss incurred in 2008/09).

David

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By observer
12th Nov 2013 18:21

The way judgments are going

I wouldn't want to have to take on HMRC in the Courts, no matter how good I thought my case was.

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By Ted Numbers
13th Nov 2013 10:53

Wide of the mark

Some of the above commentary is wide of the mark. Firstly this only applies to a limited number of avoidance schemes in which there are losses to which sch 1B TMA applies. Secondly the Supreme Court has confirmed that when the loss is (wrongly) claimed in the earlier year's return HMRC has to go down the section 9A route before collecting any tax. That seems to me especially unhelpful to HMRC!

HMRC needs to do two things:

1. open sch1A enquiries as well as 9A.

2. amend the design of the tax return to prevent this.

Alternatively the Government could give some consideration to proper simplification. Anyone unfamiliar with UK tax reading the Cotter case as it has travelled through the court system would conclude that it is simply bonkers.  

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