The case of Revenue v Charlton ( UKUT 770 (TCC), published on 7 January) is an important one for all tax practitioners. It addresses when HMRC can raise an assessment outside the normal twelve month enquiry window.
The taxpayer entered into a tax avoidance scheme to create a capital gains loss. The scheme was notified to HMRC on form AAG1 in accordance with the DOTAS rules. It was then given a DOTAS reference number, and this was included on the tax return. A declaration was made in the white space of the tax return, setting out the facts that took place but not including any technical arguments nor any statement that the taxpayer’s view of the tax position might be different to HMRC’s.
Approximately 40 other taxpayers had adopted similar planning, and most were notified that HMRC were opening enquiries into their tax returns within the normal twelve month enquiry window. The appellants had effectively ‘fallen through the net’ and in an attempt to rectify the situation, HMRC raised discovery assessments for the years in question. The question before the Upper Tribunal was whether those discovery assessments were valid?
Section 29 TMA 1970, provides a two hurdle test as to when a discovery assessment can be made, viz:
First hurdle (a) The officer of the Board must discover an insufficiency of tax
Second hurdle (b) The officer could not have been reasonably expected, on the basis of the information made available to him before that time, to be aware of the insufficiency of tax.
The Upper Tribunal considered both limbs:
The first hurdle
In relation to the first hurdle, the Upper Tribunal found in favour of HMRC. The taxpayer had argued that a ‘discovery’ requires something new to be discovered – for example a new fact or a new understanding of the law. The Tribunal disagreed:
In our judgment, no new information, of fact or law, is required for there to be a discovery. All that is required is that it has newly appeared to an officer, acting honestly and reasonably, that there is an insufficiency in an assessment. That can be for any reason, including a change of view, change of opinion, or correction of an oversight.
On this interpretation then, the first hurdle is not terribly high.
The second hurdle
It is the second hurdle, however, which is really at the heart of the case. This requires that:
- the officer could not have been reasonably expected
- on the basis of the information made available to him before that time
- to be aware of the insufficiency of tax.
Or, turning this on its head, if the officer could have been reasonably expected to be aware of the insufficiency of tax at an earlier point, a discovery assessment can’t be made. This idea is central to the ‘self-assessment’ ethos – if a ‘full’ return is made, a taxpayer can expect certainty after the normal twelve month enquiry window had ended.
Each element of the second hurdle was considered by the Tribunal.
Who is the officer?
Does one look at the particular officer in each case and the level of their knowledge, at a hypothetical officer with a reasonable level of knowledge – whatever that might be – or at HMRC as a whole? The Tribunal held that:
the test of reasonable awareness is objective, and does not depend on the particular individual officer who considers the information made available
Thus, the officer in mind is a “hypothetical officer” who has a reasonable level of knowledge and understanding; however, what it is reasonable for an officer to be aware of, will depend on a range of factors affecting the adequacy of the information made available, including the complexity of the planning.
What information was made available?
What information is ‘made available’ to the hypothetical officer? Is it simply that included on the tax return, or does it also include other correspondence with HMRC such as the separate AAG1 form notifying HMRC about the scheme itself (and bearing in mind a scheme reference number was included on the return)?
The taxpayer argued that the officer did have access to the content of the form AAG1 because a ‘white space’ declaration was made and the scheme reference number was included on the return. The tribunal agreed:
We turn therefore to consider whether… the form AAG1 submitted by the promoters of the scheme should be regarded as information made available… The [scheme reference number] was included in each Respondent’s tax return, but on a different page to the white space disclosures of the scheme and the pages setting out the capital gains computations and the figure for income on the surrender of the policy. We are, however, in no doubt that, first, the existence of the form AAG1 could reasonably have been expected to have been inferred by the hypothetical officer, and secondly, that the physical separation of the SRN number from other relevant entries on the tax return would not have prevented an officer from making the necessary link between them so as reasonably to infer the relevance of the form AAG1 to the insufficiency.”
This is important, because it means that where the scheme reference number and appropriate white box declaration is made it is not necessary to reproduce the entirety of the content of the AAG1 form on the taxpayer’s return.
What did the officer at HMRC have to be aware of?
After having established who the officer was and what information was made available to him, the final question was whether or not, based on that information the officer should have been reasonably expected to be aware of the insufficiency of tax?
HMRC argued that the tax scheme involved a complex area of law and the officer should not be expected to be aware of the technical arguments involved. On this point, the Tribunal also disagreed:
It is not necessary that the hypothetical officer should understand precisely how a scheme works, or any claimed tax treatment is said to arise. All that is needed is that from the information made available to the hypothetical officer he can reasonably be expected to be aware of the insufficiency of tax such as to justify an assessment…
There is no need for the hypothetical officer to engage with himself in the complex debate that might take place following the assessment.
The Tribunal went on to specifically state that:
We do not accept that there is any overriding requirement that the information has to explain how the scheme works (although in this case we consider that would in any event be met by the availability of the form AAG1), nor that the information must specify, if it be the case, that the view adopted by the taxpayer is different from that taken by HMRC.”
This part of the judgement directly conflicts with HMRC’s guidance in SP1/06 where they maintain that if the taxpayer takes a different view to HMRC’s published view, this must be highlighted on the tax return if a discovery assessment is to be ruled out.
What does this decision mean?
This decision provides helpful guidance as to when HMRC can issue a discovery assessment. We now know that:
- An officer can discover an insufficiency in tax without a change in facts or law. He may simply change his mind.
- A “hypothetical officer” who has a level of knowledge and understanding that would reasonably be expected in an officer, has to be considered.
- The more complex the planning, the more detailed the information that is likely to be required.
- Including a “white box” statement can help to defeat a discovery assessment