Phil Manley casts his eye over a tribunal decision which raises questions about how HMRC prepares cases to be heard at the tax tribunals. The decision may have a wider impact on other cases.
Where it started
The case was: Mohammed Ashraf v HMRC (TC06355). The initial enquiry focused on Zonehead Ltd, a company controlled by Ashraf, and was prompted by a recognition of a discrepancy with the VAT claims of Zonehead. The VAT claims were not matched by forms C79, a form which is issued to an importer when they pay customs duty and import VAT.
The enquiry was opened by a Mr Shaw, who is an inspector within HMRC’s civil fraud team, and due to the nature of the discrepancy, the enquiry was opened under Code of Practice 9 which is used where HMRC suspect fraud. The taxpayer agreed to co-operate but chose not to make an admission.
Focus on the owner
Shaw decided to focus his effort on the taxpayer’s personal affairs and as part of this analysis requested Ashraf’s personal bank statements. An income and expenditure schedule was produced by HMRC which indicated a shortfall of approximately £258,000. This shortfall resulted in assessments being issued under TMA 1970, s 29 and, after further communication with Ashraf, penalties were applied.
So far so good, one may say. A fairly standard approach by HMRC and it is certainly valid for the inspector to query the shortfall in such a manner. However, this is where it seems the investigation ended. Specifically, no “source” was found for the £258,000, which HMRC had declared to be taxable income, as it issued tax assessments on that “income”.
Doctrine of source
In the case: Mitchell & Edon v Ross (HM Inspector of Taxes) Lord Radcliffe stated, “Before you can assess a profit to tax you must be sure that you have properly identified its source or other description according to the correct Schedule: but, once you have done that, it is obligatory that it should be charged, if at all, under that Schedule and strictly in accordance with the Rules that are there laid down for assessments under it.”
HMRC submitted that the amount (as defined solely by the income/expenditure account it produced) was taxable under ITTOIA 2005, s 687 as “miscellaneous income” (although HMRC incorrectly named the relevant section as ITTOIA 2005 s 667 in their skeleton argument).
The tribunal referred to the authoritative textbook by Professor John Tiley, who stated that ‘The UK has two important principles limiting the scope of Income Tax, these are ‘Capital is not income’ and ‘Source’.
For an item to be charged by ITTOIA 2005, s 687 it must have a source, indeed in their own submission HMRC declared that “ITTOIA s 687 charges tax on income sources not otherwise charged”
Given the above, the judge’s view on the matter was understandable when he said: “It is clear that s687 does not apply” and “HMRC's post-hearing submission is wrong…”
Therefore, all charges against the appellant were dismissed and the penalties were removed in full.
What went wrong?
HMRC’s opening of the enquiry cannot be faulted. It is only right that when such discrepancies arise that the authorities investigate the matter. However, the case report does raise questions about how this case reached the first tier tribunal.
I would hope that within the process of preparing for tribunal, HMRC would instigate a number of safety measure checks to ensure that the case is suitable and that the submissions prepared are at least legislatively correct. It could be argued, on the basis of a reasonable assumption of the facts, that HMRC in its haste to ‘win’ the case had not undertaken these necessary requirements.
It is particularly concerning that despite no source, or potential source, being named, HMRC was still seeking to tax an amount of money which existed only within an income and expenditure list produced by the department.
HMRC fully agreed it hadn’t found a source of income, even when prompted to offer a suggestion by the tribunal. This is effectively the same as stating: “there is money in your bank account and despite no evidence, we are going to state that it is taxable income”.
This is not a criticism of any individual, rather a questioning of the processes used (or not used as may be the case). Representing the case for HMRC was Mr Horton who, from my own time at HMRC, I know to be a man of great intellect and talent, whose work is a credit to the civil service.
The case should have never have reached his desk as he had been provided with, in racing terms, a non-runner. Someone along the timeline of the investigation should have surely asked the most basic question within taxation: “Where do we think this money is from, and is it a taxable source?”
The fact that this question was never answered by HMRC implies a haste to complete the case which in turn damaged what started out as a most basic enquiry.
It is also a good reminder that a person having money available, does not automatically mean they have committed tax fraud. Otherwise, it will only lead to a situation where, as the late comedian Mr Dodd would agree, individuals are wary of banking their wealth.
About Phil Manley
Phil Manley spent 14 years at HMRC as an inspector in large business before being a senior technical specialist in the counter avoidance team dealing with the APN regime.
After spending a couple of years in the Big Four he has, in partnership with ex-partners from other Big Four firms, established DSW Tax Resolution, to offer a leading tax investigations service.