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HMRC loses Tooth, but staleness bites the dust

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The Supreme Court has unanimously found in Tooth’s favour, but the judgment means that tax advisers can no longer use the staleness of a HMRC decision as an escape route.

21st May 2021
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What was biting HMRC?

It all began in January 2009, when Raymond Tooth invested in a tax avoidance scheme (a film partnership) and claimed an employment-related loss which he wished to carry back against his 2007-08 tax liabilities. The scheme was ultimately invalidated by retrospective legislation, but at the time it was reasonable to hope its effect would be to reduce his liability by £475,498.20.

Using software approved by HMRC, his advisers prepared his 2007-08 SA tax return. Owing to a deficiency in the software, it was not possible for the loss to be entered in the appropriate box on the return; instead, it was entered on the “partnership” pages. A detailed explanation was entered in the “white space”, which included the phrase “I assume you will open an enquiry”.

HMRC did not open an enquiry, but eventually (in October 2014) issued a discovery assessment (under TMA 1970 s29(1)) to collect the tax.

Some arguments to chew on

Tooth’s appeal, which was heard in turn by the First-tier Tribunal (FTT), the Upper Tribunal (UT) and the Court of Appeal, centred on two hotly debated points:

  1. Did HMRC have the right to make a discovery assessment? Given the failure to open an enquiry, that would require three things to be true:
    • The return contained an inaccuracy;
    • The inaccuracy resulted from carelessness or deliberate behaviour; and
    • The inaccuracy resulted in an insufficiency of tax.
  2. Even if HMRC did have the power to issue an assessment, had the discovery grown “stale” by the time the assessment was made? HMRC took five years to issue the assessment, while the legislation empowers an HMRC officer to make an assessment when he becomes newly aware of the loss of tax.

The Court of Appeal’s position was that, while the return if read as a whole was not inaccurate, nonetheless it did contain an inaccuracy (in that an employment loss was included on the partnership pages); as it was an active choice to submit the return in that format, the inaccuracy was deliberate; and an insufficiency of tax was the result. On point 1, the Court of Appeal sided firmly with HMRC.

However, on point 2 it sided firmly with Tooth. A delay of five years does not correspond with being “newly aware” of the need to make an assessment. Accordingly, the Court of Appeal threw out HMRC’s appeal.

HMRC appealed to the Supreme Court.

The wisdom of the Judges

Looking first at the issue of deliberate inaccuracy, the Supreme Court concluded that the Court of Appeal was wrong to accept HMRC’s “tunnel vision” approach to the matter.

  • To make a statement deliberately which subsequently turns out to be inaccurate is not the same as deliberate inaccuracy, absent either intent to deceive or recklessness.
  • HMRC’s approach would, in fact, risk exposing an honest mistake to more penal treatment than actual carelessness. The parallels with the Finance Act 2007 penalty regime (from which the language of “deliberate” behaviour was derived) make it clear that treating honest error more harshly than carelessness was never Parliament’s intention.
  • The question of whether a return (or other document) contains an inaccuracy must be decided in the context of the return as a whole – including in particular the use of white space. HMRC cannot cherry-pick individual items in order to point to an isolated “inaccuracy” when those items have been fully and prominently explained in the white space. “The Revenue cannot in our view have it both ways”.
  • “Reading the return as a whole, Tooth and his advisors did their best, in the context of an intractable online form which did not appear to enable them to do it more directly, to explain the employment-related and scheme-derived basis of his ambitious claim to extinguish his 2007-8 tax liability by an admittedly contentious carry-back.”

In conclusion, HMRC lacked the preconditions to make a discovery assessment: “Mr Tooth does not fall within the scope of the condition set out in section 29(4) of the TMA [careless or deliberate action]. The situation mentioned in section 29(1) [an insufficiency of tax] was not brought about deliberately by him”.

This alone was enough to save Tooth £475,000 in tax - good news for him.

Staleness dies

The doctrine of “staleness” has in recent years been a thorn in HMRC’s side: there have been many occasions when HMRC officers have been excessively slow to take action, and the FTT has thrown out assessments accordingly.

The Supreme Court, however, could see no merit in the notion of staleness. There are clear statutory time limits for making assessments, which run from the end of the relevant tax year; to introduce additional limits which run from a different, arbitrary date (the date when a discovery is made) is unnecessary and unhelpful.

A common argument in support of staleness is that, once a discovery has been made by one HMRC officer, it cannot be made again by another. This argument was also dismissed, as was any suggestion that HMRC should be considered to have “collective knowledge”, so that the first officer to discover a loss of tax somehow permeates that awareness to all his or her colleagues.

What matters is that a particular HMRC officer becomes “newly aware” of a loss of tax – even if other officers had become aware earlier. The Court noted that the legislation says such an officer “may” make an assessment; the fact that one officer chooses not to assess does not debar another from subsequently choosing to do so.

Conclusion

There was no justification for a discovery assessment. HMRC should have dealt with the situation using the enquiry regime; since it did not, and since Tooth and his advisers bent over backwards to give HMRC all the information it needed (and even encouraged HMRC to open an enquiry!), it would be wrong to allege careless or deliberate inaccuracy.

If there had been a valid discovery, delay alone would not have been enough to prevent an assessment. The doctrine of staleness is dead.

Replies (30)

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By SteveHa
21st May 2021 15:57

Quote:
This argument was also dismissed, as was any suggestion that HMRC should be considered to have “collective knowledge”

The court's position, however, seems to completely ignore that HMRC are a part of the Civil Service, where records are king. If one individual officer becomes newly aware of an insufficiency, then the records should ensure that "collective knowledge".

This isn't rocket science, nor is it telepathy. It is simply how the system is supposed to work.

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By RayM55
24th May 2021 09:49

To enforce collective knowledge upon HMRC would make the system wholly unworkable. “Staleness” as a defence never existed, it is time limits that matter. The statute already provides an element of prior knowledge protection.

Peace and harmony have been restored!

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By Andy Keates
24th May 2021 09:38

Hi SteveHa,

Actually, they spelled out their reasoning on the "collective knowledge" aspect in far more nuanced detail than space permitted me to describe in the article. The issue is that HMRC carries out its functions using individual Officers, and questions (such as in s29) of "knowledge" can only be viewed through the lens of the knowledge available to, and the state of mind of, the particular Officer at the particular time.

At [69] the Court set out the legislative history which shows that "whether there was a discovery by an inspector depended on the particular inspector’s state of mind, not on what knowledge might be located elsewhere in the Revenue organisation". This is reinforced by "the way in which the Revenue works in practice, as illustrated by the evidence in this case, where a taxpayer’s file is allocated to a particular officer to review and take relevant decisions and actions, drawing as necessary on advice or submissions presented to the officer by others".

At [70] they drew the same conclusion from situations where an individual Officer is exercising the delegated authority of the Board: "As the delegate of the Board, the officer stood in their place. The officer would act on their behalf on the basis of the officer’s own state of mind and knowledge, not by reference to the state of mind or knowledge of anyone else in the organisation".

They went on to consider parallels within other Departments, citing:
* R (National Association of Health Stores) v Department of Health [2005] EWCA Civ 154
* Carltona Ltd v Comrs of Works [1943] 2 All ER 560
* R (Bancoult) v Secretary of State for Foreign and Commonwealth Affairs (No 3) [2018] UKSC 3; [2018] 1 WLR 973

From these they concluded "There is no principle of collective knowledge within a department. If a civil servant acts on behalf of a Minister, it is the civil servant’s knowledge and state of mind which are relevant".

At [81] they examined a number of scenarios where the idea that "records are king" might fall down in practice: "A first officer who is allocated a self-assessment return to review
* puts it in a drawer unread and so does not see that it contains an under-assessment of tax
* or fails to read it carefully and so does not spot that it contains an under-assessment of tax
* or reads it carefully but makes an error of appreciation of the facts or the law and so again does not realise it contains an under-assessment of tax
* or reads it carefully and finds the error but then goes on holiday, moves job or retires without issuing an assessment".

Developed further in [82]:
"The first officer might leave a note on the file to say that he or she has made a discovery of an insufficiency of assessment to tax but the note might be difficult to interpret, so the second officer has to repeat the exercise of examining the assessment to form his or her own view. Or the first officer’s note might be thorough and clear, but the second officer may not have confidence in what the first has done and so may wish to make his or her own evaluation".

The records arguably should (as you say) ensure that knowledge is permeated through the organisation, but this is the real world. A record is only as good as the person making it, and its impact on others is only as good as the person reading it. It is unrealistic and unreasonable to deem some sort of hive mind to exist, even among the drones and workers of the Civil Service!

Cheers,

Andy

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By poveyt
24th May 2021 09:51

This is an interesting position to take, but this means you can have a negligent officer who then leaves a ticking time bomb for a tax payer that can sit for years, all because they left a file unread in their desk. There have to be implications if an employee does their job badly, and this should not bounce back on the tax payer. This principle would, I believe, lead to a more effective HMRC as officers would be aware of the implications if they make mistakes. It is not for nothing that these people are called "officers".

In the real world, if a company employee messes up then the company loses money and the individual responsible is held to account. Why is it any different for this most important of government bodies?

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Replying to Andy Keates:
By SteveHa
25th May 2021 09:58

Quote:
whether there was a discovery by an inspector depended on the particular inspector’s state of mind, not on what knowledge might be located elsewhere in the Revenue organisation

This surely makes a mockery of the whole process, and I'm aware that the term "state of mind" has been used in other tribunal cases.

However, to assess an officer's "state of mind" retrospectively is a stretch in itself, and the term can encompass all sorts of issues. Did "the Officer" have a drinking problem, was his marriage/relationship on the rocks, had a close family member died? These will all affect his state of mind, but none should be a consideration in a judgement of professional standards, especially when the only question is a matter of legislation.

And none nullify the requirement to keep records in the CS. Even more to the point, subject to HMRC's unreasonable restriction of information internally (dating back to the OSA, and pre-dating GDPR), HMRC can simply restrict access to information at a whim to extend time limits indefinitely.

The whole thing stinks, IMO.

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Replying to SteveHa:
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By RayM55
25th May 2021 11:51

You need to buy a good tax book and try again, the time limits are clear and this decision helps taxpayers by making sure that they are properly applied.

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Replying to RayM55:
By SteveHa
25th May 2021 12:16

I have good tax books, I don't rely on HMRC guidance, but prefer to rely on the legislation, as interpreted by (binding) tribunal decisions. This case does nothing whatsoever to reinforce either, but rather skews the facts in HMRC's favour, regardless of the legislated restrictions on their powers. By opening up discovery to each and every individual in isolation, regardless of the actions of previous officers, the legislation is mocked.

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Replying to SteveHa:
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By RayM55
25th May 2021 13:32

The Court did not open up discovery to each and every individual, discovery was always open to each and every individual. The problem here is that a Tribunal judge invented the idea that a discovery could become stale and some tax advisers who could have been better informed turned staleness into a principle.

The law is clear and there remains a two tier test HMRC has to get over, 1 have I made a discovery? And, 2 can I act upon it? The latter has always been more important. I wrote an article for Taxation a few years ago in which I described arguing against the first test as a waste of time since the second test is critical.

All the SC has done is bring discovery back into line with how the courts have for a very long time interpreted it and in doing so they have stopped HMRC from pursuing an approach that was frankly absurd. Had the Court not done so then every error in a tax return would have been “deliberate” since HMRC were trying to identify the mere entry on a tax return as the deliberate act.

Instead we are back to “deliberate” being doing something in relation to your tax position that you know is bad at the point you do it.

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By Justin Bryant
24th May 2021 10:29

The SC's view is clearly that (subject to public law issues) HMRC inaction to issue a discovery assessment pursuant to an officer's discovery is fine (see the para 81 examples).

What is less clear is how Tooth applies where HMRC has employed a defective assessment and uses a DA to correct that, since in Tooth it was only HMRC's enquiry (which is merely just that and is not a form of assessment) that was inappropriate (targeting the wrong tax year) and so there could be no effective CN (which is a form of assessment) and none was issued (in none of the para 81 examples was a prior (ineffective) assessment issued).

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By More unearned luck
24th May 2021 12:07

I assume you mean defective HMRC assessments.

I don't think it matters that it was HMRC who made the inadequate assessment as pre-SA all assessments where made by the IR and therefore all further assessments (another name for DAs) were 'corrections' of an assessment raised by the taxman. DAs routinely follow SAs (for example where HMRC employ presumption of continuity to assess years for which there was no enquiry opened. The taxpayer is, of course, protected to some extent by the safeguards in s29 and the s36 time limits.

What it does mean is that a closure notice is not the final word (if it ever was) if insufficient disclosure or the taxpayer's (or his agent's) bad conduct can validate a DA and, if necessary, extended time limits.

Oddly, not pointing out to HMRC that their assessment is in too small a sum gives rise to a penalty whereas there is no penalty for failing to tell HMRC that their conclusion in a CN understates the true amount of tax owed.

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Replying to More unearned luck:
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By Justin Bryant
24th May 2021 14:28

Thanks, but I don't think any of that answers my point.

The SC did not address the "no two bites of the cherry" situation, as described at para 64 here:

https://financeandtax.decisions.tribunals.gov.uk/judgmentfiles/j11580/TC...

The CoA found that a discovery did not occur when HMRC found a new reason for contending insufficiency or invoked a different rectification mechanism. The SC skirted round that latter issue or simply failed to address it (it was not relevant in Tooth as there was no (defective) CN per my comments above).

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By More unearned luck
24th May 2021 17:15

Do you mean the wrong piece of paper argument? HMRC issued Mr T with the wrong piece of paper in 2010 (a sch 1 a enquiry notice instead of a s 9a notice). Should HMRC be allowed to correct that error if they discover their error after the enquiry window has closed? Or to put in another way from the outset they knew of the insufficiency the only thing that changed in 2014 was the realisation (post Cotter) that they had opened the wrong sort of enquiry. If so the demolition of the concept of staleness made the 2010 discovery valid, but Mr T was saved by the restoration of common sense to 'deliberate'.

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Replying to More unearned luck:
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By Justin Bryant
25th May 2021 10:41

My point is slightly subtle but important, in that the SC only dealt with an ineffective HMRC enquiry and not an ineffective CN (as was the case in the case in the link above), and the SC's comments were obiter, so possibly there is still scope to argue HMRC cannot correct a defective assessment (c.f. enquiry) with a DA.

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By More unearned luck
26th May 2021 19:58

In a taking-a-different-view case with adequate disclosure in the white space then HMRC can't correct with a DA, but in a case were they can prove bad conduct then they can.

In the recently reported case of Albany Fish Bar some assessments for deliberately undeclared VAT on takings were held to be invalid as HMRC took too long to raise the assessments, so there is 'staleness' in VAT but not in direct tax!

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Replying to Justin Bryant:
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By RayM55
25th May 2021 11:54

Sorry that is and has always been clear. Time limits!

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By Justin Bryant
25th May 2021 13:09

To spell out my point (obviously too subtle for some), what is there to stop HMRC issuing a corrective DA within 4 years when they have previously issued a defective CN per the other above case? Does Tooth unambiguously say HMRC can do this? I don't think so.

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By RayM55
25th May 2021 13:47

What do you mean by a defective closure notice other than where the enquiry was opened into the wrong taxpayer?

And why would the Court want to stop a DA within the 4 year period other than on the basis that HMRC was aware of the deficiency at the point the enquiry window closed?

The facts in Tooth are unusual and had HMRC approached the question of deliberate correctly it would not have reached the Courts but these days they like to have a go.

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By Justin Bryant
28th May 2021 18:02

I don't understand your middle sentence above. The court's job is to apply the law to the facts (as found). No more, no less. What the court "wants" is neither here nor there.

An HMRC CN may be defective for any number of reasons (e.g. a CN into a voluntary SDLT return).

I am not arguing with you re deliberate and it was a nonsense HMRC argument (as it led to the nonsense corollary identified by the SC and that the CoA was too dumb to spot - even I immediately spotted it).

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By RayM55
28th May 2021 22:52

Sorry you are taking too many abstract ideas and trying to create a world where there is uncertainty as to taxpayer rights. Providing HMRC stay within the meaning of careless and deliberate the time limits will take care of discovery, staleness, defective CNs and all that stuff.

The reality is that it is less complex than you suggest.

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By Justin Bryant
02nd Jun 2021 14:02

Again, I don't understand what you mean. Possibly this case will help you understand my above "no two bites of the discovery/assessment cherry" point, which is not an abstract/complex point at all (assuming you understand a little bit about tax): https://www.bailii.org/uk/cases/UKFTT/TC/2021/TC08131.html

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By RayM55
02nd Jun 2021 15:53

It would possibly help if I understood a little about tax, but you can’t have everything!

If I unpack your point then the situation would be: HMRC open an enquiry into Co A. They realise that it should have been company B so they close A.

They are too late to issue an enquiry into B so they make a DA instead.

With the greatest respect, there is ample authority to support two positions:

1. there was adequate disclosure made at the point the enquiry period for B ended. HMRC can make a discovery but they cannot act upon it unless they can show that the disclosure was inadequate. The latter will always be subjective since each case will depend upon its facts.

2. There was no or inadequate disclosure. HMRC can make a DA within the four year period or within the longer six and 20 year periods if they can show the necessary degree of culpability.

That is the law, it’s always been the law and I suggest that if you run your scenarios against it you will find that Tooth is a good result since it prevents HMRC from abusing the time limits.

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By Justin Bryant
02nd Jun 2021 19:19

Your examples/comments are irrelevant to my above "no two bites of the cherry" point, which you should hopefully understand if you read the case above in full - or just see para 65 (which indicates the Tooth lower court decisions re that point remain good law, which is exactly what I was saying above should be the case and yet none of the SC Tooth commentary in Tax Journal etc. seems to have noted that point - I have just checked the point with a tax QC and he agrees I'm potentially correct).

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By RayM55
03rd Jun 2021 09:25

Sorry your concern remains misplaced. If HMRC close an enquiry on the basis that there is no insufficiency despite that insufficiency being apparent at that point it is not open to them to issue a discovery assessment. The original Inspector would be prevented by the fact that he/she had not made a discovery and any new Inspector by the fact the the insufficiency was evident at the point the enquiry was closed.

Equally in an enquiry situation HMRC would be right up against the four year time limit in most cases and would need to argue a careless or worse error.

Whether, as HMRC are showing signs of doing, HMRC could seek some civil remedy to correct their error is not specifically a tax question. I also accept that whether discovery allows HMRC to assess a situation where they have erroneously issued a “clean slate” closure notice, which is what I assume you mean by defective, is moot and I suppose not dissimilar to the old S54 situation as evident in Bass Holdings (I think it was) where the issued assessment did not match the s54 agreement and the Court allowed it to be corrected.

But there is a difference that a closure notice is not an agreement at all so HMRC would likely be in difficulty. But the fact remains that if HMRC did issue a discovery assessment in the circumstances discussed the only recourse is through the appeal process. And these days...

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By Justin Bryant
08th Jun 2021 14:08

Again, you are not addressing my simple "no two bites of the discovery/assessment cherry point". I note that PLC agree with my view in their Sean Kelly v HMRC [2021] UKFTT 162 (TC) (18 May 2021) case note that this point still applies notwithstanding the SC's Tooth decision:
https://checkpoint.url-protection.com/v1/url?o=http%3A//uk.practicallaw....

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By chronus
24th May 2021 12:31

I do wonder, how much of this is a matter of "discovery " and how much of it is tax avoidance schemes. I think the real impact must be on the latter.

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By More unearned luck
24th May 2021 17:30

I disagree, its 100% the former, 0% the latter. HMRC's counsel and the judges didn't criticise Mr Tooth for participation in an avoidance scheme nor for him claiming relief on the assumption that the scheme worked. HMRC's complaint was merely about the way he had sought to carry back relief to year 1. The CoA went out of their way to say Mr T hadn't done any thing wrong. On the view of the majority blameless conduct can amount to deliberately bringing about a loss of tax. Relief was also claimed in year 2, but HMRC didn't need to accuse Mr T of bad conduct for that year so didn't. But according to the zeitgeist both claims were equally reprehensible.

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By Mr J Andrews
24th May 2021 12:51

Not so much staleness but another example of putrefaction within HMRC's administration.
Perhaps another MTD abbreviation might read My Tooth Decay ?

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By whitevanman
25th May 2021 23:54

What some seem to overlook are the facts.
The avoidance scheme gave rise to a loss in 2008/09 which was claimed to be carried back and set against income for 2007/08.
HMRC considered this was a claim "outside a return" and that led to them opening an enquiry under Sch 1a. That was in 2009.
In 2014 Cotter was decided. It confirmed (in effect) that, by making his own self assessment of the tax due, Sch 1a could not apply to Tooth. The enquiry should have been made under S9a.
At that stage HMRC could either give up and accept they couldn't collect the tax from Tooth or they could seek to argue for discovery. It would seem that the "policy" people at HMRC then got their heads together and decided to pursue the "deliberate error" argument on the basis that the partnership pages were completely inappropriate and amounted to an error in a document within s118.
It is important and interesting to note that, at no time did they ever argue that the return was incorrect simply because the loss arose under a scheme that failed. As has always been the case (but some Awebbers seem unwilling to accept) they accept that a return based on a tenable view of the law, supported by expert advice, is not an incorrect return (for relevant purposes) even if the scheme is found to fail (see the SC judgement around para 20).
I rather suspect that, if the boot was on the other foot, those who criticise HMRC'S approach, would have acted no differently in seeking to recover the £500k (ish) from Tooth and also in clarifying how the law worked for any similar cases.
All of this should be enough to show that those who assert some tardiness or incompetence on the part of HMRC officers are somewhat wide of the mark and really should read and understand the whole case.

As to comments made about discovery applying separately to each individual officer, these again mis-state the position.
S29 contains rules about information deemed to be in an officers possession and that includes anything in his / her return. That will include white space entries. The idea of a "negligent officer" simply not reading a return cannot apply.
A discovery assessment cannot be made to rectify a failure to enquire, if that discovery is based on information in the return (s29(5)).
If information arises other than in the return (such that s29(5) does not apply) then the safeguard for the client is the statutory time limit of 4, 6 or 20 years as appropriate.
A "negligent officer" could fail to take action where information is obtained in an enquiry but if that leads to an incorrect Closure Notice, again a later discovery would not be allowed (s29(5)(b))

It is difficult to imagine the circumstances where the perceived unfairness could arise.

As others have said, Tooth does not change anything in this regard, it merely confirms what has always been the position.

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Replying to whitevanman:
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By Justin Bryant
28th May 2021 19:07

As usual you've got things wrong. This bit for example

"A discovery assessment cannot be made to rectify a failure to enquire, if that discovery is based on information in the return (s29(5))."

That would only be correct in very limited cases where either the taxpayer had more or less spelled out in the return that HMRC may consider there is an under assessment (as was more or less the case in Tooth) or like in that recent case perhaps when something went through STRGL rather than P&L and should a been taxed (or this unusual case https://www.accountingweb.co.uk/tax/hmrc-policy/tax-return-software-gave... ). In other (more common) cases, a discovery is a very low threshold indeed and can arise merely from a change of view by the inspector on the information in the return. See:

"For these purposes, as shown in Charlton, it is not sufficient for the taxpayer to point out that HMRC had all the information so as to reach such a decision earlier..."

https://www.taxadvisermagazine.com/article/comedy-errors

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By Justin Bryant
02nd Jun 2021 19:08

This point is well summarized at para 59 here: https://www.bailii.org/uk/cases/UKFTT/TC/2021/TC08128.html

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