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HMRC suffers big defeat after procedural failure

16th Feb 2018
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The Upper Tribunal (UT) has upheld an FTT decision that HMRC did not satisfy the necessary conditions for making a discovery assessment, and so the taxpayer escaped a tax bill of £475,498.


In 2008, Raymond Tooth ([2018] UKUT 0038) reduced the tax on his self assessment when he invested in a tax avoidance scheme, which was subsequently invalidated by new legislation. In 2014, HMRC issued what it believed was a valid “discovery” assessment (under TMA1970, s 29) to recover tax of £475,498.20 from him.

What is “discovery”?

The legislation at TMA 1970, s29(1) allows an HMRC officer to make an assessment if they discover that one of three circumstances applies:

  1. Income or gains which should have been assessed have not been assessed
  2. An assessment has been made but charges too little tax
  3. Too much relief has been given on a claim

The word 'discover' is interpreted as meaning: the officer, acting honestly and reasonably, needs to move from not believing one of those three circumstances applies, to believing that it does. This “can be for any reason, including a change of view, change of opinion, or correction of an oversight”.

Any limitations?

HMRC can’t normally make a discovery (and raise a discovery assessment) if the taxpayer has filed a return for the tax year in question. The concept behind self assessment is that HMRC should resolve matters using the enquiry system, and open any enquiry within the enquiry window.

However, there are two situations when HMRC can step outside the usual enquiry process and make discovery assessments.

The first of these is if the shortfall of tax arose from the taxpayer’s carelessness (or that of someone acting on their behalf) or was deliberate.

The second is more complex and requires both of these things to be true:

  1. Either the enquiry window has passed without an enquiry being opened, or HMRC has formally ceased its enquiry into the return.
  2. The officer “could not have been reasonably expected, on the basis of the information made available to him before that time, to be aware” that there was a shortfall of tax. In other words, if HMRC has received enough information to enable it to deal with the matter by enquiry but fails to, that will protect the taxpayer from subsequent discoveries.

The information “made available to” the officer includes the tax return and any accompanying documents, and anything provided during the course of an enquiry, but it is limited to material provided by or on behalf of the taxpayer. In the 2004 case of Langham v Veltema (76 TC 259), the court pointed out that the officer’s awareness should come clearly and directly from this material. The HMRC officer should not need to seek elsewhere for hints that the tax was inadequate.

HMRC published a statement of practice (SP1/2006) setting out the sort of information which will suffice in a number of situations, including (as was the case with Tooth) a disagreement between HMRC and the taxpayer over an interpretation of the law. Paragraph 18 of SP1/2006 suggests: “comments to the effect that the taxpayer has not followed HMRC guidance on the issue or that no adjustment has been made to take account of it” will protect the taxpayer from discovery.

When must HMRC make the assessment

The HMRC officer, having made a discovery, needs to make the discovery assessment expeditiously – while the discovery is “new” and before it goes “stale” (terms derived from the case of Charlton UKUT 2012/770).

While no-one expects the assessment to be issued immediately, long delays are unacceptable. Even if a decision is being awaited on a pending case (which will decide whether HMRC’s view of the law or the taxpayer’s is correct), there is nothing to stop HMRC from making a protective assessment and suspending collection of the tax pending that decision. Basically, if an officer believes more tax is due, he should do something about it.

Above all, HMRC must make the discovery assessment within the appropriate time limit, which is:

  1. Four years – in the absence of carelessness or deliberate error
  2. Six years – where the inadequacy of tax arose from carelessness
  3. Twenty years – where the inadequacy arose from deliberate action.

How did Tooth escape tax?

Tooth made the investment in the tax avoidance scheme in 2008/09, but HMRC failed to raise the discovery assessment until October 2014. HMRC needed the UT to accept that Tooth had been either careless or deliberately misleading in his self assessment which reduced his tax liability on the basis of his investment in the avoidance scheme.

Sadly for HMRC, and happily for Tooth, he had been neither careless nor deliberately misleading. He made a clear disclosure in the white space of his tax return stating that he had followed a treatment contrary to HMRC’s view of the law, and expressly invited HMRC to open an enquiry into the return. This was exactly the approach which HMRC had asked for in SP1/2006!

Worse still for HMRC, not only did the tribunal decide that the discovery assessment was out of time, it also ruled that there had not even been a valid discovery in the first place.

Tooth had provided HMRC with more than enough information to be aware that (on HMRC’s understanding of the law) there was an inadequacy in his self-assessment. No enquiry was opened, so no discovery could be made later unless there had been deliberate inaccuracy – which there was not.

Even worse: if there had been a discovery, it must have happened in 2009 when HMRC first wrote to Tooth denying his claim. Not issuing an assessment for another five years meant that discovery had gone “stale”. As something can only be discovered once, HMRC cannot have been acting on a “new” discovery made in 2014.

What HMRC should have done

An enquiry under TMA 1970, s9A should have been opened into Tooth’s return and kept open until it became 100% clear that his interpretation of the law was wrong. The tax could have been collected by simply amending his self-assessment – which has no time limit.


Replies (9)

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By Vaughan Blake1
16th Feb 2018 14:53

Much as I dislike 'avoidance schemes' there is something infinitely satisfying about HMRC tripping up when they do not follow the rules, and their own guidance!

Thanks (8)
By Justin Bryant
19th Feb 2018 14:57

Yes; this must be particularly annoying for HMRC (sick to the Tooth even one might say) as we all know this was an utterly hopeless tax avoidance scheme in the 1st place with zero chance of success (barring HMRC [***]-ups), and one wonders why they did not just simply block it retrospectively as that would have easily solved the problem.

Thanks (1)
Replying to Justin Bryant:
By chicken farmer
21st Feb 2018 09:39

They DID block it retrospectively - s.128(5A) ITA 2007. This case was not about whether the scheme worked but whether the Revenue's discovery was a) valid and b) on time. Due to their incompetence it was neither

Thanks (0)
Replying to chicken farmer:
By Justin Bryant
22nd Feb 2018 10:14

I obviously meant properly retrospectively i.e. back to when Tooth did the scheme with a specific requirement for him to amend his tax return accordingly, so there then would not have been the need to take him to a Tribunal in the 1st place as he would then have no possible defence.

Thanks (0)
By Mr Trellis of N Wales
16th Feb 2018 18:15

"How did Tooth escape tax?

Tooth made the investment in the tax avoidance scheme in 2008/09, but HMRC failed to raise the discovery assessment until October 2014. HMRC needed the UT to accept that Tooth had been either careless or deliberately misleading in his self assessment which reduced his tax liability on the basis of his investment in the avoidance scheme."

The tax year in question was 2007/08. The significance of which is that October 2014 is more than six years after it ended and thus HMRC had to prove, among other things, that the loss of tax was brought about deliberately by the taxpayer or someone acting on his behalf. Carelessness was an irrelevant matter. The correct answer to the question posed "how did Tooth escape tax" is HMRC incompetence - they opened the wrong sort of enquiry.

Thanks (1)
Replying to Mr Trellis of N Wales:
By Andy Keates
28th Feb 2018 11:37

Actually, since the claim related to the carry-back of loss relief from one year to the preceding year, it falls within TMA 1970 Schedule 1B. As a result, although it is calculated by reference to the earlier year's income and gains, it is executed as a claim of the later year. Which would enable carelessness to be used to extend the assessment window to April 2015.

That very thing (ie Tooth amending his 07/08 return for a later year loss when there was no statutory authority to do so) should have triggered an immediate enquiry, even without the fact that Tooth actually told them to raise one!

Thanks (0)

It boils down to the fact that Tax is about the legal construct and every one bearing the responsibility. I wonder if this makes HMRC appear weak, given the recent powers it was further granted?

Thanks (0)
By Mr J Andrews
19th Feb 2018 12:40

A toothless Inspector or another sign of the crumbling, creaking HMRC administrative staff cutting ? I fear the latter.
At least the unacceptably p0or standard of this particular government department appears to be dysfunctional in both compliance and customer service.
It does however beggar belief why the simple procedural
task of recording the potential loss - with the time limit for making a protective assessment - was not adhered to.
Fred Davies, my old D.I. in Newport 1 Tax Office is no doubt turning in his grave at such incompetence.

Thanks (5)
By RoseTavern
20th Feb 2018 15:39

'Jaws' is successfully dishonest by virtue of the unscrupulously untruthful allegations he makes for his clients.
Get real people; lawyers are protected gangsters so STOP using them entirely.

Thanks (0)