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 ( 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:
- Income or gains which should have been assessed have not been assessed
- An assessment has been made but charges too little tax
- 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”.
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:
- Either the enquiry window has passed without an enquiry being opened, or HMRC has formally ceased its enquiry into the return.
- 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:
- Four years – in the absence of carelessness or deliberate error
- Six years – where the inadequacy of tax arose from carelessness
- 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.