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Agent’s tax return error was careless

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A tax agent incorrectly believed that a redress payment was not taxable in his clients’ 2013/14 returns, as he failed to recognise the payment related to the taxpayers’ rental business.

1st Jul 2022
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The clients were Mr and Mrs Johnson who ran a dental practice through a company. They also owned a rental property, in their own names.

Their 2013/14 tax returns were prepared by Mr Green - an experienced tax adviser who had worked in tax since 1988 - and submitted on time through Mayfield & Co.

Facts

In 2014, the Johnsons were awarded compensation relating to an interest rate hedging product.

The redress amount totalled over £100,000. Around £86,000 represented a refund of net amounts payable by the Johnsons on the original swap, plus interest of just over £18,500, against which tax was deducted at 20%.

A January 2014 letter from NatWest Bank (who awarded the compensation) stated that:

“You should include the gross interest and tax deducted figures together with the remaining balance of the redress payment in the accounts of your business and report this information to HM Revenue & Customs in either your own or your business’ tax return as appropriate.”

HMRC also published guidance in January 2015 (before the Johnsons’ returns were submitted) that the redress payment was taxable on the basis that a taxpayer would have previously claimed tax relief for the payments under the interest rate hedging product as an allowable business deduction.

Tax agent uncertainty

The tax agent considered the redress when preparing the Johnsons’ returns and was happy that the interest element was taxable.

Although Green was uncertain as to the treatment of the remaining redress, he did not look into the detail of the redress payment and the facts relating to it. As the payment was made in the taxpayers’ personal names and was not in relation to their dental business, the agent concluded that the payment related to a non-business loan. He thought that the payment related to compensation and was not likely taxable.

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Replies (12)

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By sammerchant
01st Jul 2022 10:58

Out of interest - would the redress payment have been all taxable in the year of receipt? The earlier deductions claimed might well have been at the standard rate while the redress payment taxed when received might well be taxed at the higher rate/s.

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Replying to sammerchant:
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By richard thomas
01st Jul 2022 22:03

Yes, if that's when it's accounted for (s 25 ITTOIA).

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By Paul Crowley
01st Jul 2022 12:40

I consider that the white space issue really needs to be addressed.
HMRC do not read them, reading and understanding needs a human and tax returns are dealt with by machines.
As such is the white space really a notification to HMRC?
Will there be a white space in MTD?

Thanks (5)
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By Justin Bryant
01st Jul 2022 14:15

Why not quote in full as follows?:

"8. Mr Bradley’s position is straightforward. What is required is that an agent takes
reasonable care to avoid an insufficiency or loss of tax and clearly an agent who read HMRC’s
guidance but then takes a different respectable technical review is not careless. That is not the
situation here..."

Thanks (2)
Replying to Justin Bryant:
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By Paul Crowley
01st Jul 2022 14:44

Glad you read it and posted
The article seemed to suggest that HMRC were defending the tax agent.
That would indeed be peculiar.
It comes over as if tax agent and client agreed to ignore it and the white space entry was a tail cover excercise.
Agent claimed the costs and knowingly ignored the refund

Thanks (1)
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By Mr J Andrews
01st Jul 2022 14:15

Lucy describes Mr Green as an experienced tax adviser - since 1988.
But goes on to say that Green was uncertain as to the tax treatment.............
Anything else a bit uncertain about in the past 30 odd years ?

Thanks (2)
Replying to Mr J Andrews:
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By Mr_awol
01st Jul 2022 22:12

To be fair, whilst I’d like to think I’d have got this one right (I don’t actually think it was all that ambiguous) I am reluctant to be too scathing in case there stuff this guy would have got right that I haven’t!

I haven’t read the case, only this article, but I assume the penalties were cancelled because it was the agent, not the taxpayer, who was careless and as such the client (apart from perhaps not having budgeted for c£40k of tax) are no worse off than they ‘should’ have been?

Thanks (1)
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By richard thomas
01st Jul 2022 22:01

A good summary of the Johnson case. The main thing missing from Nigel Popplewell’s decision is at paragraph 4 where he should have referred to s 36(1B) TMA as well, as s 36(1) only refers only to the case where the loss of tax was brought about carelessly by “the person”, meaning the person assessed. Subsection (1B) like s 29(4) extends the scope of subsections (1) and (1A) to the “on behalf” of case, which is what we have in Johnson.

This is the third (at least) decision in which the taxability of the interest rate hedging product redress payments has been considered (following Gadhavi and Wilkinson) and I have become increasingly bemused as to why those acting for the appellants or HMRC or even a judge of their own motion have not taken what to me is a simple and obvious argument, though it might have unforeseen consequences for the parties.

In all three cases HMRC succeeded by reference to an argument that applied the principle in Donald Fisher (Ealing) Ltd v Spencer (HM Inspector of Taxes) to the facts, and this was accepted by Marilyn McKeever in Gadhavi and Tony Beare in Wilkinson. In Johnson that was conceded, and the issue was whether the agent was careless in the way he took or did not take the HMRC guidance into account.

The relevant principle from Donald Fisher was set out by Tony Beare in Wilkinson at 31(5):

“a sum of money received in respect of an expense which has been incurred as a deductible trading expense is subject to tax as a trading receipt.”

In all three cases the taxpayers had shown the net swap payments as deductions in the P&L account and had not disallowed them in the computation. In Wilkinson and Johnson, this was reported and agreed as fact. In Gadhavi Marilyn McKeever seems to have found as a fact that they were “properly” deductible as revenue expenditure, something which(with respect to my former colleague) I do not think was open to her.

In fact I believe that all three cases were wrongly decided, because the net amount of the swap payments was not deductible for income tax purposes (CT is another matter: obviously the derivatives legislation for CT does make them deductible). The reason why not is that the payments were capital expenditure, not revenue expenditure.

Starting with the obvious point, a 10 year loan from a bank to the owner of a property business is a capital matter (see for example Beauchamp v F W Woolworth plc.) Interest on such a loan is capital expenditure (Ward v Anglo-American Oil Co Ltd, Anglo-Continental Guano Works v Bell, European Investment Co Ltd v Jackson). Of course, where the interest was annual interest relief could in effect be given as a retainable charge on income, so that when the rules for interest changed in 1969, s 137(f) ITA 1952 (disallowance of capital) was treated as modified by paragraph 4(1) Schedule 13 FA 1969 so as not to disallow interest on that account. This provision, as a proviso to the general rule, was carried forward into ICTA 1970 and ICTA 1988, in the latter as s 74(1)(f):

“any capital withdrawn from, or any sum employed or intended to be employed as capital in, the trade, profession or vocation, but so that this paragraph shall not be treated as disallowing the deduction of any interest;”

The rewrite decided to separate the main rule from the proviso, so that section 33 ITTOIA (capex) does not contain any exception for interest, but section 29 ITTOIA says:

“Interest
For the purpose of calculating the profits of a trade, interest is an item of a revenue nature, whatever the nature of the loan.”

But this only applies to interest and not to any other costs associated with a loan. Thus the incidental costs of obtaining loan finance were not deductible until special legislation allowed it (now ss 58 and 59 ITTOIA); exchange losses are not allowable (F W Woolworth) (now still only for CT) and it follows from all this that interest rate swap payments (and payments on other loan hedging derivatives) are not deductible as being capital expenditure caught by s 33 ITTOIA.

For more on the history see Richard Thomas “Retention of tax at source and business financing” in Studies in the History of Tax Law Vol. 7 (2015).

If the swap payments are not deductible, then any compensation for there having been excessive payments is not taxable, on the Donald Fisher principle. Whether they would be within CGT is another matter: it was the HMRC argument alternative argument in one of the cases.

Of course it is unlikely that anyone would argue this, as the taxpayer would be inviting HMRC to disallow the payments, though they might have an uphill task reopening many years. HMRC would be saying the receipt from the banks is only liable to CGT but we can disallow some of the payments, not as attractive for them as taxing the payments to income tax in most cases.

But them’s my views.

Thanks (6)
Replying to richard thomas:
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By Justin Bryant
02nd Jul 2022 09:57

By far the best comment on this website this year. Amazing stuff in fact from this site's foremost tax commentator. I know a little about this capital/revenue divide area from reading Norfolk and Montagu on the Taxation of Interest and Debt (the only half decent book on the subject in my view) back in 2007 when I was arguing with HMRC that an early redemption penalty on a client's mortgage was deductible revenue rather than disallowable capital and HMRC caved in just before the FTT hearing and I believe that case prompted a change in the law (the HMRC manual previously wrongly said it was disallowable capital based on case law). I have no doubt RT is correct.

Thanks (1)
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By Justin Bryant
02nd Jul 2022 18:33

Also, this same penalty issue (where a tax adviser was engaged re a mistake) was rather germane here:

"Rangers seems to have persuaded HMRC its tax conduct wasn’t sufficiently culpable to attract a penalty."

https://www.glasgowtimes.co.uk/news/18037973.rangers-hmrc-tax-case-blund...

I suspect HMRC only sought a penalty there because it was a good ol' BW scheme although some suspect foul play per the link below.

https://www.heraldscotland.com/news/19338512.revealed-secret-taxman-game...

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By Karen whitehead
12th Jul 2022 12:37

whilst I agree with the findings on the whole - I still don't see how HMRC could claim that they had made a discovery when the information was provided to them in the white space. I worry that this has implications going forward. Can HMRC raise a discovery case regardless of the information that they have been given by a taxpayer? I use the white space to explain entries on the tax return. If HMRC is going to ignore the white space then surely we are better off without it.

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Replying to Karen whitehead:
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By richard thomas
13th Jul 2022 20:30

The OP says that they “still don't see how HMRC could claim that they had made a discovery when the information was provided to them in the white space.”

This quoted part is capable of two meanings, given the context of the rest of the question:

1 How can HMRC discover that an amount of income tax or capital gains tax ought to have been self-assessed but has not been so assessed where there is a white space entry about the item of income in question (s 29(1) TMA)?

2 How can a discovery assessment be valid in that HMRC has met one of the two necessary conditions in s 29(4) and (5) where there is a white space entry about the item of income in question?

On the first point, subsection (1) by itself sets a low bar, as it is a subjective test. All it requires an officer to do is to find out that there may be income tax which has not been included in the self-assessment. That last point is important as it is not the return as a whole in which HMRC must look for an omission, but only that part which is the self-assessment. Of course an officer cannot usually find out anything much of relevance from the self-assessment alone, the result of the tax calculation, but they can look at the entries in, and not in, the return and compare them with any other information they hold.

We know (paragraph 6(2) of the decision):
“(2) The tax return for that tax year for the first appellant declares total rents from property of £3,600 and loan interest and other financial costs of £1,234. The tax return for the second appellant for that tax year records total rents of £12,480 and loan interest and other financial costs of £5,931.”
and
“(5) On page 7 of the first appellants’ 2014 tax return, there is a white space disclosure which reads “a compensation payment of GBP 43218 was received during the year from NatWest in respect of Interest Rate Hedging Products which is not considered to be taxable.”
We do not know what prompted the HMRC check three years after the return was filed, but presumably HMRC got information from Nat West or the FCA.

Having looked at the return with the information they would have seen that the income from property pages could not have included the redress payments and nor were they included in any other conceivably relevant box.

They would have seen that interest from Nat West would be on the main return, but a redress payment is not interest which was a separate matter.

The white space entry would only have confirmed them in the view that tax on the redress payment was not included in the self-assessment, and so they would be justified in holding the view that s 29(1) was fulfilled. At least had I been the judge I would have held that HMRC had made a discovery, and nothing in the report of the case suggests that the appellant thought otherwise.

I think that this is probably not what the OP is concerned about, but I put it in to draw the distinction that is sometimes overlooked between s 29(1) on its own, which is the condition for all discovery assessment whether or not a return had been made, and the conditions in subsections (4)* and (5) which only apply if a return has been made.

*Caveat: where a return has not been made so that apparently s 29(4) is not relevant, it still actually is, because the time limits for assessments are applicable whether or not a return has been made, and they require carelessness or fraud (ie deliberate conduct) to be shown by HMRC in any event (pace Justin who may still take a different view about the 20 year FTN limit).

From what the OP said, I take it the concern may be with s 29(5) (read with (6)). If you put a white space entry telling HMRC about a transaction, can they ignore the enquiry period limit and make an assessment under s 29?

The question there is: can the officer have been reasonably expected, when the enquiry limit ends, on the basis of the information made available to them before that time, to be aware that an amount of income tax or capital gains tax that ought to have been self-assessed has not been so assessed.

A reasonably competent officer would have read the white space (see Tooth in the Supreme Court). There the appellant is specifically saying that the redress payment is not taxable, but no reasons are given for holding that view. As I have posted before, I do not agree that the payment is taxable, but that’s not the point. The appellant’s adviser said in evidence that he had doubts, based on the issue of whether the loan was taken out for personal, non-business purposes. But he didn’t express those doubts or say on the basis of what facts he held that view which is contradicted by the entries on the return.

Had I been the judge and s 29(5) was in issue, I would have held that the actual white space entry here (and that’s the issue) does not prevent s 29(1) from operating.

But in this case HMRC only relied on subsection (4) as they were outside the normal time limits (5 April 2018). It was their tardiness and delay that limited them to demonstrating that s 29(4) applied. Showing s 29(5) applied would not have availed them as it does not override the time limits.

It is a separate question whether the Tribunal was right to find carelessness in this situation. I think I would not have dismissed the taxpayer’s argument about the white space quite in the way that is done in paragraph 17 of the decision, and may have considered that the white space point was relevant to carelessness. But I was not hearing the case and more importantly did not have all the papers that the tribunal did. And even if I had considered the white space argument relevant to carelessness, I am not, from my ivory tower, going to say one way or the other what I would have held. I think it is a point worthy of being considered by the UT on appeal, but I am certainly not going to say the Tribunal in this case were obviously wrong.

Thanks (1)