Upper Tribunal: discovery assessment invalid where return disclosed that legal interpretation was controversial

Out-Law Legal Update | 19 Feb 2018 | 11:15 am | 4 min. read


Raymond Tooth entered into a tax planning scheme, known as ‘Romangate’, which he understood would generate employment related losses which could be set off against income in the previous tax year. When Tooth's accountants completed his 2007-2008 self-assessment tax return, the HMRC-approved software they used did not enable them to access the box relating to capital losses. They therefore recorded the losses in the partnership pages of the return and included wording in the "white space" of the return, making it clear that the losses were employment losses and not partnership losses. The wording also stated that Tooth's interpretation of tax law may be at variance with that of HMRC and flagged that he expected HMRC to open an enquiry into the return.

In most cases, HMRC has 12 months after a tax return is submitted to open an enquiry into the return. In certain circumstances Schedule 1A Taxes Management Act 1970 enables it to open an enquiry into a claim within a 12 month period.

In August 2009, HMRC opened an enquiry into Tooth's loss claim under Schedule 1A. However, in 2013 the Supreme Court decided in the case of Cotter (13-page / 135KB PDF) that, in circumstances such as those of Tooth, HMRC did not have power to open a schedule 1A enquiry and should instead have opened an enquiry into the return under section 9A. By this time, the 12 month time limit for enquiring into the return had long-since expired, and the only way that HMRC could challenge the contents of Tooth's return was by making a discovery assessment.

HMRC can only make a discovery assessment if it 'discovers' an underpayment of tax and that underpayment is due to careless or deliberate behaviour by the taxpayer or their agent. Alternatively, HMRC can make a discovery assessment if it discovers an underpayment and can show that at the time when an HMRC officer ceased to be entitled to open an enquiry into the return, or issued a closure notice in respect of an existing enquiry, the officer could not reasonably have been expected, on the basis of the information available to them at that time, to be aware of the under-assessment of tax.

If it can show the taxpayers' behaviour was deliberate HMRC can go back 20 years to reclaim tax. The normal time limit is only four years after the end of the relevant year of assessment or six years in the case of careless behaviour.

In October 2014 HMRC issued a discovery assessment alleging that Tooth's return contained a deliberate inaccuracy that brought about an insufficiency to tax.

However, in this case the Upper Tribunal judges decided that there was no inaccuracy in the return, stating "In our judgment, where a taxpayer adopts a position in his return which, albeit controversial cannot (at the time of the return) be said to be wrong and takes the trouble to identify the position he has taken (and the fact that it is controversial) in that return cannot be guilty of an inaccuracy when, subsequently, it is established that the position taken by the taxpayer is wrong".

They said that when considering whether a document was "inaccurate", the whole document, including the context of that document, had to be taken into account.

In this situation the return becomes inaccurate, but it was not inaccurate at the time it was made. Even if there had been inaccuracies in the return, the judges said these would not be deliberate, because Tooth took steps to draw them to the attention of HMRC.

"The Upper Tribunal reiterated the seriousness of an allegation that a taxpayer has brought about a loss of tax “deliberately”, describing it as being “tantamount to fraud," said Ian Robotham, a tax disputes expert at Pinsent Masons, the law firm behind Out-Law.com.

"Put that way, the finding that Tooth had not acted deliberately can only be described as a common-sense outcome in circumstances where disclosure was made in the white space of his return explaining how it had been completed and specifically drawing HMRC’s attention to the fact that they may take issue with it due to a difference in opinion on interpretation of the law," he said.

Although the fact that there was no inaccuracy was sufficient to render HMRC's assessment invalid, the judges considered whether, if there had been an inaccuracy, HMRC had made a 'discovery'. In 2016, the First Tier Tribunal had found in favour of HMRC on this point.

However, the Upper Tribunal judges considered that two HMRC officers could not make the same discovery, stating "It seems to us that in this case, the first officer makes the discovery; the second officer simply finds out something that is new to him." The Upper Tribunal said that there was no sufficient basis, given the facts found by the First Tier Tribunal, to justify its conclusion that there was a discovery.

"The Upper Tribunal has potentially raised the bar a notch in terms of the hurdle for HMRC to overcome in proving that a “discovery” has been made," said Clara Boyd, another tax disputes expert at Pinsent Masons. "Recent cases have tended to focus on the subjective nature of a “discovery” by an officer to find in HMRC’s favour. However, in addition to considering the state of mind of the officer, the Upper Tribunal went on to undertake a more forensic examination of what, objectively, constitutes a discovery, albeit the comments are obiter dicta. This is a welcome approach, providing some practical guidance which should help towards protecting the taxpayer against stale assessments."

Pinsent Masons acted for the taxpayer in this case.