A discovery too far?
Since the Court of Appeal decision in Langham v Veltema the courts and tribunals have considered several challenges by taxpayers to HMRC's power to make discovery assessments after failing to open in time enquiries into self-assessments.
It was hoped that the Upper Tribunal's decision in Charlton2 would provide clarity in an area of law and practice that can at times seem confusing. That now seems unlikely as the First-tier Tribunal ('FTT') has decided, in Robert Smith v HMRC, that HMRC can make a discovery assessment where its failure to open an in time enquiry was caused by the HMRC officer concerned having gone on sick leave for over 3 months in the period before and after expiration of the enquiry window.
The appellant participated in the Second Hand Insurance Premium Scheme ('SHIPS'), the aim of which was to create a tax deductible capital loss of £532,695.
On 22 January 2002 the appellant submitted to HMRC his self-assessment tax return for 2000/01 ('the Return'), which contained the following 'white space' information:
- during that year he had acquired a non-qualifying second hand insurance bond for £532,695 and redeemed it for £483,229;
- for tax purposes the surrender fell to be taxed under specified provisions of the Income and Corporation Taxes Act 1988 in relation to income and the Taxation of Capital Gains Tax Act 1992 ('TCGA') in relation to capital gains;
- the income tax charge was nil, being equal to the excess of surrender proceeds over premiums paid into the policy;
- the proceeds for capital gains purposes amounted to nil as section 37 TCGA provided that sale proceeds which had been taken into account for income tax purposes should not be taken into account for capital gains purposes;
- reference was made to the additional disclosure in schedule CG7 for details of the capital gains position; and
- as expenditure incurred for capital gains purposes was the amount paid for the bond, there was an allowable loss of £532,695.
On 15 July 2002 Mr Cass, a member of HMRC's Capital Taxes Technical Group, posted a message on HMRC's intranet describing SHIPS, saying Capital Taxes were considering how best to challenge it and requesting that anyone identifying use of SHIPS should contact him.
On 13 September 2002 Mr Hiron, the HMRC officer dealing with the Return, spoke to Mr Cass. It was decided that Mr Hiron should delay any enquiry into the Return until December 2012.
On 21 November 2002 Mr Cass wrote to Mr Hiron confirming that SHIPS could be challenged.
On 31 January 2003 the window for opening an enquiry into the Return closed without an enquiry being commenced. Mr Hiron was away on sick leave and responsibility for the cases he was handling was not taken over by another HMRC officer.
Mr Hiron made the following handwritten note on Mr Cass's letter dated 21 November 2002, which was in the appellant's file:
'Tony Hiron on sick leave 21/11/02 to 3/3/03. No action during that period and therefore SA window for Enquiry already closed 31/1/03. Too late!'
An internal email dated 18 March 2004 from an HMRC Special Compliance Office ('SCO') officer to another indicated that SCO were attempting to locate the appellant's file.
On 22 March 2004 the Return was forwarded to SCO internally.
On 9 March 2006 SCO wrote to the appellant stating that SHIPS was technically flawed and that HMRC was preparing to litigate a number of selected cases.
On 8 November 2006 SCO wrote to the appellant's accountants stating that, following the decision in Langham v Veltema, they were raising discovery assessments as they did not believe any capital loss had arisen and nothing in his return precluded such an assessment.
On 29 November 2006 HMRC made a discovery assessment on the appellant, which he then appealed.
The appellant's disclosure application
At the start of the hearing the FTT rejected the appellant's application for an order requiring HMRC to disclose details from the tax returns of the other 84 SHIPS participants, notes of a meeting between HMRC and Baker Tilley and responses from other inspectors to Mr Cass's intranet message. HMRC stated they had disclosed everything they had concerning HMRC's thinking on SHIPS up to 31 January 2003, as well as some subsequent materials.
The parties' contentions
The appellant contended that there was no discovery within section 29 Taxes Management Act 1970 ('TMA'). HMRC had during the enquiry window formed its view that the scheme did not work, the only question being how to challenge it. They had opened enquiries in relation to 51 of the 84 relevant taxpayers. Mr Hiron should have opened an enquiry before the window closed and would have done so if he had not gone on extended sick leave. He was fully aware, from his examination of the Return, of the insufficiency of the assessment. It could not be correct that HMRC's incompetence in failing to open an in time enquiry (which it managed to do for 51 other taxpayers) could be overcome by substituting a mythical notional officer for Mr Hiron and his actual state of knowledge. The information in the Return was clearly sufficient to alert Mr Hiron to the use of a scheme. Mr Hiron had identified the type of scheme and contacted Mr Cass.
HMRC contended that Mr Hiron had made a discovery, the discovery hurdle being exceptionally low. There was a discovery where there was a mere change of mind as to facts or law. Section 29(5) TMA referred to a notional officer, not the real or actual officer. The FTT had to consider what a notional office would have been aware of on the basis of the information listed in section 29(6) TMA and no more. The FTT should not consider what that officer might do on the basis of that information or what he could have been expected to be aware of after having done what would have been reasonable for him to do. The Return had to show an insufficiency of tax. The scheme involved the interaction of complex legislation and, although the Return cited specific provisions of the Taxes Acts, no detailed technical explanation was given (although it was accepted that more factual details were provided by the appellant than were provided in Patullo3 and Charlton). No indication was given that this was a tax avoidance scheme and the scheme implementation documents had not been provided. Perhaps not surprisingly, HMRC also contended that Charlton had been wrongly decided.4
The FTT's decision
The FTT identified three issues in setting out its reasons for dismissing the appellant's appeal.
Was there a discovery that chargeable gains which ought to have been assessed to CGT had not been assessed (see section 29(1) TMA)?
HMRC had made a discovery within section 29(1). In the current state of the relevant case law 'discovery' is a term of art. There is a low hurdle to establish a discovery under section 29(1). According to the Upper Tribunal in Charlton:
'No new information, of fact or law, is required for there to be discovery. All that is required is that it has newly appeared to an officer, acting honestly and reasonably, that there is an insufficiency in an assessment. That can be for any reason, including a change of view, change of opinion, or correction of an oversight. The requirement for newness does not relate to the reason for the conclusion but to the conclusion itself.'
What information was made available to the officer before 31 January 2003 (see section 29(6) and (7) TMA)?
The information listed in section 29(6) and (7) is exhaustive. Information held by HMRC but falling outside those categories (e.g. Mr Cass's SHIPS files) is to be ignored. The position is as stated by Auld LJ in Veltema (at paragraph 36):
'.. the Inspector is to be shut out from making a discovery assessment under the section only when the taxpayer or his representatives, in making an honest and accurate return or in responding to a s9A enquiry, have clearly alerted him to the insufficiency of the assessment, not where the Inspector may have some other information, not normally part of his checks, that may put the sufficiency of the assessment into question.'
This was an important issue in Charlton because a separately filed document under the Disclosure of Tax Avoidance Scheme ('DOTAS') regime formed part of the relevant information. No such complication arose in the current case.
Could the officer, at 31 January 2003, have been reasonably expected to be aware of the unassessed gains, on the basis of the information made available to the officer before that time (see section 29(5) TMA)?
The FTT found as facts that when the enquiry window closed on 31 January 2003 HMRC was aware of SHIPS and its variants; that it was minded to challenge it but it was still considering 'possible counters' (some in the alternative); that HMRC had decided to open enquiries into the returns of SHIPS users and that the only reason an enquiry was not opened into the appellant's return was because of Mr Hiron's absence on sick leave.
The test, as interpreted by the courts, is whether the notional officer could not have been reasonably expected, on the basis of the information made available to him before 31 January 2003, to be aware of the section 29(1) situation. The test is not whether Mr Hiron was by that date aware of matters that warranted the opening of an enquiry or even whether a notional officer should have been aware by that date of matters that warranted the opening of an enquiry. The disclosure must alert the HMRC officer to an objective awareness of an actual insufficiency.
The officer in question is a hypothetical or notional officer, who must be assumed to have such level of knowledge and understanding that would reasonably be expected in an officer considering the information provided by the taxpayer.
Such a notional officer, in possession as at 31 January 2003 of the Return (including the white space disclosures), could not have been reasonably expected to have been aware of the insufficiency. The Return did not specifically draw the officer's attention to the fact that the appellant had participated in a tax avoidance scheme. The relevant law relating to SHIPS was of a degree of complexity such as to make it unreasonable for the officer to be aware of an insufficiency on the basis of the information in the Return.
Charlton was distinguishable for two reasons:
• In Charlton the tax returns included the scheme reference number allocated by HMRC when the scheme had been registered with HMRC. The scheme disclosure legislation post-dated the year under appeal in the current case.
• In Charlton, before the returns were submitted, the Special Commissioners had already decided in Drummond5 that the relevant scheme failed. This was confirmed by the High Court before the relevant enquiry window closed. In the current case Drummond was still several years away and HMRC were ruminating on whether the scheme in question worked. Accordingly, the hypothetical officer, even if he could have contacted HMRC's technical experts, could not have been reasonably expected, on the basis of the information made available to him before then, to be aware of the insufficiency.
The FTT appears to have had some sympathy with the appellant's predicament but considered its hands were tied by binding authorities (see paragraphs 63 and 64 of the decision).
In relation to issue 1, while it seems what HMRC really discovered was that its administrative failings had resulted in an enquiry not being opened in time, the authorities tend to confirm that HMRC can make a discovery assessment to correct an earlier oversight on its part.
In relation to issue 2, the FTT correctly decided that the only relevant information was the information in the Return but then concluded it was insufficient. The Chancellor stated in HMRC v Landsdowne Partners Limited Partnership,6 that the question, adopting the formulation used by Auld LJ in Veltema, is whether the hypothetical HMRC officer, having before him the information provided by the taxpayer, would have been aware of 'an actual insufficiency' in the declared profit. The officer is not required to resolve points of law as any disputes of fact or law can then be resolved by the usual processes. Paraphrasing Moses LJ in Landsdowne, the situation mentioned in section 29(1) TMA, to which section 29(5) applies, is a mixed question of fact and law.
The information must therefore be examined carefully. The Return stated that the appellant had during the year in question acquired a second hand insurance policy for over £500,000 and surrendered it shortly thereafter at a loss of almost £50,000; that he considered, for the reasons he gave, that there was in consequence no income on which income tax could be charged and no chargeable gain on which CGT could be charged and that he considered this arrangement gave rise to an allowable loss for CGT purposes of over £500,000.
In Veltema Auld LJ referred to the need for the taxpayer to provide HMRC with 'an honest and accurate return'. That would appear to be a fair description of the Return in this case. The information provided made it clear that a substantial capital loss was being claimed and why. The relevance of this information seems on its face clear. One would have thought that this information would have clearly alerted the hypothetical HMRC officer sufficiently to give him an objective awareness of a tax insufficiency. Admittedly no mention was made of the appellant's participation in SHIPS, but it is difficult to see what difference any mention of it would have made to how Mr Hiron dealt with the matter. At the very least, an insufficiency must reasonably have been inferred from this information (see section 29(6)(d)(i) TMA). Again, Charlton provides useful guidance (at paragraph 89):
'It is not necessary that the hypothetical officer should understand precisely how a scheme works, or any tax treatment is said to arise. All that is needed is that from the information made available to the hypothetical officer he can reasonably be expected to be aware of the insufficiency of tax such as to justify an assessment.'
As to issue 3, the authorities are clear that section 29(5) does not require the notional or hypothetical officer to be given the characteristics of an officer of general competence, knowledge or skill only (see the Charlton decision at paragraph 65). The officer must be assumed to have such level of knowledge and understanding that would reasonably be expected in an officer considering the particular information provided by the taxpayer. In short, regard has to be had to all of the circumstances of the case affecting the adequacy of the information, including its complexity.
In the present case the hypothetical officer would be someone able to deal with a return containing information that raised issues relating to income tax, CGT and the interaction between them. More particularly, 'he would also have been sufficiently aware of the law relating to second-hand insurance policies to be able to appreciate the unusual nature of the entries in the return'.7 The difficulty in this case is that, whereas the actual officer appears to have been alerted to an insufficiency, the FTT decided that a notional officer would not have been so aware. It is difficult to understand why a lower level of awareness on the part of a notional officer is substituted for the higher level of actual awareness displayed by the officer concerned, or even why Mr Hiron (with his state of awareness at the time that the enquiry window closed) or the officers who had managed to open enquiries in relation to 51 of the 84 returns of SHIPS participants were not regarded as the appropriate benchmark for the notional officer.
Many taxpayers and professional advisers have expressed disappointment with the current state of the law concerning discovery assessments. There is a perception that there has been an upsetting of the balance inherent in the self-assessment regime, in which taxpayers provide HMRC with honest and accurate returns and HMRC display a basic level of competence in deciding whether or not to open enquiries during the enquiry window. This case is a long way from Veltema, in which the taxpayer provided HMRC with his self-assessment and a connected company separately furnished HMRC with a P11D. An unduly low expectation of the level of knowledge and competence of the notional HMRC officer may be encouraging HMRC to adopt a relaxed attitude to the need to open enquiries during the enquiry window. The perception increasingly is that some HMRC officers appear unconcerned when they fail to open an in time enquiry as they believe they can always make a discovery assessment – often many years after the enquiry window has closed. Such a belief is likely to encourage inefficient practices within HMRC and delay for too long the finality that taxpayers are entitled to expect in the handling of their tax affairs by HMRC.
-  STC 544.
-  Charlton and others v HMRC  STC 866.
- R (on the application of Patullo) v HMRC  STC 107.
- The Upper Tribunal's decision in Charlton, which dismissed HMRC's appeal, was issued after the hearing of the present appeal ended but before the FTT's decision was issued. The FTT decided not to invite further representations from the parties in relation to the Charlton decision as it was decided that Charlton did not raise any issues that would cause the FTT to change its conclusions.
- Drummond v HMRC  UK SPC SPC00617.
-   EWCA CIV 1578; 2012 STC 544 (Court of Appeal).
- See Charlton at paragraph 90.