Contentious tax quarterly review
In this review, we consider the Supreme Court's decision in Tooth, concerning discovery assessments; and examine the contentious issue of when a taxpayer can rely upon a PAYE credit. We also review the increased focus by HMRC on cryptoassets and the challenges that might create for taxpayers.
This blog is based on an article first published in Tax Journal on 17 June 2021. A link to that article can be found here.
The ending of a stale argument
The concept of staleness, in the context of discovery assessments, gathered momentum following the Upper Tribunal's (UT) decision in Charlton and others v HMRC [2011] UKFTT 467 (TC). As discovery is only relevant to returns and tax years where HMRC has not opened a statutory enquiry, many commentators considered that the concept provided a degree of procedural fairness in the discovery assessment process and that HMRC should not be permitted to delay issuing an assessment for a considerable period of time after making its discovery. As recently as February of this year, Judge Malek in Mehrban v HMRC [2021] UKFTT 53 (TC) noted that it was an “absurdity” to say that the concept of staleness does not exist.
However, the Supreme Court in HMRC v Tooth [2021] UKSC 16 (a case concerning whether a discovery assessment, issued pursuant to section 29, Taxes Management Act 1970 (TMA), was validly made by HMRC), has rejected the concept of staleness and confirmed that a “discovery is a particular event in time, and does not cease to be such with the passage of time". The Court said that there was “no place for the idea that a discovery which qualifies as such should cease to do so by the passage of time” and “no basis for implication of an additional and stricter time restriction” than the time limits expressly set out in the TMA. In the view of the Court, to introduce a concept of staleness would contradict the statutory scheme under the TMA, which already contains limitation periods for discovery assessments.
What this means in practice is that so long as an HMRC officer has made a 'discovery', the fact that HMRC 'sit' on the discovery will not prevent it from issuing a valid assessment at a later point in time. Provided the assessment is issued within the relevant statutory time period (sections 34 and 36, TMA) and the statutory safeguards in section 29 are not applicable, a discovery assessment will be valid, irrespective of when the actual 'discovery' was made.
Although the Court did not accept that there was a prohibition on a discovery assessment from being issued after the relevant discovery ceased to be 'fresh', it did acknowledge that a decision to delay issuing such an assessment might be amenable to challenge by way of judicial review proceedings.
Another important issue before the Supreme Court in Tooth was whether any 'insufficiency' of tax, within the meaning of section 29(1), was brought about as a result of a 'deliberate' inaccuracy in a document provided to HMRC, for the purposes of section 29(4), TMA.
It will come as a relief to many that the Supreme Court overturned the decision of the Court of Appeal in this regard and confirmed that, for the purposes of section 29, 'deliberate' conduct requires an 'intention to mislead' (or, possibly, recklessness). The decision of the Court of Appeal to deviate from the position as it had previously been understood resulted in the surprising position of it being easier for HMRC to establish deliberate conduct (securing a 20 year window for issuing an assessment) than careless conduct (securing a 6 year window).
The Supreme Court has confirmed that, for a taxpayer to bring about an insufficiency of tax as a result of deliberate inaccuracy, there must be an intention to mislead HMRC, in other words, the statement made must be deliberately inaccurate.
The Supreme Court also confirmed (i) that an HMRC officer may make a discovery notwithstanding that there are no new facts; and (ii) it does not matter if different HMRC officers make the same discovery at different times - assessments are not reserved only to the first officer who made the discovery - the question is simply whether the officer issuing the assessment has made a discovery. In practice, both points will provide HMRC with a great deal of leeway when issuing discovery assessments.
It is important to bear in mind the safeguards contained in section 29 when HMRC issues a discovery assessment. In the recent case of Ball Europe Ltd v HMRC [2021] UKFTT 23 (TC), the First-tier Tribunal (FTT) held that the presence of amounts in a taxpayer's accounts but not its tax return was sufficient for a 'hypothetical officer' of HMRC reasonably to be expected to be aware of a tax insufficiency and this prevented HMRC from issuing a valid discovery assessment. The knowledge to be attributed to a hypothetical officer has always been a difficult issue because the FTT, when considering this test, cannot take account of the actual knowledge of a specific HMRC officer, but has to look generically at what a non-existent officer might be expected to know. Historically, the FTT has been extremely generous to HMRC when applying the hypothetical officer test, but this decision demonstrates how important this safeguard is.
Credit where credit is due
Taxpayers could be forgiven for thinking that the amount of tax which they have to pay is an issue which would squarely fall to be determined on appeal by the FTT. They would, however, be wrong.
In recent years, many column inches have been dedicated to the issue of contractor loan schemes (including in relation to the loan charge). Despite the passage of time, ultimate resolution of certain issues connected to such arrangements seems some way off. A number of such issues recently fell to be determined by the UT in Hoey v HMRC [2021] UKUT 82 (TCC). The facts of the case can be stated shortly. Mr Hoey was an IT specialist who provided his services to end-users through an offshore company. The company employed him at a modest salary and the company made contributions to a trust which made various interest free loans to Mr Hoey. The original expectation was that tax would be payable on the salary and the small ‘benefit in kind’, represented by the interest free loan made to Mr Hoey. However, following the decision in Rangers (RFC 2012 Plc (in liquidation) v Advocate General for Scotland [2017] UKSC 45), Mr Hoey accepted that the contributions to the trust should be treated as his employment income and as such, subject to income tax.
There were several issues in the case ranging from the transfer of assets abroad rules contained in Chapter 2, Part 13, Income Tax Act 2007, their interaction with EU law on freedom of movement of capital, and whether HMRC had made a valid ‘discovery’ for the purposes of section 29, TMA. But the key point of Mr Hoey’s appeal, for present purposes, was relatively straightforward. As the payment to the trust was employment income, tax ought to have been accounted for under PAYE (in the circumstances of the case, by the end-user rather than the offshore employer) and Mr Hoey was entitled in his self-assessment to be credited with that tax in accordance with Regulations 185/188 of the Income Tax (Pay As You Earn) Regulations 2003 (the PAYE Regulations), regardless of whether it had actually been accounted for by the payer.
However, HMRC, relying on section 684(7A), Income Tax (Earnings and Pensions) Act 2003 (ITEPA), purported to exercise its discretion to disapply the PAYE Regulations and thereby absolve the end-user from the obligation to operate PAYE. This aspect of the case concerned whether HMRC was entitled to do so and if it was, whether this resulted in Mr Hoey ceasing to be entitled to the credit.
Mr Hoey's appeal was not successful. The UT decided to follow the FTT in declining to allow Mr Hoey the benefit of the tax credit. However, this was on the basis that the question of whether the tax credit was available was not within the jurisdiction of the tax tribunals. The UT went on to say what it would have decided if it had had jurisdiction:
"If we were wrong in finding against Mr Hoey that the FTT lacked jurisdiction to consider the PAYE credit, we consider that, given the scope of the 7A discretion and the fact it only applies prospectively with no indication it can overturn the effect of obligations which have already been incurred, Mr Hoey would be entitled to the PAYE credit as the discretion would be ineffective to remove the PAYE liability from the end-users after those liabilities had been incurred".
The UT heard argument on both the scope of the section 684(7A) discretion and also whether it had the effect which HMRC argued for, removing Mr Hoey's right to a PAYE credit. In considering the scope of the section 684(7A) discretion, the UT concluded that it could not be exercised retrospectively. This followed from the plain reading of the statutory language, the adverse retrospective effects which would follow, the statutory scheme and the absence of clear words.
In Mr Hoey's case, HMRC failed to exercise the powers which clearly do apply (i.e. the imposition of PAYE assessment on employers) and wished instead to utilise a discretion (which Mr Hoey argued did not apply) to cover up that failure. If HMRC's analysis on the construction of section 684(7A)(b) is correct, it would undermine the carefully calibrated system of the collection of income tax through the PAYE system. More particularly, it would place in the hands of an HMRC officer the power to impose a tax liability on an employee, by retrospectively relieving their employer of an obligation to deduct tax, in circumstances where HMRC would otherwise be outside the statutory limitation period to assess the employer. In addition, if HMRC's construction is correct, the powers conferred through the PAYE Regulations to assess employers for under-declared PAYE tax would appear to be largely redundant, not least because, on HMRC's analysis, it would be able to simply exercise a discretion retrospectively to disapply the obligation on the employer to pay tax. This, in turn, would impose a payment obligation on the employee at a later point in time, not limited by statute. This startling contention was rejected by the UT.
As the UT noted, this decision means that actual PAYE deductions are within the FTT's jurisdiction but not deemed deductions. The UT saw this as reflecting the wider principle that amounts that taxpayers must ultimately pay to HMRC are not necessarily those set out in assessments. This leads to the unsatisfactory situation where some issues relating to liability are capable of determination by the FTT and others simply constitute a potential defence in enforcement proceedings.
Crypto tax
The Biden administration recently announced that cryptocurrency transfers of more than $10,000 will have to be reported to the US tax authorities. These new proposals come amid a tightening of the regulatory environment in relation to crypto and digital currencies. The proposals are part of a broader initiative aimed at curbing tax evasion.
HMRC accepts that the majority of individuals and businesses pay the correct amount of tax which is due from them. However, a small minority of taxpayers engage in tax evasion, and e-money, value transfer systems and crypto, have been used to conceal assets from HMRC and other regulatory bodies. Most 'noobs' (amateur traders and investors) tend to be young individuals who may not fully appreciate the tax implications of their activities. Given the potential for large financial gains to be made (for example, Etherium, the second largest crypto by market capitalisation, rose in value from £140 per token to almost £3,000 per token over the space of a few months earlier this year), there will be some amateur investors who need to consider carefully the tax implications of their investments, which may not be straightforward.
Given the increase in popularity of cryptocurrencies it is not surprising that HMRC is beginning to take more of an interest in this area. On 30 March 2021, HMRC published its cryptoassets manual, which expands on and replaces previous HMRC guidance. Anyone involved in transactions involving cryptoassets should review the manual if they wish to glean an insight into HMRC's thinking in this area.
It is likely that a crypto transaction that locks in a gain will be treated as a disposal for capital gains tax purposes. Selling cryptoassets for real rather than digital money is clearly a disposal but so is exchanging one type of coin for another, a common feature of crypto investing. In a rising market, every transaction made by an investor is likely to crystallise gains even if they are not turning them into cash.
Generally, profits from crypto-trading will fall into the category of capital gains tax rather than income tax as most individuals will not be considered to be professional crypto traders. However, should HMRC form the view that professional trading is taking place, any gains will be taxed as income. Income tax will also be payable on interest received on coins that are staked (to give exchanges liquidity) even if the interest is received in the form of other coins. Airdrops given as payment in return for services will also be taxed as income.
As the popularity of crypto-trading and cryptocurrencies continues to grow, there will inevitably be a greater focus by HMRC on this area. The bottom line is that taxpayers are required to declare their taxable gains and payments on all types of crypto assets, including exchange, utility and security tokens and stable coins. We are aware that HMRC is actively engaged with exchanges seeking information about their customers. Those found to have not paid the full amount of tax lawfully due are likely to face severe penalties, and those suspected of tax evasion may face criminal proceedings.