Derry – HMRC prevented from collecting tax in avoidance case
In R (ota of James Derry) v HMRC [2017] EWCA Civ 435, the Court of Appeal, in allowing the taxpayer's appeal, has confirmed that HMRC is not able to ignore a claim for carried back loss relief where the taxpayer has self-assessed and computed his liability to tax.
BackgroundMr Derry (the taxpayer) made a claim in his 2009/10 tax return for carry back of losses and set these off against his taxable income for that year in the sum of £165,800. The loss arose from a disposal of shares made by him in the 2010/11 tax year.
On 22 March 2010, the taxpayer bought shares, at a cost of £500,000, in a company called Media Pro Four Limited (Media). This was a qualifying trading company for the purposes of section 131, Income Tax Act 2007 (ITA).
The taxpayer sold his shares in Media on 4 November 2010, to Island House Private Charitable Trust for £85,500, resulting in a capital loss to him of £414,500 in the 2010/11 tax year.
The taxpayer claimed share loss relief under Chapter 6, Part 4, ITA and carried it back for one year to 2009/10. This had the effect of reducing his taxable income for that year by £414,500.
The taxpayer filed his return on 24 January 2011. In the additional information section of his return he completed boxes 3 and 4 entitled 'Trading losses'. In box 3, he entered £414,500 as the amount of the loss relief and in box 4 he specified 2009/10 as the tax year for which he was claiming the relief.
In the white space box the taxpayer stated:
'Box 3 of page Ai 3 shows capital losses realised on disposal of subscriber shares in an unlisted trading company in year ended 5 April 2011. These losses have been carried back to year ended 5 April 2010 and relief claimed under s 131, s 132 ITA 2007.'
The taxpayer calculated his own tax and completed pages TC 1 and 2 on his return. In this section, he entered £165,800 in box 15, headed 'Any 2010/11 repayment you are claiming now' and in box 16, headed 'Any other information', the taxpayer said:
'The reduction in tax payable in box 15 of page TC 2 relates to the loss carry back claim arising from the carry back of losses of GBP 414,500 as set out on page Ai 3. The corresponding reduction in tax payable in the year ended 5 April 2010 following this loss carry back claim is GBP 165,800 being GBP 414,500 at 40 per cent.'
As the taxpayer had already paid tax at source, the effect of his return entries was to generate a repayment to him of £70,253.64 which HMRC paid on 18 October 2011.
HMRC later claimed that the repayment had been made in error because checks had yet to be completed in relation to the loss relief claim.
On 16 December 2011, the taxpayer filed his 2010/11 return. In this return he recorded losses used against income of £414,500. In the relevant white space he stated:
'I have incurred a capital gains loss of GBP 414,500 on the sale of unlisted shares in 2010/11 and claim the loss under s132(B) [sic], ITA 2007 against my income in 2009/10. This loss relief has already been claimed and relief obtained in 2009/10.'
HMRC opened an enquiry on 4 January 2012 in respect of the share loss relief claim for 2009/10. The enquiry was opened on the express footing that the claim was one made 'outside of a return' by virtue of paragraph 2(3), Schedule 1B, Taxes Management Act 1970 (TMA).
A further enquiry was opened on 16 February 2012, into the taxpayer's return for 2010/11, under section 9A, TMA. In its covering letter HMRC said that its enquiry would run in tandem with its enquiry into the loss relief claim and that in order to be satisfied about the taxpayer's entitlement to the relief claimed it would be necessary for HMRC to look at all of the arrangements surrounding the claim.
HMRC's position was that the taxpayer was not entitled to claim the disputed share loss relief as a deduction from his taxable income for 2009/10 and sought to recover the tax it had repaid to the taxpayer.
HMRC issued a demand for the tax that the taxpayer had originally self-assessed in his 2009/10 return.
The taxpayer challenged HMRC's decision to issue the demand by way of judicial review proceedings. The Upper Tribunal dismissed his application and he appealed to the Court of Appeal.
Legislative background
The relevant provisions relating to share loss relief are found in sections 131 to 151, ITA. Section 132 sets out the entitlement to claim.
The procedure relevant to the making and investigation of such claims is governed by the TMA. Section 8(1), TMA, gives HMRC the power to issue a notice to a taxpayer to make or deliver a return 'containing such information as may reasonably be required in pursuance of the notice'.
Section 8(1AA)(a) stipulates that the amounts shown are to be net amounts which take into account 'any relief or allowance a claim for which is included in the return'. Under section 8(1AA)(a), the amount payable by the taxpayer is 'the difference between the amount in which he is chargeable to income tax and the aggregate amount of any income tax deducted at source'.
Section 9A(1), TMA, gives HMRC the power to enquire into a return if notice is given. The time allowed is 12 months from the date of delivery, for returns delivered on or before the filing date, and up to 15 months for returns delivered after the filing date. The scope of the enquiry extends to anything contained (or required to be contained) in the return, 'including any claim … included in the return'.
The provisions relating to the making of a claim are found in section 42, TMA. In substance, it provides that where a claim can be made in a return it must be made there.
Accordingly, it was only open to the taxpayer to make his claim for loss relief in the body of his return and HMRC could only enquire into that claim by issuing a notice of enquiry under section 9A. However, Schedule 1B, TMA, which deals with 'Claims for relief involving two or more years' indicates that where a claim for losses relating to a later year is made in an earlier year, the claim is deemed to relate to the later year. Paragraph 2(2), Schedule 1B, indicates that section 42(2), TMA (the section which provides that claims should be made in a return) does not apply.
Schedule 1A,TMA, gives HMRC power to enquire into claims which are made outside of a return and it gives HMRC the power to enquire into that claim.
Similar issues were considered by the Supreme Court in Revenue and Customs Commissioners v Cotter [2013] 1 WLR 3514. In that case, Mr Cotter was seeking to carry back employment loss relief. The provisions enabling the loss to be carried back were largely the same as those relating to share loss relief, however, in relation to employment loss relief, section 128(7), ITA provides:
'This Chapter is subject to paragraph 2 of Schedule 1B to TMA 1970 (claims for loss relief involving two or more years).'
There is no equivalent provision in Chapter 6, relating to share loss relief. The question before the Court was whether the claim for share loss relief could be said to be one made in a return. This was important because HMRC can open an enquiry either under section 9A into the return, or under paragraph 5, Schedule 1A, into the claim itself.
The fact that a claim was, as a matter of fact, made in the body of the return is not necessarily relevant. In Cotter this point was considered at considerable length.
HMRC argued that a claim could only be included in a return if it was to affect the calculation of tax for the relevant year. Additionally, the taxpayer in Cotter left it to
HMRC to undertake that calculation. Accordingly, in Cotter the Supreme Court concluded that the claim for relief did not affect the calculation for the current year and that HMRC could only open an enquiry under Schedule 1A.
The potential distinctions in the present case were the nature of the loss claimed (share not employment), that Schedule 1B did not apply, and the fact that the calculation was completed by the taxpayer in his return.
Court of Appeal's judgment
The Court allowed the taxpayer's appeal.
The Court was not persuaded that the absence of an express signpost to Schedule 1B (as was present with claims for employment loss relief), lead to the conclusion that it was not relevant. The Court was of the view that Schedule 1B did apply to the facts of the present case, including the exclusion contained in paragraph 2(2), relating to claims in returns.
The taxpayer's second argument was that his 2010 return assessed his liability to tax and afforded him a repayment of £70,253.64. The substance of this argument was that the entries in boxes 1 and 15 of the tax calculation pages in the return, together with the explanation for those entries provided in box 16, showed the amounts due both before and after adjustment by the loss relief claimed.
The Court recognised that there was a distinction to be made between a 'claim' made in a return and a taxpayer's self-assessment of tax. In the latter case, the Court found that although errors may be made in such self-assessments, HMRC's could deal with any such errors by either amending the return or opening an enquiry under section 9A, TMA. As HMRC had not availed itself of that right it was now out of time to do so.
Comment
This case confirms that HMRC's broad powers to enquire or amend are not without significant limitations. The important point arising from the judgment is that if HMRC has not made an enquiry into the return for the year in relation to which the carry-back claim is made within the relevant time limits, it cannot recover the tax relief claimed and paid. The Court of Appeal was of the view that this was the clear implication of Lord Hodge's judgment in Cotter, which it said the Upper Tribunal had failed to properly take into account.
It is understood that HMRC are seeking permission to appeal to the Supreme Court.
A copy of the judgment can be found here.