Discovery assessments - HMRC fails to discharge burden of proof
The following is taken from an article originally published in Tax Journal
(2 December 2015, pp. 4-5, www.taxjournal.com).
In the recent case of Burgess and Brimheath Developments Ltd v HMRC, [2015] UKUT 578 (TCC), the Upper Tribunal (UT) has confirmed that in appeals against discovery assessments (issued pursuant to section 29, Taxes Management Act 1970 (TMA) or paragraph 41, Schedule 18, Finance Act 1998 (FA 1998)), HMRC bears the burden of demonstrating that the assessments are valid, irrespective of whether the appellant has raised objections as to the validity of the assessments.
Background
As readers will be aware, once the time limit for opening an enquiry has expired, or an enquiry is closed, the taxpayer's liability for the relevant tax year is generally regarded as final. In such circumstances, HMRC can only demand a further tax payment by issuing a discovery assessment pursuant to section 29 TMA, in relation to individuals and paragraph 41, Schedule 18, FA 1998, in relation to companies. As there are no material differences in the wording of the two provisions, for ease of reference, these provisions are referred to as the 'discovery assessment provisions', throughout the remainder of this blog.
A discovery assessment, as the name suggests, can only be made by HMRC in circumstances where it has made a 'discovery' that tax has been underpaid in relation to a period where it is not open to HMRC to make an adjustment through the enquiry process. It is important to remember that the discovery assessment provisions can only be relied upon by HMRC in circumstances where:
(i) a loss of tax has been brought about by careless or deliberate conduct by the taxpayer (or a person acting on his behalf); or
(ii) in circumstances where an HMRC officer could not reasonably be expected, on the basis of the information available to him at the end of his enquiries or expiry of the enquiry window, to be aware of the facts leading to the potential tax loss.
The underlying facts of Burgess are not important for present purposes. In the case of Mr Burgess, HMRC issued discovery assessments for income tax in relation to alleged failures to return profits of his business as a sole trader for the tax years 1996–97 to 1999–2000. In the case of Brimheath, the assessments related to corporation tax on alleged under-declarations of profits for the accounting periods ended 30 November in each of the years 1999 to 2008 (apart from 2000).
The taxpayers appealed against the discovery assessments to the First-tier Tribunal (FTT).
FTT's decision
Before the FTT, the taxpayers' appeals were unsuccessful. The FTT found that in relation to both taxpayers, profits had been under declared and upheld HMRC's assessments to tax (with one exception, which is no important for present purposes).
The taxpayers appealed the FTT's decision to the UT.
UT's decision
Before the FTT, the validity of the discovery assessments did not form the basis of the taxpayers' appeals and the FTT made no findings in relation to whether the above tests had been satisfied, seemingly content to proceed on the basis that as the taxpayers had not raised the issue it was not necessary for it to satisfy itself that the discovery assessments were valid.
In the UT, the taxpayers did not challenge the FTT's substantive finding that they had under-declared their profits for the relevant periods, but contended that it had made errors of law in failing to consider the underlying validity of the discovery assessments. The focus of the appeal before the UT was therefore whether the FTT had properly considered whether the discovery assessments had been validly made.
The taxpayers argued that the FTT had made errors of law in failing to consider:
(i) whether the relevant conditions for the issue of an assessment under the discovery assessment provisions, namely, that the taxpayers' conduct had been deliberately fraudulent or careless, had been satisfied – the 'competence' issue; and
(ii) whether the assessments were issued within the necessary statutory time period (section 36, TMA and paragraph 46, Schedule 18, FA 1988) – the 'time limit' issue.
HMRC submitted that it understood, from the way the taxpayers had argued their case before the FTT, that only the underlying substantive issue required determination and there was no obligation on it to raise the competence and time limit issues. It argued that these issues were new points of law which had not been argued by the taxpayers before the FTT and as such they should not be allowed to raise them before the UT.
The UT was not impressed with HMRC's arguments and agreed with the taxpayers that HMRC had not discharged the burden of proving that in their case the conditions necessary for issuing a discovery assessment had been met (namely, that the tax loss had arisen from the taxpayers' deliberate conduct and that the assessments were therefore in time). In the view of the UT, this was a positive requirement of the legislation and it was not sufficient for HMRC to simply rely on the taxpayers' failure to raise validity objections in their appeals and to assume that validity issues had been conceded by the taxpayers. Appeals against discovery assessments do not require taxpayers to expressly object to the validity of the assessments. The UT concluded that given HMRC's failure, it was not open to the FTT to uphold the discovery assessments simply because it had been established that there were under-declared profits of the businesses. The FTT erred in not allowing the appeals because HMRC had failed to prove that the assessments were validly issued. The UT also refused to remit the matter to the FTT because to do so would give HMRC a "second bite of the cherry", which, in the view of the UT, would not be just and fair.
Comment
The UT has confirmed that when considering an appeal against a discovery assessment, HMRC must establish before the FTT that the necessary conditions for issuing the discovery assessment were satisfied and that the assessment is therefore valid. The appeal cannot be dismissed simply because the FTT is satisfied that there has been an underpayment of tax.
Generally, in an appeal to the FTT, it is the appellant taxpayer who bears the burden of proof. He must prove his case, on the balance of probabilities, and demonstrate, for example, that an assessment is excessive. However, in relation to the validity of discovery assessments, the burden shifts and it is incumbent upon HMRC to prove, on the balance of probabilities, that the necessary circumstances existed to permit a discovery assessment to be made.
There are very good reasons for this. The discovery assessment provisions are designed to afford additional protection to the Crown beyond the ordinary statutory limitation periods. In cases of carelessness, the ordinary time limit of 4 years is extended to 6 years and in cases where the loss is brought about deliberately the period is extended to 20 years (sections 34 and 36, TMA). The ordinary limitation period is designed to provide certainty and finality to taxpayers. As mentioned above, once the time limit for opening an enquiry has expired, or an enquiry has been closed, the taxpayer's liability for the relevant year is generally regarded as final. However, as HMRC have the power to demand a further tax payment by issuing a discovery assessment, Parliament has provided that certain conditions must be satisfied before a discovery assessment can be issued. Such pre-conditions are designed to moderate the issue of discovery assessments and as it is HMRC who will be asserting that it is entitled to issue a discovery assessment, and that the necessary conditions are therefore satisfied, the burden of establishing that those conditions are satisfied, naturally falls on HMRC.
During the UT hearing, HMRC argued that it was not for it to argue a point which was not in issue before the FTT. The UT had little difficulty dismissing this argument. Citing Phipson on Evidence, the UT explained that if one party bears the burden of proof on an issue, but fails to plead a positive case on it, the other side has no obligation to argue against the point. If HMRC fails to plead, it will fail to discharge the burden.
HMRC had assumed that because the taxpayers had not advanced specific arguments on the validity of the discovery assessments the issue of validity did not need to be determined by the FTT. The UT was of the view that the validity of the assessments was an "essential element of HMRC's case" which needed to be positively proved by HMRC. By making no findings on whether HMRC had discharged the burden of proof regarding the validity of the assessments and yet still dismissing the taxpayers' appeals, the UT found that the FTT had made an error of law.
As HMRC had failed to argue the point, the UT refused to permit it to do so on appeal – following the long standing rule that new issues should not be introduced for the first time on appeal (barring exceptional circumstances which were not present in this case).
HMRC regularly seeks to use the discovery assessment provisions and a number of judicial decisions have reduced the substance of what amounts to a 'discovery' to an almost meaningless level. What is required for there to be a 'discovery' was succinctly expressed by the tribunal in HMRC v Charlton [2013] STC 866:
"In our judgment, no new information, or fact or law, is required for there to be a 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."
As a consequence of the wide meaning given to the word 'discover' by the courts, in order for a discovery assessment to be found to be invalid, the focus tends to be on whether the taxpayer has acted with reasonable care and provided HMRC with sufficient information.
The UT's decision represents an important restatement of the legal position in relation to the burden of proof which operates where HMRC decides to issue a discovery assessment which is subsequently appealed.
For the full judgment please click here.