Judicial review: does the Court of Appeal’s decision in Murphy offer taxpayers a glimmer of hope?
Judicial review provides a constitutionally important judicial check on the exercise of statutory powers by public bodies such as HMRC. However, the wide margin of appreciation afforded to public bodies by the courts, coupled with recent reforms to the judicial review process, make it a remedy of last resort that can be difficult for taxpayers to pursue successfully. In overturning the High Court’s refusal of the taxpayers’ judicial review claim, the Court of Appeal in Murphy v HMRC confirmed that HMRC had breached their legitimate expectation as to the application of an extra-statutory concession. While Murphy is unlikely to be the harbinger of a wholesale rebalancing of the judicial review scales in the taxpayer’s favour, it is a welcome step in the right direction.
This article was originally published in Tax Journal
An extra-statutory concession (ESC) is described by HMRC as a relaxation that gives taxpayers a reduction in tax liability to which they would not be entitled under the strict letter of the law: see HMRC’s guidance Extra Statutory Concessions: ex-Inland Revenue (Concessions as at 6 April 2018) (via bit.ly/ESCs). Most concessions are said to be made in order to deal with what are, generally, minor or transitory anomalies under the relevant legislation and to meet cases of hardship at the margins of the tax code where a statutory remedy would be difficult to devise.
While there is no explicit statutory power governing the issuing of ESCs, the courts have confirmed that HMRC has a ‘wide managerial discretion as to the best means of obtaining for the national exchequer from the taxes committed to their charge, the highest net return that is practicable having regard to the staff available to them and the cost of collection’ and that this discretion ‘enables the commissioners to formulate policy in the interstices of the tax legislation, dealing pragmatically with minor or transitory anomalies, cases of hardship at the margins or cases in which a statutory rule is difficult to formulate or its enactment would take up a disproportionate amount of parliamentary time’ (see R v IRC, ex p National Federation of Self-Employed and Small Businesses Ltd [1982] AC 617, per Lord Diplock at para 636; R (Wilkinson) v IRC [2005] UKHL 30, per Lord Hoffman at para 21).
That ESCs are policy instruments, separate and distinct from the underlying legal provisions, the purpose of which is to disapply the underlying statutory tax regime in respect of cases falling within the concession and to facilitate the workings of the taxation system, has long been recognised by the courts (see R (oao Accenture) v HMRC [2009] EWHC 857 (Admin); and Argyll House Developments [2009] CSOH 131). As such, an ESC should not be construed as if it was a statute (see R (Greenwich Property Ltd) v C&E Commrs [2001] EWHC Admin 230).
Where a taxpayer claims to be entitled to take advantage of an ESC, their claim is in the nature of a claim to benefit from an enforceable substantive legitimate expectation (see R v IRC, ex p. MFK Underwriting Agencies Ltd [1990] 1 WLR 1545). In that regard, the ESC must satisfy the general requirement for a legitimate expectation, namely, it must be clear, unambiguous and devoid of relevant qualification, and the taxpayer must demonstrate that they have acted strictly in accordance with what the ESC permits and has complied with all the conditions necessary to obtain the relief (see Greenwich Property Ltd supra).
In a claim for breach of the legitimate expectation said to arise from a taxpayer’s reliance on an ESC, the meaning of an ESC is therefore of vital importance and is a matter for the court to determine. The courts’ approach to the proper interpretation of an ESC is to consider how the ESC would be read by the ‘ordinarily sophisticated taxpayer, ’ who is taken to be representative of those to whom the ESC is directed (see MFK Underwriting Agencies Ltd supra).
ESC B18
In Murphy and another v HMRC [2023] EWCA Civ 497, the courts considered the proper approach to the construction of ESC B18 (first issued in 1978), which sought to address certain anomalies that arose under FA 1973, in respect of payments out of discretionary trusts. The underlying statutory provisions were re-enacted without any substantive change in ICTA 1988, and subsequently replaced by ITA 2007 ss 492–498.
ESC B18 extended the ‘look-through’ relief contained in FA 1973 s 18 (later ICTA 1988 s 809) to non-resident beneficiaries of a non-resident trust with UK source income, enabling them to claim credit for UK income tax paid by the trustees (Concession One). Credit could only be obtained in respect of taxed overseas income that arose to the trustees not earlier than six years before the end of the year of assessment in which the payment was made to the beneficiary. ESC B18 provided a ‘similar concession’ in relation to payments from a non-resident discretionary trust, subject to the trustees submitting the requisite returns and paying the additional rate tax on UK source income.
Further iterations of ESC B18 were issued in 1994 and 1999. ESC B18 (1994) extended relief to UK resident beneficiaries of non-resident trusts. ESC B18 (1999) largely replicated ESC B18 (1994). It retained Concession One, and contained two further concessions under the heading ‘Non-resident trusts’: one applying where ‘a non-resident beneficiary receives ... a payment out of income of the trustees in respect of which, had it been received directly, it would have been chargeable to UK tax’ (Concession Two) and the other allowing a ‘UK beneficiary of a non-resident trust’ to ‘claim appropriate credit for tax actually paid by the trustees on the income out of which the payment [to the beneficiary] is made’ (Concession Three).
The key issue in Murphy was whether Concession Three was subject to the six-year limitation period.
Murphy v HMRC
For present purposes, the facts in Murphy can be stated shortly. The claimants were the beneficiaries of a retirement trust (‘the trust’). The trustees were resident for UK tax purposes in Guernsey and the claimants were resident in the UK. The trustees received UK source income in the form of interest, on which they were liable to (and did) pay UK income tax. The net amounts generated further income as overseas bank interest.
The claimants sought confirmation from HMRC that ESC B18 applied to allow tax credit on distributions from the trust with no six-year limitation. HMRC advised that a six-year limitation applied.
The claimants requested that HMRC reconsider its decision but, before HMRC replied, the trust deed was varied and the trust assets were distributed to the claimants. The distributions constituted income in the hands of the claimants for tax purposes. Each claimant paid UK income tax on the distributions, but made claims for tax credit, under ESC B18, in respect of the UK income tax paid by the trust in all past tax years on the income out of which the distributions were made.
HMRC allowed the claim for credit for income tax paid by the trustees on UK source income arising to the trustees for the previous six years and repaid the income tax paid. However, HMRC rejected the claims for credit in respect of the income tax paid by the trustees on UK source income arising in tax years before that period.
The claimants brought a judicial review claim challenging HMRC’s decision, arguing that Concession Three granted relief without a six-year limitation, such that HMRC was wrong to reject their claims. The claimants also argued that ESC B18 had to be interpreted so as not to infringe the EU law rights of taxpayers, and that HMRC’s interpretation would constitute unjustified discrimination contrary to articles 49 (freedom of establishment) and/ or 63 (free movement of capital) of the Treaty on the Functioning of the European Union.
The High Court’s decision
The High Court (HC) determined that ESC B18 was susceptible to two competing interpretations and, to decide between them, it was necessary to go beyond the language of ESC B18 and consider the statutory scheme and previous iterations of ESC B18. The HC considered that to be the context against which the ordinarily sophisticated taxpayer would read ESC B18.
The HC held that while Concession Three may have extended the credit mechanism in FA 1973 s 17 (later ICTA 1988 s 687), which was not subject to the six-year limitation, rather than the look-through relief in FA 1973 s 18, it did not follow that the extension was unrestricted.
Rather, taken in conjunction with the fact that the draftsman regarded Concession Three as a second limb of Concession Two, it would be anomalous if Concession Three provided relief to a greater extent than either s 18, Concession One, or Concession Two. The HC considered that conclusion was supported by the fact that Concession Three granted relief that must be claimed, and it was understandable that HMRC would wish to limit the number of years of records it had to check when deciding whether to grant such relief. In the view of the HC, the claimants’ case was not advanced by resorting to principles of EU law. Accordingly, the claim was dismissed.
The Court of Appeal’s decision
The Court of Appeal (CA) approached the interpretation of ESC B18 in a rather more orthodox fashion than the HC, focusing primarily on the text of the concession itself. In that regard, the CA determined that, read naturally, the text of ESC B18 strongly supported the claimants’ case. In particular, it concluded that, on a natural reading, it was clear that the conditions specified in Concession One, including the six-year limitation, were applicable also to Concession Two. That was because both Concessions supplemented ICTA 1988 s 809, such that it was to be expected that both Concessions were restricted in the same way as s 809.
However, the CA considered the position was different for Concession Three for five reasons. Firstly, because of the way in which ESC B18 was laid and the fact that Concession Three was located in a separate paragraph to Concession Two. Secondly, if the conditions set out in respect of Concession One were intended to apply to Concession Three, there would have been no need to spell out the conditions contained in the text of Concession Three.
Thirdly, while the conditions listed in Concession Three largely replicated those provided for Concession One, the draftsman did not consider it appropriate to repeat the requirement for a payment to be ‘out of income which arose to the trustees not earlier than six years before the end of the year of assessment in which the payment was made’. In the view of the CA, the obvious inference was that Concession Three was not intended to be subject to that limitation. Fourthly, the absence of any paragraph break in key parts of the text provided additional reasons for thinking that the conditions in Concession Three were stated comprehensively. Fifthly, it was highly significant that Concession Three specifically invoked ICTA 1988 s 687, which differed from s 809 in its omission of the limitation.
Further, and unlike the HC, the CA did not consider that issues of practicality for HMRC would lead an ‘ordinarily sophisticated taxpayer’ to infer there was a six-year limitation if ESC B18 did not otherwise so indicate. That was especially the case given the stringency of the conditions specified in Concession Three.
The CA was also of the view that EU law was of significance. . In particular, the CA determined the hypothetical ‘ordinarily sophisticated taxpayer’ could be expected to appreciate that, read in the way advanced by HMRC, ESC B18 could favour UK trusts over non-resident ones and therefore potentially run counter to EU law principles. The CA considered that would tend to confirm that, contrary to HMRC’s case, Concession Three was not subject to a six-year limitation.
The CA expressed some doubt as to whether it was right to have regard to previous versions of ESC B18 because an ‘ordinarily sophisticated taxpayer’ would not expect to have to research earlier versions in order to understand ESC B18 (1999), especially when ESC B18 (1978) and ESC B18 (1994), were not readily available. An ‘ordinarily sophisticated taxpayer’ should not be assumed to have looked at, or even to have had access to, old books where earlier versions of ESC B18 may have been located, and neither of the earlier versions was readily accessible on the internet. In any event, if it was appropriate to consider the earlier versions, the CA held that, on balance, the prior history tended to support the claimants’ case.
Finally, and although obiter, the CA agreed with the HC that no account should be taken of materials that the ‘ordinarily sophisticated taxpayer’ could not have been expected to be aware of. As such, if the ‘ordinarily sophisticated taxpayer’ would have had no means of knowing of an HMRC practice in relation to an ESC, it was appropriate to disregard it. Conversely, the CA considered there may be cases in which the ‘ordinarily sophisticated taxpayer’ would have been alerted to a settled practice of HMRC through, for example, HMRC manuals, published guidance or commentaries in practitioner texts, and such materials may be relevant when determining whether a taxpayer had a legitimate expectation in those cases.
The CA therefore found that Concession Three was not subject to a six-year income limit and allowed the appeal.
Comment
Judicial review is a fundamental of the UK justice system and essential to the maintenance of the rule of law. It is an important mechanism by which individuals can assert and protect their rights in the face of powers exercised by public bodies that affect their day-to-day lives. In that regard, judicial review is also an important constituent in maintaining the sometimes-fragile balance between the powers wielded on behalf of the government and the rights of UK citizens.
In recent years, judicial review has come under scrutiny, arguably as a result of high-profile cases that have involved the intersection of individual rights and freedoms with policies that are highly political in nature. The Brexit-related decisions of the Supreme Court in R (on the application of Miller and another) v Secretary of State for Exiting the European Union [2017] UKSC 5 and R (on the application of Miller) v Prime Minister [2019] UKSC 41, are two such recent examples, but there are many more. It is apparent that the inconvenience and frustration of ministers unable to implement their chosen agendas has led to growing calls amongst certain politicians for the courts’ judicial review powers to be curtailed and for the range of cases in which judicial review can be sought to be reduced. The recent reforms to the judicial review process enacted in the Judicial Review and Courts Act 2022 is arguably intended to appease some of those demands, although for how long remains to be seen.
In the tax sphere, increasing demands on public finances, coupled with a seemingly ever-worsening economic climate, have brought HMRC’s revenue gathering function into sharp focus, and HMRC being provided with a wide array of powers to help it increase the tax yield. HMRC’s exercise of its powers has, in some cases, been more ambitious than Parliament intended, with the result that, in recent times, there has been no shortage of judicial review claims against HMRC. However, the perception is that it has become more difficult in recent years to successfully challenge a decision of HMRC by way of judicial review. The Supreme Court’s decision in R (on the application of Haworth) v HMRC [2021] UKSC 25, being perhaps the most high-profile recent example of a taxpayer successfully challenging a decision of HMRC.
It is against that backdrop that the CA’s decision in Murphy was made and why many tax practitioners will welcome the decision. That is not to suggest that Murphy represents a seismic shift in the taxpayer’s judicial review fortunes, it does not. However, it is nonetheless a small step in the right direction for a number of important reasons.
Firstly, on the substantive point, the decision confirms that there is no time limit in respect of Concession Three of ESC B18. That is of course a significant outcome for UK-resident beneficiaries of non-UK resident trusts. Secondly, the CA’s guidance on the characteristics to be attributed to the ‘ordinarily sophisticated taxpayer’ provides helpful clarification on the test to be applied in claims for breach of legitimate expectation. Thirdly, the CA’s guidance is supplemented by its preference for a more orthodox approach to the courts’ task of construing the statements on which a legitimate expectation may be founded, which arguably limits HMRC’s ability to expand the type of knowledge to be ascribed to the ‘ordinarily sophisticated taxpayer’ in any given case. The CA’s comments, albeit obiter, on the irrelevance of materials such as HMRC manuals, guidance and commentaries that the ‘ordinarily sophisticated taxpayer’ could not have been expected to be aware of are especially helpful in that regard. Finally, the CA’s confirmation that EU law can be of relevance when construing the statement in dispute will strengthen taxpayers’ claims for breach of legitimate expectation where the interpretation favoured by HMRC can be shown to be inconsistent with EU law. All of these will be welcomed by taxpayers.
Overall, Murphy demonstrates that judicial review remains a vital and effective tool in defending taxpayers’ public law rights.
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