Quarterly Contentious Tax Review – Winter 2021

22 December 2021. Published by Adam Craggs, Partner

HMRC has extensive powers to require information and documentation from taxpayers and these powers were bolstered in the last Finance Act to include financial institution notices. Failure to comply with information notices can attract penalties. The most severe penalties are those imposed by the Upper Tribunal (UT). We examine in this review, HMRC's increasing use of these powers, together with HMRC's penchant for 'nudge' letters and recent developments in the application of the transfer of assets abroad (TOAA) provisions.

A copy of this article was first published in Tax Journal on 2 December 2021. 

Tax geared penalties imposed by the UT 

Paragraph 1, Schedule 36, Finance Act 2008, provides the power for an officer of HMRC to require a taxpayer to provide information, or produce documents, if they are "reasonably required" for the purpose of "checking the taxpayer’s tax position". Paragraph 7, Schedule 36, sets out the obligation of a taxpayer to comply with an information notice. 

Where a person fails to comply with an information notice he is liable to a penalty of £300 (paragraph 39,  Schedule 36). If that failure continues after a paragraph 39 penalty has been imposed then the person is liable  to a further penalty not exceeding £60 for each subsequent day on which the failure continues (paragraph 40, Schedule 36). Where a person becomes liable to a penalty under paragraph 39, and the failure to comply with the information notice continues after that penalty has been imposed and an officer of HMRC has reason to believe that, as a result of that failure, the amount of tax that a person has paid, or is likely to pay, is "significantly less" than it would otherwise have been and the officer applies to the UT within 12 months of the taxpayer becoming liable to the paragraph 39 penalty, the UT has a discretion to impose an additional 'tax-geared' penalty under paragraph 50, Schedule 36, in an amount decided by the UT. In determining the amount of any such penalty, the UT "must have regard to the amount of tax which has not been, or is not likely to be, paid by the person".

The only published decisions concerning paragraph 50 penalties are Tager & Anor v HMRC [2018] EWCA Civ 1727 and HMRC v Mattu [2021] UKUT 0245 (TCC). In Tager, the Court of Appeal held that the UT must have regard to the amount of tax at risk from failure to comply with the information notice and that the penalty to be imposed was not intended to be a substitute for recovery of the unpaid tax (as would be the case with, for example, tax-geared penalties imposed under Schedule 55, Finance Act 2009). The Court said that paragraph 50 was not a prescriptive tax-geared penalty, unlike Schedule 55, as the legislation only required the UT to "have regard" to the amount of tax unpaid. However, ascertaining that figure is not always straightforward, particularly where HMRC is at a stage in its enquiry where it claims to have limited information. The amount of tax unpaid, along with other relevant circumstances, should inform the determination of quantum, yielding a result that is proportionate to the scale and nature of the alleged tax shortfall.

As the power to impose a tax-geared penalty is penal in nature, it can be inferred that Parliament  intended it to be reserved for serious cases of non-compliance with information notices where the imposition of fixed daily penalties is insufficient to secure compliance by the recipient of the notice. It was confirmed in Tager that a link has to be established between the taxpayer's failure to comply with the relevant notice and the amount of tax that he paid, or was likely to pay. It is a pre-requisite of imposing a paragraph 50 penalty than an officer of HMRC had reason to believe that, as a result of the failure to comply, the amount of tax that the person has paid, or is likely to pay, is "significantly less than it would otherwise have been". 

In deciding whether a paragraph 50 penalty should be imposed, the UT must have regard to the usual considerations applying to the imposition of a tax penalty, including the reasons for non-compliance, the extent to which the position had been remedied, the gravity and duration of the non-compliance, the presence of any aggravating or mitigating factors, and the need to achieve a fair and proportionate outcome, having regard to the interests of the general body of taxpayers as well as the circumstances of the non-compliant taxpayer. 

As a matter of general principle, when penalties are disputed, the onus is on HMRC to satisfy the tribunal of their amount. Mattu is the first published decision after Tager in which these issues were considered. For present purposes, the facts in Mattu can be stated shortly. Mr Sukhdev Mattu was the sole beneficiary (albeit a discretionary beneficiary) of an offshore trust.  Although not named as the initial settlor of the trust, he made contributions of capital to it over a number of years amounting to some US$1.3 million in total. He also made loans to the trust exceeding £1 million.  The trustee was resident either in Switzerland or St Kitts & Nevis, with some administration also carried out in Panama. The trust held a number of offshore companies, incorporated variously in the BVI, Monaco and the Seychelles.  Some of the companies held land or property in the UK. Mr Mattu was a UK resident since 2010-11 and although he asserted that he was not domiciled in the UK, he had claimed the remittance basis only in 2016-17 and subsequent years.  HMRC’s enquiries related to the years 2012-13 to 2016-17 and discovery assessments were issued in respect of each of those years.  Apart from 2016-17, the discovery assessments were issued before the date of HMRC’s paragraph 50 application.

HMRC’s concerns related to the question of whether the income or capital gains of the trust, or the companies it controlled, were attributable to Mr Mattu so as to result in tax liabilities for him personally, whether pursuant to the TOAA legislation (section 703 et seq, ITA 2007), the settlements legislation (section 619 et seq, ITTOIA 2005) or section 13, TCGA 1992. HMRC identified, through documents obtained from other sources, various income and capital gains of the companies controlled by the trust in the years in question which, if they gave rise to a tax liability in relation to Mr Mattu personally, would result in tax of £1,916,315.  Such a liability had not been declared or assessed in Mr Mattu's self-assessment tax returns. HMRC had commenced a COP8 enquiry, but limited information had been provided to HMRC. The trustee, and the entities connected with the trustee, did not provide any substantive information.  HMRC issued a third-party notice under paragraph 2, Schedule 36, to Mr Mattu’s solicitors, which was complied with. Mr Mattu himself failed to provide any information or to comply with the information notice which had been issued to him. 

Mr Mattu challenged the paragraph 50 application on the following grounds:

1. the reasonableness of the issuing officer’s belief (under paragraph 50(1)(c)), including the necessary causal link between the non-compliance with the information notice and a significant amount of tax at risk of non-payment;

2. whether there could be a causal link where HMRC had issued discovery assessments, either before or after the paragraph 50 application, assessing amounts similar to the tax said to be at risk; and

3. the application of the UT’s discretion under paragraph 50(3), as to the amount of the penalty.

Rejecting Mr Mattu's arguments, the UT allowed HMRC’s application for a penalty to be imposed under paragraph 50 (although it was only 17% of the amount of the penalty HMRC had asked the UT to impose). In concluding that the conditions had been met, the UT found, inter alia, that a taxpayer cannot deflect its obligation to comply with an information notice by directing HMRC to a third party. The non-compliance in this case had been egregious and the officer's belief (paragraph 50(1)(c)) was rational, based on the information HMRC had gathered to date. 

The above decisions confirm that paragraph 50 applications should be reserved for cases of serious non-compliance. However, what HMRC considers to be serious non-compliance may not always accord with what taxpayers and their advisors consider to be serious non-compliance. We have noted a recent increase in the number of paragraph 50 applications being made by HMRC, and there are a number of such cases currently before the UT where the decision of the UT is awaited. We expect this trend to continue as HMRC's compliance activity increases. 

HMRC back to 'nudging' taxpayers  

Whilst data from HMRC shows that Britons paid £392billion in tax between April and October this year, which is an increase of £99.8billion (34%) from the same period last year, as at 30 September 2021, there was some £44 billion in uncollected tax. The figures suggest that up to 2.4 million more taxpayers now have outstanding tax liabilities following the pandemic. As has been widely reported,  HMRC’s investigation work plummeted during the Covid lockdowns, with only approximately 27,000 new investigations being opened during the second quarter of 2020, as HMRC adapted to the pandemic and home working. For obvious reasons during the pandemic, HMRC tended to adopt a Covid-sensitive approach to taxpayers who were under enquiry and we found that many existing enquiries were either not progressed at all, or proceeded at a slower pace than normal. By the first quarter of 2021, the number of new investigations increased by nearly 400%, compared with the same period last year. 

We have seen in recent months an increase in compliance activity, in particular, through the use by HMRC of so-called 'nudge' letters designed to influence the behaviour of taxpayers. This type of HMRC activity is not driven by statute, but by behavioural science. HMRC uses nudge letters to prompt taxpayers to review their tax affairs and if appropriate disclose any non-compliance. Such letters are normally sent out in large batches as part of a specific campaign and typically after it has processed data received from overseas tax authorities under the Common Reporting Standard, or following data analysis carried out by its analytical computer systems. HMRC uses a data analytical model (Connect and successor versions), which processes and analyses large amounts of data.

If information received, or data, suggests a group of taxpayers may have failed to complete their tax returns accurately, or a potential tax loss is identified, nudge letters are a relatively inexpensive way for HMRC to follow up without opening a formal enquiry. The popularity of nudge letters with HMRC, shows no sign of abating. HMRC has issued several different nudge letters in recent months, including in connection with cryptocurrency and foreign investment income. 

In relation to cryptocurrency, the department is using its extensive information gathering powers to obtain details of cryptocurrency holders from various exchanges. For example, Coinbase has confirmed that it provided details of all UK resident taxpayers who, in 2019/20, entered into cryptocurrency transactions worth more than £5,000. 

HMRC's cryptocurrency nudge letters target those who may need to pay tax on profits or gains made from disposals of cryptocurrencies. The tax treatment of cryptoassets is complicated and not straightforward. Crypto investors, many of whom will be realising sizeable gains in the current tax year, often overlook fundamentals, such as when a gain might be realised, for example, when switching from one cryptoasset to another. Other technical issues, such as the situs of cryptoassets and the impact on disposals for non-UK domicilaries must also be carefully considered. 

In HMRC’s view, asset-linked cryptoassets are situated where the asset they represent is located. For example, if a gold bar is held in a vault in Switzerland, then the token is a Swiss asset irrespective of the token holder's location. For non-asset-linked cryptoassets, HMRC acknowledges that there are currently no statutory provisions for the taxation of cryptocurrencies and it will therefore treat the cryptoasset as being situated where the beneficial owner of that cryptoasset is resident. HMRC claim that this provides a clear and objective rule which can be easily applied (CRYPTO22600). HMRC's position is, however, problematic, for a number of reasons. Cryptocurrencies are usually held in either a 'hot' or 'cold' wallet (the former being online, the latter being physical/offline). It is far from clear why the location of a wallet (in particular, a cold wallet) should determine a cryptocurrency's situs.  Under HMRC’s recently updated manual concerning the tax treatment of cryptoassets, remittance basis taxpayers may cause a remittance by simply carrying a cold wallet back to the UK from abroad. Uncertainty in this area looms large, but it would appear to be an area which is attracting the close attention of HMRC and we expect to see further concerted compliance activity in relation to cryptoassets. 


A large number of disputes between taxpayers and HMRC involve the application of anti-avoidance provisions. In recent years, HMRC's approach has been to expand the remit of both general and targeted anti-avoidance provisions. The TOAA code is a powerful weapon in HMRC's arsenal and one which it frequently relies on in disputes involving high net worth individuals. 

The main purpose of the TOAA code is to prevent UK resident individuals from avoiding income tax by transferring income producing assets to a ‘person’ (typically a company or a trust) outside the UK. The rules operate by treating the income arising to the person abroad as taxable income of the transferor. It is possible to avoid the application of the TOAA code if a ‘motive defence’ can be relied upon. To successfully rely upon such a defence, the taxpayer must establish that either the avoidance of tax was not the purpose, or one of the purposes of the relevant transactions, or that the transfer and any associated transactions took place for genuine commercial reasons and not for the purpose of avoiding a tax liability.

In Fisher v HMRC [2021] EWCA Civ 1438, three UK resident taxpayers (mother Anne, father Stephen and son Peter) transferred their gambling business from a UK company to a Gibraltar company. This was because it was commercially advantageous to offer customers a reduced rate of betting duty. Competitors had relocated their businesses outside the UK and the taxpayers felt they had no choice but to follow suit on the understanding that customers of betting companies demonstrate little loyalty, typically taking their custom to the cheapest provider.

The taxpayers were directors and shareholders of both companies and paid tax in the UK on their salary income and dividends. HMRC sought to tax them on the entire profits of the Gibraltar company in proportion to their shareholdings, on the ground that they had made a transfer of assets abroad. Much of this profit had been reinvested in the business. Although the actual ‘transferor’ in this case was the company, the Court of Appeal concluded that even though Stephen and Peter each held minority interests (and did not therefore control the company), they did act together to procure the transfer. However, only two of the three judges agreed on this point. In relation to Anne, it was found that she had entrusted her responsibilities to Stephen and Peter and was not therefore a quasi-transferor. Accordingly, the TOAA code applied to Stephen and Peter but not to Anne. This decision can be contrasted with HMRC v Andreas Rialas [2020] UKUT 367, in which HMRC argued, unsuccessfully, that an individual was able to procure a transfer of assets abroad by acting with a joint, albeit unconnected, shareholder. 

The Court of Appeal in Fisher also found that, although there had arguably been no avoidance of income tax, there was no requirement that income tax had been avoided in order for the TOAA code to apply. The legislation may be headed “prevention of avoidance of income tax”, but in the view of the Court it does not follow that the rules cannot operate in the absence of any avoidance of tax. 

Notably, the Court of Appeal disagreed with the UT’s finding that the taxpayers had a valid motive defence. Although the main purpose of the transfer was to save the business, this was only possible by avoiding the betting duty. The two were inseparable, and there was therefore a tax avoidance motive. It was noted that “it will rarely, if ever, be the case that a transferor wishes to avoid liability to tax for the sake of it; in normal circumstances, a transferor will be intending to use the avoidance of tax to attain another objective”. If a taxpayer could simply look beyond tax avoidance to its consequences then the motive defence would typically be available, which is both illogical and not Parliament’s intention. Finally, the Court also rejected the contention that the TOAA code infringed the EU freedom of establishment principle, because the UK and Gibraltar were part of a single Member State.

For the time being, the TOAA code will need to be applied carefully to the specific facts of each case. While HMRC will consider the restrictions identified by the Court to be useful in assessing other taxpayers, there remains room for manoeuvre based on careful structuring. HMRC will no doubt continue to seek to apply this legislation in cases where there has been a transfer of assets abroad and it considers the transferor has thereby avoided a tax liability.

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