In the recent First Tier Tribunal decision of Anthony Bayliss v HMRC (TC/2015/06609), the Tribunal not only cleared the taxpayer of fraud, but also of negligence, and criticised the "highly questionable" approach taken by HMRC to the penalties issued against him for his use of a tax avoidance scheme.
The taxpayer in question, Mr Bayliss was considered to be an unsophisticated investor. He was originally a teacher and had developed a business refurbishing and letting residential properties. He instructed an accountant, Mr Mall of Appleby Mall, in his tax affairs, whom he relied upon for his tax advice for over a decade.
When Mr Bayliss disposed of his property portfolio, Mr Mall suggested that he could reduce his capital gains payment through a tax avoidance scheme led by Montpelier Tax Consultants, a scheme known as "Pendulum". Mr Mall arranged for Mr Bayliss to meet with Montpelier, receiving commission as a result of the introduction which was not disclosed to Mr Bayliss. Mr Mall offered the assurance to Mr Bayliss that he had seen the Pendulum scheme work successfully on a number of occasions and was so confident of it that he would invest in it himself if he were in Mr Bayliss's position. The Tribunal was satisfied from Mr Bayliss's evidence that he had understood that this scheme was legal, and that it was backed by a Counsel's opinion.
Mr Bayliss invested in this scheme and, in accordance with its purpose, Mr Mall prepared Mr Bayliss's tax return on the basis that he had suffered losses which could be offset against his CGT liability. The scheme did not work, and the loss relief was therefore not available.
HMRC subsequently investigated the Pendulum scheme and commenced an investigation against Mr Bayliss personally. As a result of the investigation, HMRC ordered Mr Bayliss to pay the amount of tax that had been underpaid, and issued a penalty of 35% of this amount under s.95 of the Taxes Management Act 1970 ("TMA") on the basis that when he delivered incorrect self-assessment returns, he did so fraudulently or negligently. This penalty was calculated by HMRC based on the allegation of fraud, and in accordance with their practice of considering rebates for disclosure, co-operation and seriousness.
There was no dispute that the returns were incorrect or that the additional tax was not due. Mr Bayliss appealed to the Tribunal solely in relation to the penalty issued by HMRC.
The Tribunal reminded HMRC that the burden of proof was on them to show, on the balance of probabilities, that Mr Bayliss (and not his advisor, Mr Mell) had acted fraudulently or negligently.
HMRC sought to argue that being reckless, that is careless whether his tax return was true or false, was enough for fraud. Perhaps significantly, they confirmed they were not suggesting that the Pendulum scheme was a sham. The Tribunal disagreed with HMRC's approach to determining fraud, confirming that the key question was whether Mr Bayliss had an honest belief about the correctness of his return and therefore, in order to prove fraud, HMRC must prove that he did not.
The Tribunal concluded that none of the arguments put forward by HMRC to support its allegation of fraud could be sustained. The Tribunal was critical of HMRC pursuing fraud, stating that an allegation of fraud is "a serious one", and reminding HMRC that the burden of proof rests on them.
The Tribunal also rejected HMRC's allegation that Mr Bayliss was negligent in filing a tax return; they were persuaded that he relied fully on his tax adviser, Mr Mall, who had completed the return.
The Tribunal criticised HMRC's determination of the amount of the penalty. In accordance with HMRC's standard practice, it considers abatements to the 100% penalty amount for the following: disclosure (up to a maximum reduction of 20%, or exceptionally, 30%); co-operation and seriousness (up to a maximum of 40% for each). In this case, HMRC applied abatements of 15% for disclosure, 25% for co-operation and 15% for seriousness, thus bringing the total penalty sought from Mr Bayliss to 35%. The Tribunal found it to be "highly questionable" that HMRC's approach to considering the amount of reduction to be applied on the grounds of seriousness did not distinguish between fraud and negligence, noting that fraud is quite a different category. They also criticised HMRC's failure to award the maximum abatement for disclosure and co-operation on the basis of Mr Bayliss' accountant, Mr Mall's, initial responses during the enquiry. Being satisfied that Mr Bayliss was not aware of Mr Mall's responses, the Tribunal stated the maximum abatement for co-operation was appropriate. Mr Bayliss's appeal was therefore allowed.
In the midst of HMRC's clampdown on tax avoidance, this decision provides a welcome sense check. It reinforces the important principle that a taxpayer, acting in good faith, is entitled to reasonable reliance on his professional adviser, and a distinction must be made when considering the wrongdoing on the part of the taxpayer and his adviser.