In R(oao Hely-Hutchinson) v HMRC1, the High Court has held that a taxpayer who incurred capital losses as a result of the Court of Appeal decision in Mansworth v Jelley2, and subsequent HMRC guidance, had a legitimate expectation that those capital losses would not be denied, and that the closure notices denying those losses should be quashed.
Mr Hely-Hutchinson (the taxpayer), was employed by a bank. He was granted options over shares as part of his employment remuneration package following the commencement of his employment in 1989. He exercised and disposed of the shares in 1999 and 2000 and in each case disposed of the shares on the same day. The taxpayer completed his tax returns for the relevant years on the basis that, as was the understanding at the time, no gain or loss arose on the disposals.
The Court of Appeal, in Mansworth v Jelley, held that the acquisition cost for capital gains tax (CGT) purposes of shares acquired on exercise of a non-tax-advantaged employee share option was deemed to be the market value of the shares at the time of exercise of the option, rather than the actual amount paid to exercise the option and acquire the shares.
Following the Court of Appeal’s judgment, on 8 January 2003, HMRC issued a technical note (the 2003 Guidance) explaining that it would treat the CGT base cost of shares acquired on an exercise of an employee share option which gave rise to an income tax liability as the sum of:
- the market value of the shares at exercise (as decided in Mansworth v Jelley)
- the amount charged to income tax on exercise (under section 120, Taxation of Chargeable Gains Act 1992).
The effect of this was that the amount charged to income tax was included in the base cost twice. A taxpayer who exercised a share and immediately sold the shares would make a capital loss equal to the amount charged to income tax. This beneficial treatment was to apply only for shares acquired under options exercised before 10 April 2003.
On 12 May 2009, HMRC published Brief 30/09 (the 2009 Guidance) announcing that it had received legal advice that the 2003 Guidance was incorrect, as it permitted the option holder to increase the base cost by adding on the amount chargeable to income tax. As a consequence, HMRC considered that the correct CGT base cost for shares acquired on exercise of an employee share option before 10 April 2003, was limited to the market value of the shares on exercise of the option.
In May 2014, HMRC published the decision of its Personal Taxes Contentious Issues Panel (the 2014 Guidance), which confirmed that it could use its collection and management powers to give taxpayers the benefit of the 2003 Guidance where:
- the taxpayer could demonstrate, on the balance of probabilities, that he relied on the 2003 Guidance
- the taxpayer would suffer detriment if those losses were denied
- the taxpayer would have been able to demonstrate a legitimate expectation that he could rely on the 2003 Guidance, except that HMRC’s delay in dealing with his enquiry meant that the amount of evidence available to him was limited.
Following the Court of Appeal’s decision in Mansworth v Jelley and the publication of the 2003 Guidance, the taxpayer adjusted his tax returns for the relevant years to claim capital losses for the amounts charged to income tax. In June 2003, HMRC opened enquiries into his returns. As is so often the case, the enquiries dragged on for many years and it was not until 12 November 2010 that HMRC finally issued closure notices refusing the capital losses. On 7 December 2010, the taxpayer appealed the closure notices and commenced judicial review proceedings.
The High Court’s decision
The Court found in favour of the taxpayer and quashed the closure notices.
In the view of the Court, HMRC’s responsibility for the collection and management of taxes under section 1, Taxes Management Act 1970 (TMA), co-existed with its duty to treat taxpayers fairly and not to discriminate between them, and to stand by its published statements in order to provide certainty to taxpayers.
The Court said that HMRC’s duty to collect tax could not prevail over all other considerations where collection of tax would cause such unfairness as to amount to an abuse of power. Contrary to the 2014 Guidance, such unfairness was not limited to cases where a taxpayer had relied, to his detriment, on HMRC’s published statements.
In the view of the Court, the 2003 Guidance was clear, unambiguous and devoid of relevant qualification (the criteria laid down in R (Davies and Another) v HMRC and R (Gains-Cooper) v HMRC3). The Court therefore concluded that the 2003 Guidance gave the taxpayer a legitimate expectation that his capital losses would be taxed in accordance with it.
Although the 2009 Guidance was a valid exercise of its powers, HMRC had failed to exercise its duty of fairness, which required it to balance the taxpayer’s legitimate expectation arising from the 2003 Guidance and the unfairness caused by its withdrawal, against its duty to collect tax.
HMRC claimed that there had been no detrimental reliance by the taxpayer, but the Court said that HMRC should have considered:
- whether its action was fair as between taxpayers – HMRC had accepted similar claims for capital losses from many other taxpayers
- whether the 2009 Guidance was unfair because it was retrospective in its application and applied a new interpretation of the law to past disposals
- the fact that unfairness had arisen as a result of a mistake by HMRC which it had taken a considerable amount of time to rectify
- the length of the enquiries – closure notices had been issued 11 years after the claims had been submitted to HMRC.
This is an important decision in the context of public law and confirms that it is not necessary for a taxpayer to rely to his detriment on a published statement of HMRC, in order to be successful in an application for judicial review following the withdrawal, or disapplication, of that statement.
This case also illustrates the Courts’ dislike of attempts by HMRC to resile from its own published guidance in circumstances where to do so is “conspicuously unfair”.
The decision can be read here.