Should taxpayers be entitled to rely on HMRC's guidance, even when it is incorrect? The High Court recently considered this question in relation to guidance published by HMRC in 2003 on the taxation of unapproved share options. In addition to those taxpayers still directly affected by the guidance in question, the case is of wider application because the Court commented in some detail on the circumstances in which it will be so unfair for HMRC to collect tax due that they should not seek to do so.
The tax treatment of non-tax advantaged (unapproved) share options has been the subject of a long-running saga. This began with the case ofMansworth v Jelley in 2002, which changed the way in which gains on the sale of shares in such schemes are charged to tax. As a result of the judgment in this case, HMRC published new guidance on unapproved share options, the effect of which was to reduce the capital gains tax liability of the employee selling such shares or, in many cases, to create a loss for capital gains tax purposes on the sale, which the employee could set against other gains.
However, HMRC later obtained legal advice to the effect that this treatment was incorrect and that the correct treatment was less advantageous to the taxpayer. HMRC withdrew its guidance and later began to apply the less favourable but (widely now considered to be) correct treatment to enquiries and appeals which were already open, including for years to which the incorrect guidance had previously applied. The result of this was that some taxpayers who would otherwise have benefitted from the tax treatment set out in the incorrect guidance were not permitted to do so.
Ralph Hely-Hutchinson had exercised options to buy shares in an unapproved share scheme and sold the shares between 1999 and 2000. When the incorrect guidance was published in 2003, Mr Hely-Hutchinson sought to amend his tax returns for the relevant years so that he would benefit from the more favourable tax treatment. However, HMRC then opened an enquiry into his tax returns (for unrelated reasons) and ultimately denied the capital losses resulting from the incorrect tax treatment which their previous guidance had permitted.
After a protracted dispute with HMRC, Mr Hely-Hutchinson submitted a claim for judicial review, on the basis that he had a legitimate expectation that his tax should be calculated in line with the incorrect guidance and HMRC’s refusal to honour this was unfair.
The Court’s Decision
The High Court ruled that Mr Hely-Hutchinson did have such a legitimate expectation and described HMRC's approach as "very unfair". It therefore required HMRC to make a fresh decision on Mr Hely-Hutchinson’s case.
The Court placed significant emphasis on the fact that HMRC appeared to have treated different classes of taxpayer differently. While most taxpayers were permitted to benefit from the tax treatment set out in the incorrect guidance for the years to which it applied, those who had an enquiry open at the time the guidance was withdrawn, were not. The Court considered that this amounted to unfair discrimination which “risked undermining public confidence in a fair and non-discriminatory tax system”. However, it did accept that it is not necessarily unfair for HMRC to pursue its obligation to collect tax from one taxpayer just because it has not pursued its obligation to collect such tax from all such taxpayers.
Conversely, the Court put less emphasis on the need for a taxpayer to rely on HMRC guidance to their detriment. While acknowledging that, in many cases, the major reason for unfairness would be this detrimental reliance, it stated that there were other reasons that could make a decision unfair. Mr Hely-Hutchinson sold his shares before the incorrect guidance was published so did not expect to receive the more favourable tax treatment at that time. Once the guidance was published, Hely-Hutchinson did seek to rely on the indication in it that he could amend tax returns already submitted but overall detrimental reliance was not a key factor in this case. HMRC had considered only whether a taxpayer had relied on their guidance to his detriment when deciding whether to collect unpaid tax but the Court said that they should have looked at a wider range of factors which could indicate unfairness.
Although Mr Hely-Hutchinson was successful on this occasion, the Court stressed that the degree of unfairness required for HMRC to be required to remake a decision as a result of a judicial review had to be so high as to constitute an abuse of power. Therefore, the taxpayer will not always be entitled to more favourable tax treatment as a result of errors in HMRC’s guidance. However, this case does show the Court’s reluctance to allow HMRC to renege on its guidance and also shows that HMRC’s duty to maximise tax revenue is not a “trump card” which automatically overrides its duty to treat taxpayers fairly.