In a recent case the First-tier Tribunal (FTT) has found that a taxpayer was not fraudulent or negligent in the completion of his tax return when relying on the advice of his professional advisors.
In Anthony Bayliss v HMRC  UKFTT 0500 (TC), Mr Bayliss (the taxpayer), appealed against penalties charged by HMRC pursuant to section 95(1)(a) Taxes Management Act 1970 (TMA) on the basis that he had fraudulently or negligently delivered incorrect self-assessment returns. The alleged fraudulent or negligent behaviour related to a claim to a capital loss in the sum of £539,000 that the taxpayer included in his return for 2006/07, but which he subsequently accepted was not available. The capital loss was used to offset gains arising both in 2006/07 and 2007/08. HMRC sought penalties in respect of the tax understated in each of the two years.
The loss related to the taxpayer's participation in a tax planning structure called "Pendulum Long" which involved the use of contracts for differences (CFD), which was subsequently found not to produce the intended fiscal consequences.
As part of his involvement in the arrangements, the taxpayer had completed a "sophisticated investor" statement for the purposes of the Financial Services and Market Act 2000. However, the taxpayer had no experience of CFD or the stock market. He had been a teacher, who in the early 1990s began purchasing, refurbishing and letting properties to students. In 1996 he left the teaching profession to concentrate on his property business.
The taxpayer disposed of his property portfolio over the three tax years 2005/06-2007/08. In the first year capital gains tax (CGT) was paid in the usual way on the realised gains. In the following year, his tax advisers suggested involvement with the planning which would generate a loss which could be used to offset CGT.
The taxpayer and his accountant attended a meeting with representatives of Montpelier Tax Consultants (Montpelier), the promoter of the scheme, on 15 January 2007. It was at this meeting that the taxpayer was informed that the "sophisticated investor" declaration was merely a formality which he was qualitied to complete owing to his experience of the property market. This was incorrect.
HMRC opened an enquiry in January 2009. The taxpayer maintained (and the FTT accepted) that he took no part in responding to HMRC's enquiries, leaving the matter in the hands of his accountants.
In December 2010, the taxpayer was informed by HMRC that a criminal investigation was being conducted into the activities of the Montpelier companies and the CFD scheme. In its letter, HMRC indicated that it would continue to treat the taxpayer's enquiry as a civil enquiry.
The taxpayer heard nothing more until 2012, when he learnt that Montpelier had been raided. The taxpayer sought further advice from his accountants who recommended the purchase of a certificate of tax deposit to cover the disputed tax and interest, in case the arrangements were ultimately demonstrated not to produce the desired loss. This he duly did in December 2012.
In April 2013, a new officer within HMRC reviewed the taxpayer's file for a possible Code of Practice 9 (COP 9) investigation. HMRC's COP 9 procedure governs civil investigations where a taxpayer is suspected of fraud. HMRC concluded that there was sufficient evidence to indicate tax fraud. Accordingly, in July 2013, HMRC wrote to the taxpayer explaining that he was suspected of committing tax fraud and inviting full disclosure under the COP 9 procedure (under which, in return for full disclosure of any fraud, HMRC undertakes not to prosecute the taxpayer).
The taxpayer refused to admit any fraudulent behaviour. He offered to withdraw his claims for loss relief and even offered, on a 'without prejudice' basis, to pay a penalty of 5% on the basis of negligent behaviour, but he maintained that he had not committed fraud. HMRC rejected the offers. The taxpayer withdrew his claims for loss relief in October 2014.
HMRC issued penalties of 35% of the amount of tax at stake on the basis of fraudulent or negligent behaviour. The taxpayer appealed against the penalties.
HMRC accepted that the burden of proof was on it to show, on the balance of probability, that the taxpayer had acted fraudulently or negligently.
The FTT observed that in determining whether the taxpayer had been fraudulent or negligent in completing his return it was not relevant what had happened after the date of filing. The FTT also made explicit the point that an allegation of fraud is a serious matter. A critical ingredient for any allegation of fraud is to demonstrate some dishonesty on the part of the accused. Something which the taxpayer strenuously denied.
Significantly, HMRC's representative specifically confirmed at the hearing that HMRC was not seeking to argue that the arrangements were a sham.
HMRC argued that the taxpayer had indicated on his returns that he had made an "economic loss" when, in fact, he had not. The FTT gave short shrift to this argument stating that the tax system is "highly complex" and that there were "many instances where the calculation of a profit or loss for tax purposes differs markedly from the economic profit or loss". The question was whether the taxpayer considered the content of his return to be correct at the time it was completed. The FTT concluded, on the basis of the evidence before it, that he did.
HMRC also referred to the taxpayer's declaration that he was a "sophisticated investor" as evidence of fraudulent behaviour. Again, the FTT rejected this argument. It accepted that the taxpayer was advised to complete the declaration by his advisors and he relied on that advice.
With regard to the broader category of negligence, HMRC relied on the decision in Litman & Newall v HMRC  UTFTT 089 (TC), in support of its arguments. Litman also concerned a Montpelier scheme involving a loan relationship. The taxpayer in that case was found to have been negligent because he did not look into the "basic commercial reality" of the arrangements.
The FTT declined to apply Litman to the present case. Critically, there was no evidence that the loan at issue in Litman had even been made or repaid and the taxpayer's failure in that case to establish that the scheme was not a sham was found to demonstrate negligence. In Litman HMRC had argued sham, whereas in the present case it had not. This distinction was important. The taxpayer had seen documents to demonstrate that the transactions at issue were real and, although he had concerns about the competency of the junior staff working for Montpelier, he had received reassurances. In the FTT's view, he was entitled to rely on such assurances.
The taxpayer's appeal was therefore allowed.
The FTT has confirmed that a taxpayer acting in good faith is entitled to rely on the advice of an adviser he trusts as to how the tax position may differ from the accounting position. The FTT did not see how taking into account the response of advisors to queries from HMRC in circumstances where the taxpayer has no knowledge of those communications should adversely affect the level of a reduction applied to a particular penalty.
This decision is also a timely reminder that HMRC should not treat any suspected wrong doing on the part of an adviser as that of the taxpayer. This is particularly important when deciding whether to invoke the COP 9 procedure. It is not necessarily sufficient that HMRC may suspect a taxpayer's adviser of fraud. In order to subject a taxpayer to a COP 9 investigation it must suspect the taxpayer himself of fraud.
There is a perception amongst some taxpayers that HMRC has in recent times subjected them to a COP 9 investigation simply because they have participated in tax planning which HMRC disapproves of and in respect of which HMRC suspects fraud on the part of one or more professional advisers associated with the planning. The use of the COP 9 procedure by HMRC in such circumstances may constitute an abuse of its powers challengeable by way of an application for judicial review. Any taxpayers so affected may wish to consider the options available to them.
A copy of the decision can be found here.