In the recent case of Herefordshire Property Company Ltd v HMRC1, the First-tier Tribunal (Tax Chamber) ("FTT") allowed the taxpayer's appeal against the imposition by HMRC of a penalty, which was based on an allegation of negligent implementation of a tax planning scheme by the taxpayer.
Regular readers of our blog may recall my post from 3 July 2014, HMRC fail to demonstrate negligence in tax planning case, in which I reported on the FTT's decision inR, A and M Gardiner v HMRC2. In that case, HMRC had failed to adduce sufficient evidence in support of its case that the taxpayer had been negligent, which had been based (as in this case) on a failure by the taxpayer to implement tax planning correctly. Readers can be forgiven for experiencing a degree of déjà vu when considering this latest decision of the FTT.
Mr Smeal was the principal shareholder of Herefordshire Property Company Ltd (the "taxpayer"), and its controlling director. Following serious ill-health, Mr Smeal decided to simplify and rationalise his assets, and decided that the taxpayer should sell the substantial investment property it owned and distribute the profits to him.
The cumulative total of corporation tax on the disposal of the investment property, and tax on distributing the proceeds to Mr Smeal as a shareholder, was in the region of 68% of the gain. Mr Smeal (perhaps unsurprisingly) considered this to be excessive, and so sought advice from Montpelier Tax Consultants (Isle of Man) Limited ("Montpelier") as to whether the tax charges could be mitigated.
Montpelier had provided planning to the taxpayer which was intended to create an allowable capital loss, which could be utilised by the taxpayer to offset against the gain which had been realised on the disposal of the property. The planning operated through the acquisition and disposal of capital redemption policies.
Similar arrangements were at the time being provided by a number of professional advisers, including KPMG and Grant Thornton.
The Montpelier scheme was duly implemented, and the taxpayer included on its tax return details of the capital gain on the disposal of the property, the loss claimed in respect of the redemption of the policies acquired under the scheme, and the DOTAS reference number of the Montpelier scheme.
Subsequent to the submission of the taxpayer's return, the Court of Appeal delivered its judgment in Drummond v HMRC3, in which it concluded that a scheme which was substantially similar to the Montpelier scheme failed. The taxpayer's loss relief claim, in the instant case, was therefore withdrawn and the tax due on the capital gain in respect of the property disposal was paid to HMRC.
As in the Gardiner case, HMRC was not satisfied with this and wrote to the taxpayer to the effect that all the participants in the Montpelier scheme were to be charged penalties on the basis that the Montpelier scheme would have failed in any event due to the manner in which they were implemented. HMRC suggested that "nothing had happened at all", ie no steps were taken in implementing the planning, and that the taxpayer, together with other clients of Montpelier, ought to have appreciated this. Having not appreciated this, HMRC alleged that they were negligent in their failure to seek further independent advice or to challenge the basis on which the scheme was implemented.
HMRC did not seek penalties from taxpayers who had implemented similar planning provided by other advisers such as KPMG and Grant Thornton.
The FTT observed that Mr Smeal had considerable faith in Montpelier. His past experience of the firm had been "highly satisfactory", and there was no belief, or concern, that he was dealing with a firm of poor repute. In the view of the FTT, nobody could have expected Mr Smeal, or the taxpayer, to verify the 'behind the scenes' steps in the transactions. The taxpayer was entitled to consider that its professional adviser had prepared all necessary documentation.
In the view of the FTT, the taxpayer was entitled to conclude that the scheme would operate as intended and accordingly there was no basis to conclude that it had been negligent in the submission of its return and should be subject to a penalty. The taxpayer's appeal was allowed.
This decision can be distinguished from the Gardiner case because HMRC at least managed to properly plead its case. However, the FTT was clearly unconvinced by its arguments, to such an extent that it was able to give its decision orally at the end of the hearing.
HMRC should appreciate that a taxpayer is entitled to rely upon professional advice when implementing tax planning, and irrespective of how much it may object to such planning, it does not automatically follow that such a taxpayer should be subject to penalties. In the words of the FTT: "there should be no penalty for honestly implementing a legal scheme, with no element of evasion, and with full provision of the DOTAS number."