In Robert Don Hunter Dougan v HMRC [2022] UKFTT 00140 (TC), the First-tier Tribunal (FTT) cancelled certain discovery assessments issued to a taxpayer by HMRC, on the basis they were issued out of time because the taxpayer's behaviour was careless rather than deliberate, for the purposes of section 36, Taxes Management Act 1970 (TMA). The FTT also cancelled various late filing penalties and late payment surcharges issued by HMRC, on the basis the notices were not validly served on the taxpayer.

Background

Mr Dougan was an Australian national who lived and worked in the UK under the terms of a visa and was a successful musical composer/producer who operated a music business as a sole trader in the relevant tax years. He was concerned about the future viability of his music business and invested significantly in setting up a new wine business in France, with a view to supplementing or replacing his income from the music industry.

At all material times, Mr Dougan was resident in the UK for income tax purposes and carried on business as a musician, first as a sole trader and then through an incorporated business. He was also a partner in a partnership known as Partnership Lindfield.

Mr Dougan failed to file various tax returns on time. HMRC issued discovery assessments to Mr Dougan in respect of the 2004/05, 2005/06, 2006/07 and 2007/08 tax years, pursuant to section 29, TMA (the Discovery Assessments), as well as various late filing penalties and late payment surcharges (the Penalties). Mr Dougan appealed the Discovery Assessments and the Penalties to the FTT.

FTT decision

Following two case management hearings, the FTT directed that the matters that should be the subject of a substantive hearing were:

1. an appeal against the Discovery Assessments;

2. whether the Penalties, or any of them, were validly issued and served;

3. if so, whether Mr Dougan was out of time to make an appeal against them;

4. if, before the date of the hearing, Mr Dougan had applied to be allowed to make a late appeal against the Penalties, whether that appeal should be admitted; and

5. if there was a valid appeal against the Penalties (either because it was made in time, or had been admitted out of time), whether the appeal should be allowed.

Discovery assessments

HMRC agreed before the substantive hearing that the Discovery Assessment for 2007/08 and the late payment surcharges for that year should be cancelled.

In making their submissions regarding the Discovery Assessments, the parties addressed the following issues:

1. whether the Discovery Assessments were validly issued within the time limit for cases that involve careless behaviour, or whether Mr Dougan’s behaviour was deliberate;

2. when Partnership Lindfield began trading; and

3. whether the consultancy fees charged by SCEA Robert Dougan (a French company) to Partnership Lindfield were deductible.

The FTT found that Mr Dougan did not address his tax responsibilities and that his focus was on his new wine business, young family and litigation in relation to his music business. Although Mr Dougan had a history of late filing, he had periodically caught up with his UK tax filing in the past, and the FTT found that this was his intention in relation to the years under appeal. Mr Dougan met with his UK accountants regularly and sought to provide them with the necessary paperwork. He believed that HMRC was aware of his music income and his understanding was that his UK tax liability would be offset by his losses from the new wine business.

Applying the test formulated in Tooth v HMRC [2019] EWCA Civ 826 to the facts, the FTT concluded that Mr Dougan did not intend to bring about a loss of tax. Mr Dougan's behaviour was therefore careless rather than deliberate, for the purposes of section 36, TMA. As a result, the Discovery Assessments for 2004/05 and 2005/06 were not issued within the 6 year time limit provided for in section 36 and were invalid. The Discovery Assessment relating to 2006/07, was validly issued as it had been issued within 6 years.

Having established that the Discovery Assessment for 2006/07 was validly issued, the FTT considered the quantum of Mr Dougan’s liability for that year. As Mr Dougan had claimed his share of Partnership Lindfield’s losses against his personal income in the tax years that were the subject of the Discovery Assessments, it was necessary to address the tax position of Partnership Lindfield and in particular to determine when it commenced trading, and whether the fees that it paid to SCEA Robert Dougan were tax deductible, such that it had tax losses available for Mr Dougan to set against his personal income using sideways loss relief.

Taking account of the evidence available, the FTT considered that, on the balance of probabilities, Partnership Lindfield commenced trading after 5 April 2007. The basis period for its first year of trading was 2007/08.

As the FTT had found that Partnership Lindfield had not commenced trading in the relevant tax years, the FTT concluded that the fees paid to SCEA Robert Dougan could not have been for the purposes of the trade. The FTT stated that, if it were wrong in its finding about the date of commencement of trading, the evidence supported identifying a proportion of the consultancy fees for each year that were incurred wholly and exclusively for the purposes of the trade.

Penalties

With regard to the Penalties, the FTT applied the guidance provided by the Upper Tribunal in Barry Edwards v HMRC [2019] UKUT 131, to its findings of fact to determine whether the penalty notices had been properly served. In the view of the FTT, Mr Dougan’s claim that he did not receive the Penalties was supported by his credible and consistent evidence that he had not received notice of the Penalties. In addition, Mr Dougan had identified several discrepancies in HMRC’s records of his address and although the FTT accepted that other documents, such as statements of account, had been received and actioned by Mr Dougan, it considered that, given his method of dealing with demands from HMRC, he would have paid the Penalties as and when they were received if he had been notified of them. The FTT considered it would not be logical to pay statements of account but not small, fixed penalties and it therefore concluded that the Penalties had not been properly served and should be cancelled.

The FTT decided that:

1. the Discovery Assessments for tax years 2004/05 and 2005/06 should be cancelled (HMRC agreed that the Discovery Assessment for 2007/08 should also be cancelled);

2. the Discovery Assessment for tax year 2006/07 was upheld, but varied in accordance with section 50, TMA, to reflect HMRC's revised calculations; and

3. the Penalties should be cancelled.

Comment

This decision provides an interesting discussion of the important issue of when a taxpayer's behaviour is careless or deliberate, for the purposes of section 36, TMA, and the issuing discovery assessments under section 29, TMA. The decision is also notable for its discussion of what constitutes valid service of a penalty notice. Both these issues are of general significance to many taxpayers.

The decision can be viewed here.