This is a brief update to record the outcome of two recently decided cases. The first dismisses an economic reality argument put forward by HMRC. The second is a reminder that a late filed paper return will attract a penalty even if “corrected” by an electronic return filed before the electronic filing deadline.

Economic reality

The First-tier Tribunal (FTT) case of Russell Baker v The Commissioners for HMRC [2013] UKFTT394 (TC) is interesting on a number of levels.

It concerns a company and its two shareholders, A and B (Russell Baker). A and B fell out and the company agreed to buy back B’s shares for £120,000 (or so). This amount was paid for B’s shares, who did not account for tax on it. HMRC enquired into his return, and assessed him for tax. B appealed.

One of the grounds of appeal was that the share buyback was void since the company did not have distributable reserves to cover the £120,000.

So (one of the taxpayer’s argument ran):

  • (a) Simply because the company pays £120,000 does not make that payment taxable. You need to look at the legal basis for the payment. It could be paid out by loan, it could be a distribution, it could be employment income. The tax treatment follows the legal analysis.
  • (b) HMRC’s argument that the payment was a distribution was misconceived since the transaction was void from the start. So the cash paid to B was held by B as constructive trustee and the company would have an “unanswerable claim” for its repayment.

One of the arguments put forward by HMRC was that B should be taxed on the basis that “the transaction had still actually taken place and the “economic reality” of what had happened was that the company had purchased its own shares from the appellant in exchange for the cash payments and other assets transferred to him... The tax treatment must follow the economic reality... It made no sense to conclude that the appellant was still a shareholder and the consideration was anything other than an outright payment, given the clear intention to sever all relations”.

The Tribunal gave short shrift to this assertion.

“We discount entirely any suggestion that the appellant should be taxed on the basis of the “economic reality” of what has taken place. Such a submission has a degree of unreality about it, bearing in mind the approach taken by HMRC in the sad appeals from defrauded investors in complicated life insurance bonds who have lost most or all of their investment but are still being taxed by HMRC on entirely fictitious gains arising under the life policy 'chargeable events' rules.”

On the facts of the case, the taxpayer won. The payment was not a distribution. The own share purchase was void. B is under an obligation to return the £120,000 to the company.

The Tribunal left open the tax consequence that may ensue in the future should the company fail to recover the £120,000, or write it off; but it is a reassuring judgment, emphasising that tax should only be charged in accordance with the legal reality of a transaction, rather than the “economic reality”.

Paper returns

The decision in executor of the Estate of Teresa Rosenbaum (deceased) [2013] UKFTT408 (TC) looks at the position of penalties for paper returns which are filed late.

In this case, the executors accountants sent a letter to HMRC on 9 January 2013 stating:

“Please find enclosed the tax return of the above named estate for the year ended 5 April 2012 ”.

HMRC issued a penalty for £100 on 15 January 2013 under paragraph 3 Schedule 55 FA2009. It was issued on the basis that under Section 8A TMA, where a paper return is submitted, the return must be submitted by 31 October 2012 (in relation to the tax year ended 5 April 2012).

On 24 January 2013, the appellant’s tax return for that year end was filed on line.

The issue was whether the paper return, filed on 9 January, was a “valid one”.

The important point to remember is that the following proposition was endorsed by the Tribunal. “I agree with HMRC’s basic proposition that if a taxpayer files a valid paper return after 31 October even if he or she subsequently files online before the following 31 January, an automatic £100 penalty arises under paragraph 3 Schedule 55 Finance Act 2009... If no valid paper return is submitted and an online return is submitted before the following 31 January no penalty can arise”.

The Tribunal then went on to observe that the onus of proving penalty cases rests on HMRC, who had provided no evidence that the paper return sent with the letter of 9 January 2013 was a valid return. The document had not been produced, and there was no evidence that it had been signed by the appellant (HMRC’s consistent practice has been that a paper return must be signed by the taxpayer in order to be valid).

So in the absence of evidence that the paper return was valid, the appeal was allowed, and the penalty assessment discharged.