Concern has been building for some time amongst taxpayers and their advisers about HMRC’s apparently unfettered use of discovery assessments.  The recent decision in Charlton and two Others v HMRC [2011] UKFTT 467 (TC), in which the First-tier Tribunal found that the discovery assessments issued against the Appellant taxpayers were invalid, is therefore welcome news.

Section 29 Taxes Management Act 1970 (“Section 29″)

As readers will be aware, section 29 gives HMRC the power to raise assessments where an under-assessment of tax is “discovered” after the enquiry window has closed.  Unless the original under-assessment was brought about deliberately or carelessly by the taxpayer or their agent, assessments can only be raised where the condition in section 29(5) is satisfied.  The condition is that:

[…] at the time when an officer of the Board –

(a) ceased to be entitled to give notice of his intention to enquire into the taxpayer’s return […] in respect of the relevant year of assessment; or

(b) informed the taxpayer that he had completed his enquiries into that return,

the officer could not have been reasonably expected, on the basis of the information made available to him before that time, to be aware of [the under-assessment]

Section 29(6) provides:

For the purposes of subsection (5) above, information is made available to an officer of the Board if –

(a) it is contained in the taxpayer’s return […] in respect of the relevant year of assessment […], or in any accounts, statements or documents accompanying the return;

(b) it is contained in any claim made as regards the relevant year of assessment by the taxpayer acting in the same capacity as that in which he made the return, or in any accounts, statements or documents accompanying any such claim;

(c) it is contained in any documents, accounts or particulars which, for the purposes of any enquiries into the return or any such claim by an officer of the Board, are produced or furnished by the taxpayer to the officer; or

(d) it is information the existence of which, and the relevance of which as regards the situation mentioned in subsection (1) above –

(i) could reasonably be expected to be inferred by an officer of the Board from information falling within paragraphs (a) to (c) above; or

(ii) are notified in writing by the taxpayer to an officer of the Board.

The Facts

The Appellants entered into a second-hand insurance policy (“SHIP”) tax avoidance arrangement in the year 2006/2007.  38 other taxpayers also entered into the arrangement, in the same or preceding year.  The arrangements had already been disclosed to HMRC for the purposes of DOTAS and a form AAG1, which gave full details of the arrangements and the statutory provisions relied upon, submitted.  All of the participants, including the Appellants, inserted similar details about the arrangements, including the DOTAS reference number, in their tax returns.

HMRC opened enquiries into the returns of the 38 other taxpayers on the basis that they did not consider the SHIP arrangement, as implemented, to be effective.  This position was supported by the then recent decision of the Special Commissioners in Drummond v HMRC [2007] STC (SCD) 682, which considered a similar SHIP arrangement.  However, due to administrative errors, HMRC failed to open enquiries into the Appellants’ returns before the enquiry window closed. 

HMRC subsequently realised this omission and raised discovery assessments into the Appellants’ returns under Section 29.  By this time the decision in Drummond had been upheld on appeal in the High Court and the Court of Appeal, and the taxpayer refused permission to appeal to the Supreme Court.  The 38 other taxpayers, for whom “in time” enquiries were opened, had also conceded that the capital losses claimed were not available.  The Appellants appealed against the validity of the discovery assessments on the basis that an officer could reasonably have been expected to be aware of the under-assessment before the enquiry window closed, so the assessments were blocked by section 29(5).  

The Tribunal’s Decision

The Tribunal found that, in order to satisfy the condition in section 29(5):

HMRC must show that the notional officer, relying on all of, but no more than, the subsection (6) information would not have arrived at the belief, at the end of the enquiry window, that there had been an under-assessment, and that in order to rectify matters a new assessment was justified, and that assessment had a reasonable chance of being sustained. (emphasis in original)

The Tribunal found that, confronted with the information listed in section 29(6), an “average” officer would have been alerted to the fact the Appellants had entered into a marketed tax avoidance structure and the inclusion of the DOTAS reference would have made it obvious that a form AAG1 disclosure would have been made to HMRC specialists and that these specialists would most likely have already taken a view as to whether the arrangements might be successfully challenged.  Therefore, had the officer made such enquiries he would have been alerted to the view within HMRC that the arrangements did not result in available losses, as supported by the decision in Drummond.  Accordingly, an averagely competent HMRC officer would have discovered the under-assessment.

However, HMRC submitted that the chain of enquiry which the section 29(6) information might prompt was simply not relevant.  The effect of section 29(6) was that the notional officer referred to in section 29(5) was deemed to have considered only the information listed in section 29(6) and the legislation did not permit any further enquiries which that information may have prompted to be taken into account.  Rather, the legislation envisages that the notional officer will review the information listed in subsection (6) and then decide whether a new assessment is justified without recourse to further research or enquiries.  That this was (hopefully) not how an officer would in reality behave did not matter.

As the Tribunal put the question: “[g]ranted that deeming the officer to sit and worry in his dark room without guidance is the last manner in which we would expect the officer to proceed, is this unrealistic state of affairs one that we are compelled to adopt by statute or by any authority?“ 

The Tribunal decided that it was not, though seemed to reach the decision based on a broad view of the purpose of the section 29(5) condition rather than an analysis of the wording of the legislation.  It concluded: “if it is glaringly obvious either that the relevant officer should consider the law, and possibly refer to published material or, where an SRN number is disclosed, simply send an e-mail or make a phone call to colleagues and ask for guidance, this is precisely how we should treat the notional officer as proceeding“.

It is to be hoped that this decision will give HMRC cause for reflection and will lead to a more restrained and considered exercise of their section 29 powers, limited to circumstances where they have genuinely “discovered” a tax loss due to new information, as required by the wording of the statute.  Section 29 was not introduced to spare HMRC’s blushes in circumstances where the taxpayer has provided adequate disclosure in a return but an enquiry is not opened in time due to administrative or other failings on the part of HMRC. This was not the intention of Parliament in enacting the section. Where they have made adequate disclosure, taxpayers are rightly entitled to certainty in their tax affairs – this decision is to be welcomed.