The recent unanimous judgment of the Court of Appeal in R (on the application of Haworth) v HMRC  EWCA Civ 747, is the first successful judicial review challenge against follower and accelerated payment notices. The decision throws into question the way in which the relevant statutory provisions, contained in Finance Act 2014 (FA 2014), relating to follower and accelerated payment notices have been interpreted and operated by HMRC and as a consequence many other notices may also have been issued by HMRC unlawfully.
This blog is based on an article first published in Taxation on 18 June 2019. A copy of that article can be found here.
Section 204, FA 2014, enables HMRC to issue a follower notice to a taxpayer requiring the taxpayer to take 'corrective action' to relinquish a particular 'tax advantage' arising out of that taxpayer's chosen tax arrangements. A taxpayer who fails to take such corrective action can be liable to a penalty of up to 50% of the understated tax. On the issue of a follower notice, section 219, FA 2014, enables HMRC to issue an accelerated payment notice requiring the taxpayer to pay the disputed tax to HMRC before the dispute has been determined on appeal, or by way of agreement.
In order for a follower notice or accelerated payment notice to be issued, the following conditions must be satisfied:
A. a tax enquiry must be in progress into a return or claim made by the taxpayer in relation to a relevant tax, or the taxpayer must have made an appeal in relation to a relevant tax which has not been determined, abandoned, or otherwise disposed of (sections 204(2) and 219(2), FA 2014);
B. the return or claim or, as the case may be, appeal, must be made on the basis that a particular tax advantage ('the asserted advantage') results from particular tax arrangements ('the chosen arrangements') (sections 204(3) and 219(3), FA 2014).
In order for a follower notice to be issued, the following additional conditions must be satisfied:
C. HMRC must be of the opinion that there is a 'judicial ruling' which is relevant to the chosen arrangements (section 204(4), FA 2014); and
D. no previous follower notice must have been given to the same person (and not withdrawn) by reference to the same tax advantage, tax arrangements, judicial ruling and tax period (section 204(5), FA 2014).
A 'judicial ruling' is a ruling of a court or tribunal on one or more issues and is 'relevant to the chosen arrangements' if:
(a) it relates to tax arrangements;
(b) the principles laid down, or reasoning given, in the ruling would, if applied to the chosen arrangements, deny the asserted advantage or a part of that advantage; and
(c) it is a final ruling (section 205(3), FA 2014).
In order for an accelerated payment notice to be issued, condition C in section 219(4), FA 2014, must also be met, which means the tax arrangements in question must be disclosable to HMRC under the disclosure of tax avoidance schemes regime referred to in FA 2004, or HMRC must have issued a follower notice to the taxpayer in respect of the same arrangements.
Mr Haworth had established a trust to hold shares for his benefit and that of his family. The trustees were resident in Jersey. When he considered the disposal of the shares in 2000, he replaced the Jersey trustees with trustees resident in Mauritius. This was intended to avoid capital gains tax on the disposal of the shares.
Mr Haworth argued that he was not chargeable in respect of the gains made because they were exempted from the charge to UK capital gains tax by virtue of the UK/Mauritius double tax treaty. If, applying the ‘tie-breaker’ provisions under the treaty, the place of effective management of the trust was in Mauritius, not the UK, the gain would be exempt from capital gains tax. There was no Mauritian tax on the gain. This arrangement is commonly referred to as the 'Round the World' tax avoidance scheme.
In Smallwood v HMRC  EWCA Civ 778, the Court of Appeal held that a trust whose trustee was a Mauritian resident company was actually managed and controlled from the UK and not Mauritius so double taxation did not apply. Accordingly, an arrangement similar to the one implemented by Mr Haworth failed. Following the Smallwood decision, HMRC issued both follower notices and accelerated payment notices to a large number of taxpayers, including Mr Haworth.
As many readers will be aware, there is no right of appeal against a follower notice or an accelerated payment notice and Mr Haworth therefore challenged HMRC's decision by way of judicial review in the High Court.
The question for determination was whether the 'principles laid down, or reasoning given' in Smallwood would, if applied to the circumstances of Mr Haworth's case, deny the 'asserted advantage'.
High Court judgment
Mr Justice Cranston held that Smallwood contained both principles and reasoning that were capable of application to similar arrangements implemented by other taxpayers, such as Mr Haworth. In the view of Cranston J, HMRC had correctly applied Smallwood to determine whether the trust in Mr Haworth's case was controlled from the UK and if it was, this would deny Mr Haworth his asserted tax advantage.
Mr Justice Cranston also concluded that the follower notice was not defective due to any irregularities in its form and/or the manner in which it was issued.
Mr Haworth appealed to the Court of Appeal.
Court of Appeal judgment
The appeal gave rise to two principle issues for determination:
1) whether the words 'principles laid down, or reasoning given', in section 205(3), refer exclusively to points of law determined in the 'judicial ruling' in question; and
2) whether the word 'would', in section 205(3), requires HMRC to be of the opinion that the principles or reasoning in the ruling in the relevant decision would (as opposed to would be more likely than not) deny the asserted advantage.
Mr Haworth argued that section 205(3)(b) refers exclusively to points of law determined in the 'judicial ruling' in question and that 'reasoning given' was a translation into English of the ratio decidendi, or reason for the decision, which is recognised as the legal basis upon which a case is decided. The Court of Appeal agreed with the High Court that 'reasoning given' was an alternative to 'principles laid down' and extended beyond legal points.
The Court of Appeal concluded that the inclusion of the words 'or reasoning given' in section 205(3)(b), did not support Mr Haworth's contention. The High Court was therefore correct to hold that ‘principles laid down’ and ‘reasoning given’ are separate and alternative concepts. The Court of Appeal noted at para :
"In the circumstances, it seems to me that HMRC are not constrained to have regard only to the ratio of a case, but can also take into account other reasoning to be found in it. Were, say, appellate judges both to conclude that the FTT had been entitled to make a finding of fact and to say that they agreed with it, there could be no doubt but that the latter comment could be material. Of course, though, the fact that an observation did not form part of the ratio could potentially have a bearing on the weight to be attached to it."
The Court of Appeal therefore found in favour of HMRC on the first issue.
With regard to the second issue, HMRC argued that section 205(3)(b) requires no more than for it to consider that the principles or reasoning laid down in the relevant judicial ruling relied upon are more likely than not to result in the asserted advantage being denied.
Mr Haworth submitted that HMRC is required to be of the opinion that the principles or reasoning would deny the asserted advantage, not merely that they would be likely to do so, and that follower notices can only properly be issued if HMRC believes that there is no real prospect of the taxpayer succeeding in his appeal.
The Court of Appeal agreed with Mr Haworth on this issue. It is not enough that HMRC considers that the principles or reasoning in the relevant ruling would be more likely than not to deny the advantage. The word 'would' implies that HMRC must be of the opinion that, should the point be tested, the principles or reasoning found in the relevant ruling relied upon will deny the asserted advantage. This demands more certainty than simply a perception that there is a more likely than not chance of the advantage being denied. The Court of Appeal noted at para [36(iii)]:
"[HMRC's] construction of section 205(3)(b) would allow follower notices to be given in a surprisingly wide range of cases. There would seem, for example, to be no bar on such a notice being given if HMRC believed there was a 51% chance of a high-level principle found in a decided case (say, the Ramsay approach applied recently in UBS AG v Revenue and Customs Commissioners  UKSC 13,  1 WLR 1005) being held to apply in a quite different factual situation. On this basis, it would theoretically be possible for HMRC to use follower notices routinely in relation to disputes pending before the FTT. After all, HMRC’s “Litigation and Settlement Strategy” explains in paragraph 16 that they “will not usually persist with a tax dispute unless it potentially secures the best practicable return for the Exchequer and HMRC has a case which it believes would be successful in litigation.”
The Court of Appeal referred to the Explanatory Notes to FA 2014, and the comments relating to follower notices, where it is stated that they are directed at a case where "a tribunal or court has concluded in another party’s litigation that the arrangements do not produce the asserted tax advantage" (our emphasis). In other words, 'the arrangements' must be the same (or materially the same) arrangements as those implemented by the taxpayer to whom the follower notice is to be issued.
The Court of Appeal noted the serious consequences that can flow from the issuance of a follower notice, noting that a recipient is exposed to the risk of having to pay a penalty of up to 50% of the amount at stake plus smaller penalties if he does not comply with an accelerated payment notice and commented at paras [36(iii) and (iv)]:
"I can see no indication that follower notices were meant to be available to HMRC otherwise than in relatively exceptional circumstances ...
Parliament might be expected to have intended such a regime to be applicable only in a limited class of cases".
The Court of Appeal referred to the dicta of the Supreme Court in R (UNISON) v Lord Chancellor  UKSC 51, where it was said that "the constitutional right of access to the courts is inherent in the rule of law" and observed at para [36(vi)]:
“impediments to the right of access to the courts can constitute a serious hindrance even if they do not make access completely impossible …
[e]ven where a statutory power authorises an intrusion upon the right of access to the courts, it is interpreted as authorising only such a degree of intrusion as is reasonably necessary to fulfil the objective of the provision in question.”
The Court concluded that, as receipt of a follower notice may deter a taxpayer from pursuing his appeal to the First-tier Tribunal, the aforementioned principles provide further reason for interpreting section 205(3)(b) so as to require more than a 51% chance of the principles or reasoning from an earlier decision denying the asserted advantage. In other words, there must be a high degree of certainty that the appeal would fail.
In the view of the Court of Appeal, it could be inferred that when deciding to approve a follower notice in Mr Haworth’s case, HMRC was proceeding on the basis that mere likelihood was sufficient, and did not ask itself whether the 'principles laid down or reasoning given' in Smallwood would deny Mr Haworth the asserted advantage. This, the Court said, amounted to a misdirection on the law by HMRC.
The Court rejected HMRC's argument that its misdirection could be saved because HMRC could (although it did not) rationally conclude that the principles or reasoning in Smallwood would deny Mr Haworth the asserted tax advantage.
The follower notice and accompanying accelerated payment notice were therefore quashed.
The Court of Appeal accepted that the follower notice issued to Mr Haworth was deficient in its form as it had failed to explain why Smallwood made Mr Haworth's case futile and did not provide sufficient detail on the way in which the principles or reasoning in Smallwood would defeat his appeal. However, on the facts, including lack of prejudice to Mr Haworth, the Court did not consider that the follower notice would be rendered invalid because of these deficiencies.
The principles relied upon by the Court of Appeal in dismissing HMRC's arguments are important in protecting the rights of the citizen against the executive authority of the State and maintaining the rule of law. The powers in question were described by the Court as "draconian", and as Lord Justice Gross stated in his judgment in support of Lord Justice Newey's leading judgment, these powers should be "carefully circumscribed, not least … because of their impact on access to the courts and the rule of law".
The decision has implications for other taxpayers who have received follower notices in recent years. For example, following the Supreme Court's decision in RFC 2012 Plc (in liquidation) (formerly The Rangers Football Club Plc) v Advocate General for Scotland  UKSC 45 (the Rangers case), HMRC issued a large number of follower notices to taxpayers who had participated in employee benefit type arrangements. Whilst some of these arrangements may have been similar to the arrangements considered in the Rangers case, not all of them were materially the same as the arrangements considered in Rangers. In light of the Court of Appeal's decision in Haworth, some of those follower notices may have been issued invalidly.
Going forward, HMRC should not issue a follower notice to a taxpayer simply because it considers that the principles or reasoning in the relevant judicial decision it relies upon would be likely to deny the tax advantage in that taxpayer's case. The Court of Appeal has confirmed that HMRC must have a "substantial degree of confidence" that the taxpayer's appeal would fail. In practice, this should mean that a follower notice is only issued when the same, or materially the same, arrangements have been entered into by the taxpayer who is to receive the follower notice.
With regard to existing follower notices, if a taxpayer has received a follower notice which relies on a judicial decision in which the underlying arrangements are not the same as those in which the taxpayer participated, consideration should be given to whether HMRC should be invited to withdraw the follower notice and any accompanying accelerated payment notice.
Given the significance of this decision, it would not be surprising if HMRC was to seek permission to appeal to the Supreme Court.
The judgment can be viewed here.