This Upper Tribunal case looked at whether HMRC discovery assessments on capital gains tax issued under section 29 Taxes Management Act 1970 were valid in circumstances where each of the taxpayers had included a Disclosure of Tax Avoidance scheme reference number in their income tax return. The case also examined whether an officer could not have been reasonably expected to be aware of an insufficiency of tax on the basis of the information provided.

Background

During the tax year 2006/07, each of the taxpayers in the case (Dr Charlton and Mr and Mrs Corfield) entered into arrangements designed to create allowable losses for capital gains tax purposes to set off against capital gains arising in the same year. Briefly, those arrangements entailed the purchase of an existing (and thus “second-hand”) life assurance policy, the effecting of a partial surrender of that policy and the subsequent final surrender of the policy.

A similar, but not identical, scheme was considered in the case of Drummond v Revenue and Customs Commissioners [2009] STC 2206 (CA). The final decision in Drummond was that that scheme failed and as a result it was accepted that the arrangements entered into by Dr Charlton and Mr and Mrs Corfield in this case did not work and thus failed to give rise to the anticipated capital losses.

The arrangements fell within the provisions of the Finance Act 2004 which required disclosure to HMRC of tax avoidance schemes (the “DOTAS” – disclosure of tax avoidance schemes – rules). In accordance with the DOTAS rules, and in particular the Tax Avoidance Schemes (Information) Regulations 2004, the promoters of the scheme notified HMRC on a form AAG1 and subsequently the scheme was given a DOTAS scheme reference number (“SRN”). The allocation of an SRN did not indicate any judgment on the part of HMRC whether or not the proposed scheme achieved any particular outcome.

The notification set out, as a summary of the proposal/arrangements, “a capital loss arises to an individual through the partial withdrawal and surrender/sale of life assurance policies.” The various steps and the expected tax treatment were explained under the detailed statutory provisions referred to. This complied with a specific request from HMRC that the form AAG1 should refer to “the specific legislation, including sub-sections, from which the expected tax advantage arises”.

Dr Chorlton and Mr and Mrs Corfield submitted their tax returns for the tax year 2006/07 before the due filing date of 31 January 2008, but after the special commissioner's decision in Drummond. Despite including additional information and the SRN, HMRC did not open enquiries into the relevant tax returns. This was in contrast to other participants in the scheme arranged by the same promoter. In all there were 41 participants, 38 of whom had enquiries raised prior to the latest time for opening an enquiry into self-assessment returns.

HMRC believed it had opened an enquiry into Mrs Corfield's return, but the letter (which had been prepared and dated 8 January 2009) was not sent. By the time that the enquiry window for 2006/2007 closed on 31 January 2009, the High Court had affirmed the decision of the Special Commissioner in the Drummond case.

However, various procedures within HMRC failed to result in enquiries being opened into these returns. It was only when the officer in charge of coordinating all investigations into schemes of this nature became aware in March 2009 of what had happened, and called for the papers, that consideration was given to the making of assessments under section 29 Taxes Management Act (TMA) 1970.

Instead of making those assessments immediately; HMRC waited until after the Court of Appeal's judgment in Drummond and after it became clear that there would be no appeal to the Supreme Court.

The First-tier Tribunal was then asked to assess whether the discovery assessments that had been raised against each of the taxpayers were valid. If they were not, then despite the arrangements failing on technical grounds, the self-assessments made by them each of which offset the losses against capital gains and reduced their tax liabilities accordingly, would remain undisturbed.

The First-tier Tribunal decided that the discovery assessments were not valid because the condition in section 29(5) of the TMA 1970 (the only relevant condition) had not been fulfilled. The taxpayers could not therefore be assessed under that.

In allowing the tax payers appeal, the First-tier Tribunal concluded that the condition in s29(5) for

1. the raising of discovery assessments was not met because:an officer could reasonably have been expected to consult his specialist colleagues, and would accordingly have been aware of the insufficiency in the Taxpayers' tax returns; and
2. if it was wrong to suppose that the officer could be expected to consult a specialist, the officer:
   1. would have been aware that the claimed tax treatment depended on the exclusion of a gain that had been taken into account for income tax purposes (where no income had been returned); and
   2. could legitimately take the view that it might well be decided that something should only rank as having been taken into account for income tax purposes when in reality that treatment had been demonstrated

HMRC contended that the First-tier Tribunal was wrong in both respects.

The First-tier Tribunal also rejected arguments of the taxpayers that:

(i) the meaning of “discovery” connotes that there has to have been the emergence of something new, and that since nothing new had emerged after the closure of the enquiry window, no proper “discovery” had been made.

On this, the First-tier Tribunal accepted the argument of HMRC that a discovery assessment can be made merely where the original officer of HMRC changes his mind or a new officer takes a different view.

(ii) because the tax return gave the scheme reference number, then the information in form AAG1 is deemed by section 29(6) to be information supplied to the officer for section 29(5) purposes.

The taxpayers' appeal was allowed, and it was from that decision that HMRC appealed to the Upper Tribunal. The taxpayers also cross-appealed on the specific issues that the First-tier Tribunal decided against them.

Decision of Upper Tribunal

At the heart of the dispute was whether, as the taxpayers argued, the word “discovers” implies a requirement for something new to have arisen, or, as HMRC submitted, a discovery can be said to be made whenever an officer of HMRC realises that insufficient tax has been assessed.

In support of the argument for the taxpayers, four propositions were put forward as follows:

1. That a “discovery” requires a threshold to be crossed; that is, from the position of not knowing to the position of having reason to believe;
2. That to cross that threshold requires something new, for example a new fact or a new understanding of the law. Merely revisiting prior knowledge does not amount to a discovery.
3. That these principles apply whether or not there is an earlier HMRC assessment which has been determined either under the provisions of s 54 TMA or by a decision of the Tribunal; and
4. That the corporate knowledge of HMRC is relevant. An officer merely looking at an old file cannot be said to make a discovery.

The Upper Tribunal held that no new information, of fact or law, is required for there to be a discovery. All that is required is that it has newly appeared to an officer, acting honestly and reasonably, that there is an insufficiency in an assessment. That can be for any reason, including a change of view, change of opinion, or correction of an oversight.

The requirement for newness does not relate to the reason for the conclusion reached by the officer, but to the conclusion itself. If an officer has concluded that a discovery assessment should be issued, but for some reason the assessment is not made within a reasonable period after that conclusion is reached, it might, depending on the circumstances, be the case that the conclusion would lose its essential newness by the time of the actual assessment.

But that would not include a case, such as this, where the delay was merely to accommodate the final determination of another appeal which was material to the liability question.

Such a delay did not deprive the HMRC officer's conclusions of their essential newness for section 29(1) purposes.

Thus the taxpayers' cross-appeal was dismissed, the Upper Tribunal found that the First-tier Tribunal was correct to conclude as it did that a discovery assessment can be made merely where the original officer of HMRC changes his mind or a new officer takes a different view.

The First-tier Tribunal decided that, in determining whether an officer could not have been reasonably expected, on the basis of the information made available to him, to be aware of the insufficiency, the notional officer would either have considered the law himself or, more appropriately still, in light of the information on the tax return regarding the SRN reference number, would have sought guidance from specialist colleagues

The Upper Tribunal's view was that the question to be addressed is the awareness of an officer, and not on what an officer might do. They did not consider that the right approach to take as a starting point is a hypothetical officer with limited knowledge and then to assume, however obvious it might be to do so on that hypothesis, that the officer would seek guidance from other “real” officers within HMRC. That is not what section 29(5) required the tribunal to consider.

According to the Upper Tribunal the correct focus of section 29(5) is on the quality and extent of the information made available. It is not necessary that the hypothetical officer should understand precisely how a scheme works, or any claimed tax treatment is said to arise. All that is needed is that from the information made available to the hypothetical officer he can reasonably be expected to be aware of the insufficiency of tax such as to justify an assessment.

As well as an officer being aware of the matters referred to, he would also have been sufficiently aware of the law relating to second-hand insurance policies to be able to appreciate the unusual nature of the entries in the return, and he would have been aware of the High Court judgment in Drummond. Furthermore, he would be treated by virtue of section 29(6)(d)(i) as having the information in the form AAG1.

In all the circumstances, on the basis of the information made available before the closure of the enquiry window, an officer would have been reasonably expected to have been aware of the insufficiency of tax such as to justify an assessment. The condition in section 29(5) was not therefore fulfilled, and HMRC's appeal failed.

The full text of the case is available at http://www.financeandtaxtribunals.gov.uk/judgmentfiles/j7102/TC02590.pdf