This month’s Chartered Accountants Tax Case Digest examines an appeal by a taxpayer against HMRC’s refusal to grant relief from accounting for income tax from payments made to a number of sub-contractors.

In its decision, the First-Tier Tribunal highlighted that a taxpayer’s level of reasonable care depends on the circumstances of the case and that engaging a tax agent can, in certain cases, be sufficient. This particular aspect of the decision is interesting in the context of HMRC’s ongoing view that appointing an agent is generally not sufficient to argue reasonable care in a penalty situation.

Background

The case concerned an appeal which examined whether relief under Regulation 9(5) of the Income Tax (Construction Industry Scheme) Regulations 2005 was available on payments made by Mr Mabe (“the taxpayer”) to a number of sub-contractors. The taxpayer operated a Fire Protection business which fell within the definition of a construction operation under the Construction Industry Scheme (“the CIS”). The CIS was essentially introduced to address concerns about widespread tax evasion in the construction industry. This scheme replicates the PAYE system and puts the initial burden to account for tax on the person making the payments.

In this case, the taxpayer failed to deduct income tax from payments made to subcontractors. The amount of income tax in question amounted to £19,295 for 2011–12 and £16,558 for 2012–13.

On 6 March 2015, following an investigation into the taxpayer’s tax affairs, HMRC wrote to the taxpayer’s tax adviser stating that they would be raising a determination under Regulation 13(2) of the CIS Regulations. This regulation allows an officer of the HMRC to determine the amount of income tax which, to the best of his judgement, a contractor is liable to pay.

The taxpayer requested that HMRC issue a direction under Regulation 9(5) of the CIS Regulations which would relieve him from the obligation to account for income tax.

HMRC refused this request on the basis that the conditions of Regulation 9(3) had not been met. These conditions state that the contractor must satisfy an officer of HMRC that reasonable care was taken to comply with the Regulations and that the failure to deduct the tax was due to an error made in good faith or a genuine belief that tax was not required to be withheld.

The taxpayer appealed against HMRC’s decision in June 2015.

The facts

The taxpayer had been registered personally as a sub-contractor since May 1999. He also ran a business, B&J Sprinklers Ltd with his wife until 2010 and this company had operated the CIS satisfactorily.

The taxpayer had limited formal education and had difficulties reading and writing. He had no understanding of tax or accounting and became extremely anxious when dealing with such issues. His wife had handled all the paperwork, including all accounting and tax matters. The taxpayer had also had a very unpleasant divorce from his wife and as a result was unable to work for some time due to depression.

On his return to work, the taxpayer decided to engage a Chartered Accountant to look after all of his accounting and tax affairs. He had been introduced to that accountant by the mechanic who services his vehicle. The taxpayer delivered a bag containing all of his invoice and payment records (including details of sub-contractor expenses) to that accountant entrusting him with his accounts. That accountant produced a set of accounts and negotiated a tax liability with HMRC. He then advised the taxpayer of his obligations to operate a PAYE system in another business operated by the taxpayer but did not advise the taxpayer of his obligations under the CIS.

In early 2013, the taxpayer became friends with someone who worked for a firm of chartered accountants and had expertise in accounting and tax matters. She stated to the taxpayer that he needed to register for VAT and CIS. Subsequently, the taxpayer registered for VAT and submitted his first return under the CIS in February 2013. A significant payment of VAT was also made to HMRC at that time.

It was acknowledge by both sides that the taxpayer had acted in good faith throughout the period and complied fully with the requirements of both the CIS and VAT legislation as soon as he became aware of his obligations. There was no attempt by him to “cheat” the system.

However, HMRC considered that the taxpayer had not taken reasonable care to comply with his obligations under the CIS. There was emphasis placed on the fact that there was no suggestion by the HMRC that the taxpayer had not acted in good faith but HMRC did not believe that the taxpayer had a genuine belief that the CIS did not apply to the payments.

HMRC stated that three factors contributed to their belief:

1. The taxpayer had registered as a sub-contractor in his personal capacity since 1999;
2. The taxpayer had been involved with the CIS through B&J Sprinklers Ltd; and
3. CIS deductions had been made from payments to the taxpayer.

The taxpayer’s grounds for appeal were made on the following basis:

1. It is unfair that the taxpayer is required to pay tax which rightfully should be paid by the persons to whom the payments were made;
2. The taxpayer had no prior knowledge of VAT, PAYE or the CIS and did not think he was doing anything wrong;
3. The taxpayer used a firm of qualified professional accountants who failed to inform him of his obligations. He therefore had no reason to think that he was not fulfilling his tax and accounting obligations until the fact was made clear to him.

The legislation examined in this area was Regulation 9 of the CIS legislation which states that where the contractor fails to deduct income tax, recovery can be made from the sub-contractor if:

1. It appears to the officer of Revenue and Customs that the deductible amount exceeds the amount actually deducted, and
2. Condition A or B is met.

Regulation 9 (3) continues:

3. Condition A is that the contractor satisfies an officer of Revenue and Customs—
   1. that he took reasonable care to comply with section 61 of the Act and these Regulations, and
   2. that—
   1. the failure to deduct the excess was due to an error made in good faith, or
   2. he held a genuine belief that section 61 of the Act did not apply to the payment.
4. Condition B is that—
   1. an officer of Revenue and Customs is satisfied that the person to whom the contractor made the contract payments to which section 61 of the Act applies either—
      1. was not chargeable to income tax or corporation tax in respect of those payments, or
      2. has made a return of his income or profits in accordance with section 8 of TMA (personal return) or paragraph 3 of Schedule 18 to the Finance Act 1998(18) (company tax return), in which those payments were taken into account, and paid the income tax and Class 4 contributions due or corporation tax due in respect of such income or profits;
      and
   2. the contractor requests that the Commissioners for Her Majesty’s Revenue and Customs make a direction under paragraph (5).

It was agreed that the necessary conditions for Condition B to apply were not met because HMRC had checked the tax positions of the recipients of the payments and confirmed that they have not made a full disclosure of this income.

Condition A was then examined. It was agreed that there was no question that the taxpayer acted in anything other than good faith and therefore section 3(a) (i) is met. The question in point is whether the taxpayer took reasonable care to comply with section 61 and the CIS regulations.

The words of Judge Berner in the First-tier Tribunal case of Barrett v Commissioners for her Majesty’s Revenue and Customs [2015] UKFTT 329 (TC) were quoted to establish whether reasonable care was taken. In that case, he said that “The test is to determine what a reasonable taxpayer in the position of the taxpayer would have done in those circumstances, and by reference to that test to determine whether the conduct of the taxpayer can be regarded as conforming to that standard.”

It was also noted that a person who is aware of his obligations cannot avoid those obligations by delegating them to a third party without taking reasonable steps to ensure compliance with those obligations. Normally, reliance on a third party is an unacceptable excuse for failing to fulfil the known obligations.

In this case, the taxpayer, while aware of the CIS scheme from the perspective of a sub-contractor, had no involvement in the paperwork of B&J Sprinklers Ltd and had no knowledge of the operation of the CIS scheme from the perspective of a contractor. In addition, the taxpayer had very limited understanding of tax and accounting matters.

While the taxpayer did not do any background checks on his Chartered Accountant’s abilities as an accountant, it was noted as that accountant was a chartered accountant and not a less qualified bookkeeper, it was reasonable to expect that the taxpayer would not carry out any further checks.

While the taxpayer did not have a formal contract with the Chartered Accountant setting out any obligations to advise on issues other than the preparation and submission of accounts to HMRC, it was noted that his accountant had pointed out to the taxpayer the requirement to register for PAYE for his other business. It was found therefore that it would be reasonable to expect that his accountant would bring to the taxpayer’s attention any other basic tax requirements like the need to register for VAT and for the CIS.

Decision

It was the view of the court that the taxpayer, in employing a professionally qualified chartered accountant to manage his accounting and tax affairs, took reasonable care and such were the actions of a reasonable taxpayer.

It was noted that the test is one of reasonableness. No higher or lower standard should be applied. To quote Judge Berner in Barrett, “What might be considered an unreasonable failure on the part of one taxpayer in one set of circumstances might be regarded as not unreasonable in the case of another whose circumstances are different.”

Furthermore, the court stated that the taxpayer was clearly unaware of his filing obligations when he first hired sub-contractors. However he engaged a professional accountant and the accountant was aware of the fact that the taxpayer hired sub-contractors. A reasonable taxpayer in this instance would have been entitled to rely on the accountant to draw attention to any relevant filing obligation and where there was silence on the matter, would have been correct to assume that there were no obligations outstanding.

It was therefore found that the taxpayer took reasonable care to comply with section 61 of the CIS Regulations and that Condition A of Regulation 9 (3) of the CIS Regulations was fulfilled. The appeal was therefore allowed.

The full judgment in this case is available from http://www.financeandtaxtribunals.gov.uk/judgmentfiles/j9079/TC05098.pdf