This article was written for and first published in Taxation.
For many years I have been involved with the Central London Small Practitioners Group of Chartered Accountants, which nowadays is primarily a tax discussion group – probably because the agenda tends to be things I have come across in the previous month that I think of wider interest. One of our members is Mr Cooke’s accountant. When he outlined to me his tale of woe, I said that if the client wanted to go to the Tribunal I would argue the case pro bono. I did so because I thought it raised a number of important issues.
The facts were very simple. In both 2012/13 and 2013/14, Mr Cooke received dividends from companies in France and Germany. In each year he completed a foreign page which showed the countries concerned and the foreign tax deducted, and ticked the box to show he was claiming Foreign Tax Credit Relief.
HMRC opened an enquiry for 2013/14. They asked only one question, which was along the lines of “Do you agree that the double tax credit should be restricted to 15% in accordance with the French and Canadian double tax agreements?” The accountant immediately agreed and apologised for the error. He then received a letter saying that HMRC intended to raise a discovery assessment for 2012/13. HMRC said that they did not need any further information from the accountant as everything that they needed to raise this assessment was shown on the tax return.
The discovery rules are in Taxes Management Act 1970, s 29. It is important to realise though that they do not date from 1970; they date from 1994, because they are part of the self-assessment legislation that was introduced in that year. They were intended to reproduce the effect of two House of Lords decisions, Cenlon Finance Co Ltd v Ellwood in 1962 and Scorer v Olim Energy Systems Ltd in 1985. That is etched on my mind as I remember that I (and Derek Allen the then Tax Director of the Scottish Institute) accused HMRC of bad faith in not having explained that to the courts in Langham v Veltema.
This context is important because on the introduction of self-assessment, HMRC tried very hard to produce a fair system that would balance HMRC’s needs against taxpayers’ rights (sadly subsequent legislation has been far less concerned about taxpayers’ rights). The big “carrot” for taxpayers of self-assessment was the concept of finality. Once the enquiry window had closed, the taxpayer’s affairs would be final even if something subsequently came to light. Discovery undermines finality. Some would say that the way the Court of Appeal interpreted section 29 in Langham v Veltema completely destroyed that concept, but I do not think it goes that far. The point is that discovery creates an exception to finality. It is probable that Parliament intended that exception to be triggered only exceptionally, and that the taxpayer should have to have done something that warranted forfeiture of his right to finality. What might that be? He could complete his return fraudulently or without taking reasonable care so that HMRC were unaware of the income or gain (that is s 29(4)) or he could have provided insufficient information for HMRC to be able to understand what he is claiming (that is s 29(5)).
Because s 29 creates an exception, it is for HMRC to prove (on the balance of probabilities) that they are entitled to raise the assessment. To do this, they need to show that they have discovered a tax underpayment and that either s 29(4) or s 29(5) applies. What is meant by discovery deserves an article of its own and I do not intend to address that here. It was not an issue in Mr Cooke’s case. The issue there was whether either of the two sub-sections applied. They would do so if HMRC could show either that the accountants had not taken reasonable care (it was accepted that the client had done so) or that an HMRC Officer “could not have been reasonably expected, on the basis of the information made available to him before [the enquiry window closed] of the situation mentioned in sub-section (1)” (the underpayment of tax).
Both the HMRC Officer and the Reviewer took the view both that the accountant had not taken reasonable care by relying on his computer software and that the HMRC Officer could not have been reasonably expected to know the claim was excessive. This raised two important issues. Firstly, it sets a higher expectation on the accountant (who is a financial GP, not a tax specialist) to know the tax law than an HMRC Officer (who is by definition a tax specialist) to do so. That seemed illogical. It is equally illogical to contend that a taxpayer is entitled to rely on professional advice, but the professional advisor is not entitled to rely on the advice from his computer software. Indeed, in the context that Making Tax Digital aims to force all businesses and landlords to use tax software because HMRC believe that will significantly reduce errors, I thought it unreasonable for HMRC to be saying that, although it wants to force people to use software, they must take responsibility for ensuring that the software is programmed adequately to identify all tax issues. Happily, the Tribunal agreed that the accountant had indeed taken reasonable care and was entitled to rely on the software to get it right (at least until he has knowledge of the software’s deficiency – the accountant explained that he had changed his procedures once the problem came to light).
HMRC had a potential problem with sub-section (5) as the Officer had specifically said that all the information he needed had actually been included on the return. Their approach was different. They said that in 2013/14, they had told their staff to review double tax relief claims and the Officer might well not have picked up the issue had they not done so. They had given no such instruction in 2012/13, so the Officer could not have been expected to review such claims in that year.
Effectively, they seemed to me to be saying that the Tribunal should interpret s 29(5) not in the context of what Parliament might have intended when it enacted it, but in the context that in 1994 HMRC’s intention was to review all returns, at least superficially, but that they no longer do this so the Tribunal should consider what it is reasonable for today’s HMRC Officer to do.
That cannot be the law. Although the subsection (5) test is framed in terms of what the HMRC Officer could be expected to know, it is what he could be expected to know from the information provided by the taxpayer. The test is whether the taxpayer has told the Officer enough; not what the Officer should have known if he had chosen to look at the information provided. I remember explaining this to HMRC in a consultation meeting many years ago when they asked why I kept telling accountants to send accounts with personal tax returns, as HMRC do not look at them. I replied, “Exactly!” and watched their realisation of what the legislation says sink in.
HMRC’s flawed argument does raise another issue though. Suppose they had not instructed staff to look out for DTR claims in 2013/14, but that an Officer had looked at the return for that year. Could he really not be expected to realise that the taxpayer was claiming tax relief for the full withholding tax and that a double tax agreement might limit the relief? That raises the question of the level of tax knowledge expected of the hypothetical HMRC Officer. The Court of Appeal in HMRC v Lansdowne Partners Limited Partnership thought that “plainly it is necessary to assume an Officer has reasonable knowledge and understanding”. It thought he would be aware of House of Lords decisions and “would know from his General Knowledge of [the House of Lords decision in] Arthur Young and s 71(1)(a), ICTA 1988, that payments to partners are not usually deductible for tax purposes”.
Another issue is that Mr Cooke’s returns were filed electronically. I thought that HMRC’s computer interface was designed so as not to accept a return that is arithmetically incorrect, so it ought to have rejected Mr Cooke’s returns. If it is acceptable for HMRC’s software to get it wrong, how can it be unacceptable for the agent’s software to do so?
I would not have taken this case had I not expected to win it. But I have written a book on the Taxes Management Act, “Guide to Taxpayers’ Rights and HMRC Powers”, so I think I know it fairly well. The real lesson for practitioners is that TMA is as important as ITEPA, ITTOIA, ITA or CTA, not only in relation to time limits but in relation to penalties and other procedural matters. If you do not know enough of what is in TMA to be able to question procedural issues, you are probably letting your client down.