The Upper Tribunal's decision in Charlton

It is not often that one feels grateful when coming to the conclusion after reading the judgment of a tax case. In the case of HMRC v Charlton & Corfield FTC73/2011 [2012] UK FTT 770 (TCC), having absorbed the basic facts, I felt just that. I feared a different result when we were initially treated to a consummate summary of the factors involved in ‘discovery’ for tax purposes. The taxpayers had actually lost at this stage and salutary lessons are to be learnt from this, but more was to come. When considering whether the actual or hypothetical officer had information made available in the taxpayer’s returns, such that he could reasonably have been expected to have been aware of the need for further assessments and hence able to validly make such assessments, the Upper Tribunal considered what might have been inferred. Here we are breaking new ground, and to the general benefit of taxpayers.

In the first instance, it is really worthwhile examining the tribunal’s deliberations on what constitutes discovery, to recognise soberly the great freedom and flexibility HMRC has. This is not cheerful but, just as importantly, we can take comfort that if an explicit or implicit statement or analysis of the taxpayer’s position taken is clearly stated in his return, enquiries can only be raised within the normal statutory time limits.

Briefly, the facts in Charlton were as follows. The taxpayers had submitted tax returns quoting a scheme reference number (SRN) under the disclosure of tax avoidance schemes (DOTAS) rules, after the Special Commissioner had determined that the scheme was not effective in a previous case. They had used the ‘white spaces’ in their returns to set out the details of the transaction: dates; the amount invested; realised; the quantum of loss claimed; and the rationale for the loss claim. On the face of it this might have been thought sufficient and indeed HMRC had raised enquiries within the statutory time limits in most cases quoting this SRN. They had even prepared an enquiry letter for Corfield. For whatever reason, not known, the letter was never sent. When, some few months later, the omission came to light, assessments on both Charlton and Corfield were deferred until the appeal against the Special Commissioner’s decision had been finalised (in HMRC’s favour) in the other cases.

The First-tier Tribunal had allowed the taxpayers’ appeal against the assessments made by HMRC under the ‘discovery’ provisions of TMA 1970 s 29(5). This was on the basis that the officer reviewing the returns ‘could reasonably have been expected to consult his specialist colleagues’ and hence would have been aware of the insufficiency of the self assessments. He would have been aware that the claimed tax treatment depended on the exclusion of a gain taken into account for income tax, whereas the gain had not been returned as income. They concluded that the officer had not raised valid discovery assessments.

Following both the taxpayers’ and HMRC’s appeal on various aspects of the First-tier Tribunal’s judgment, the Upper Tribunal considered firstly, whether ‘discovery’ requires a threshold to be crossed by the HMRC officer, from a position of ‘not knowing’, to the position of having ‘reason to believe’. Secondly, whether crossing the threshold requires a new fact or new understanding of the law. They rejected this, relying upon Aramayo (1913) 6 TC 279 when Bray J said ‘discovery’ means ‘comes to a conclusion from the examination he makes’ and Lush J said it was equivalent to ‘finds’ or ‘satisfies himself’. Cenlon Finance Co Ltd v Ellwood [1962] AC 782 was quoted to include ‘any case in which for any reason it newly appears that the taxpayer has been undercharged’, rather than the ascertainment of a new fact.

So, it is clear, no new facts need to be uncovered to enable a discovery. Nevertheless, taxpayers’ counsel argued that the HMRC officer did not appear to have even changed his opinion. He was simply acting belatedly to correct an earlier oversight. This point was not initially followed up and became a reiteration by the Tribunal that changing one’s mind need not be by reference to new facts or new interpretation of the law in order to be a discovery.

However, the tribunal went on to consider Commercial Structures Ltd v Briggs (1948) 30 TC 477, a case where there was no new fact and no new decision on the law. The inspector had simply had a change of view and the Court of Appeal had determined that this constituted a valid discovery. The Upper Tribunal therefore concluded that all that is required for there to be a discovery is that it ‘newly appears to an officer acting honestly and reasonably, that there is an insufficiency in an assessment, for any reason whatsoever, including the correction of an oversight’ (my italics).

Whilst there are time limits for enquiries to be raised under normal statutory provisions, there are no time limits for action to be taken by HMRC when an insufficiency is realised. It thus appears that HMRC’s powers of discovery are incredibly wide.

The only protection for the honest taxpayer lies in the conditions set out in s 29(5) and (6). These state that, at the date of expiry of the time limits for enquiry or subsequent formal completion of an enquiry into a taxpayer’s self-assessment, the HMRC officer can only make a further assessment if he could not have been ‘reasonably expected, on the basis of the information made available to him before that time’ to be aware of the insufficiency of the self assessment.

The onus is on HMRC to prove that the conditions of s 29(5) and (6) are met. The protection provides a modest counterbalance to the wide HMRC powers of discovery, but affords valuable certainty to the taxpayer in normal circumstances.

The tribunal proceeded in Charlton to consider what would constitute information made available to the officer, or should have been inferred by him.

In the first instance the tribunal determined that we should consider what information a hypothetical, not the actual HMRC officer, had available to him or he could have inferred. They stated that what mattered was what he could actually be expected to be aware of, not what he might be expected to do to acquire that awareness. The landmark case of Veltema [2004] STC 544 was referred to confirming that if an HMRC officer would have had to make enquiries to obtain further information, there should be no reasonable expectation that he should do so in order to subsequently make a discovery assessment. Likewise, there should be no presumption that the hypothetical officer would consult specialist colleagues to ascertain the relevance of information provided by the taxpayer. Finally, the hypothetical officer’s personal qualities or level of knowledge are not relevant, (although we may assume that the officer has ‘reasonable’ knowledge and understanding, ‘reasonable’ was not expounded). We also cannot regard the officer as being in possession of any specific knowledge elsewhere within HMRC. The hypothetical officer is not the ‘embodiment of HMRC as a whole’. We should only consider the quality and extent of the information provided, not the ability of the officer to understand it.

However, when considering the quality and extent of the information, we should bear in mind the complexity of the matter giving rise to the potential insufficiency of the self assessment. This factor should maintain the balance between HMRC’s right to assess further tax believed to be due, and the taxpayer’s right to have certainty in his tax affairs, following an honest and open self assessment. In a complex case, both the nature of the information and the way it is presented will be material in determining its adequacy in order to prevent a valid discovery assessment.

At this stage of the judgment things were looking pretty bleak for the taxpayers. HMRC had virtually carte blanche to make a discovery. To then raise an assessment, out of time, based on that discovery apparently required a simple allegation that HMRC considered that the information in the taxpayer’s return was inadequate, even in other cases where the same such information had triggered a timely enquiry.

Finally, we come to the tribunal’s consideration of s 29(6), where it is stated that ‘information is made available to an officer if it and its relevance can reasonably be inferred by that officer from any information in the return, correspondence or accompanying documentation’.

The tribunal determined that ‘inference’ could not have as wide a meaning as sought by taxpayers’ counsel, such that the existence of the relevant information could only have been ascertained by an internal or external enquiry of the officer. However, they determined that inference is not restricted to understanding purely factual matters set out in the taxpayer’s return. There must be an inference from the facts set out in the return of relevance and reasonableness to a potential insufficiency and drawn only from the taxpayer’s return or supporting documents.

By way of illustration of this principle, the relevance of the valuation report of the property transferred in Veltema could not have been inferred, as there was no other indication in the return of any potential insufficiency.

The last consideration of the Charlton tribunal was, whether the notification of the SRN, together with form AAGI previously submitted was sufficient to alert HMRC of the insufficiency of tax and hence preclude the raising of valid discovery assessments.

Bearing in mind the in-depth analysis of what constitutes ‘discovery’, what constitutes ‘information made available’, what constitutes a reasonable ‘inference’, it is a little surprising, although very welcome, that the overriding factor in determining that sufficient information had been made available or could have been inferred is the simple notification of the SRN. Perhaps this is too simplistic. It had been noted and approved by the tribunal that the text in the tax return had given a sufficient indication of the tax thinking underlying the transaction, for the tribunal to realise instantly, precisely how it was thought that the scheme worked for tax purposes. Actually the tribunal thought it didn’t matter how the scheme was thought to work, only that from the information provided, the hypothetical officer could have been reasonably aware of the insufficiency.

Lessons to be learnt

First and foremost, the Charlton case rings a bell loud and clear; HMRC can make a discovery whenever they decide there has been an underassessment. Discovery can be based on:

• a change in the interpretation of the law;
• new facts coming to light;
• new awareness of the relevance of facts not previously considered; or
• simply the realisation that HMRC had failed to act on a timely basis before.

Countering these enormously wide powers, HMRC needs to evidence that it was not in possession of adequate information, or could not reasonably have inferred the relevance of the information they were in possession of, from an honest taxpayer’s timely returns, accounts, and accompanying documentation and correspondence, in order to make a valid discovery assessment.

Charlton will be a landmark case, summarising succinctly, what constitutes ‘discovery’, ‘information made available’ and ‘reasonably inferred’. The real lesson to be learnt by professional advisers is the value, or rather the imperative need, to set out clearly the details of any transaction undertaken and its claimed tax effect, together with the relevant SRN under DOTAS if applicable. Advisers may also recognise the case as yet another tribunal decision supportive of HMRC’s drive to counter tax avoidance.

Aileen Barry is a consultant to DLA Piper UK LLP