UK: Disclosure, Information Notices And Discovery

1. INTRODUCTION

This briefing note outlines the post April 2009 situation concerning discovery, information notices and discovery assessments in the light of the following tax cases:

1. Langham v Veltema
2. Neil Pattullo and
3. Dr Michael Charlton and others v HMRC (TC01317).

HMRC's statement of practice 01/06 on self assessment and finality is also reproduced in full.

2. DISCOVERY

Under the discovery provisions of the Taxes Management Act 1970 s29, HMRC may make a discovery assessment where they become aware that:

• income or gains that ought to have been assessed have not been;
• an assessment is, or has become, insufficient, or;
• a relief given is, or has become, excessive.

If a tax return has been submitted, a discovery assessment can only be raised if one of the following two conditions is met:

• Condition 1 - the under-assessment or excessive relief is due to fraud or negligent conduct on the part of the taxpayer or someone acting on his behalf.
• Condition 2 - knowledge of the tax under-assessment has been obtained outside the normal enquiry period for a tax return, or the officer had already informed a taxpayer that he had completed his enquiries into a particular tax return and the officer could not have been reasonably expected, on the basis of information made available to him prior to that time, to have been aware of an under-assessment to tax or an excessive amount of relief.

The legislation states that a discovery assessment cannot be raised to make good an under-assessment or excessive relief having been granted, where that error or mistake arose as a result of the tax return having been made in accordance with generally prevailing practice at the time when it was made (TMA 1970 s29(2)). However HMRC may wish to argue whether a generally prevailing practice existed in any particular case.

3. INFORMATION NOTICES

Prior to 1 April 2009, in certain instances where there was no open enquiry into a return, HMRC could call for information (from the taxpayer or a third party) that would be relevant to determining the amount of a tax liability, by issuing a notice under Taxes Management Act 1970 s20. They were also required to give the taxpayer reasonable opportunity to supply the information voluntarily prior to issuing the notice. Such a notice had to be authorised by a General or Special Commissioner, or in certain cases by the Board of HMRC, and they could only be issued if there was a reasonable prospect of raising an assessment. A taxpayer was not obliged to comply with a voluntary request for information.

From 1 April 2009, procedures changed on information notices in cases where tax returns have been submitted within the required timescale, (the new provisions are found at FA2008 Sch36). Information notices, which in most cases no longer need authorisation by First Tier Tribunal, can be issued if one of four conditions is present. These are:

• a notice of enquiry has been issued and the enquiry is not completed,
• an HMRC officer has reason to suspect there is an under-assessment, or that a relief given is or has become excessive,
• a notice is given to check a person's VAT position, or
• a notice is given to check a person's deductions etc with respect to PAYE regulations.

There are penalties for non compliance with notices and these are an initial penalty of £300, followed by a daily penalty not exceeding £60 per day for continuing failure. Compliance with a notice is required within a reasonable timescale (usually specified in the notice). There is a right of appeal against a notice to provide information, unless the issue of the notice has received prior approval of the Tribunal. However, this appeal does not extend to any information or documents which form part of a taxpayer's statutory records.

If an information notice is issued in relation to income tax, capital gains tax or corporation tax for a tax return that is outside the enquiry period, then HMRC must have reasonable grounds for believing there is an underassessment.

3.1. Disclosure

The important tax cases of Langham v Veltema and the Judicial review case of Neil Patullo (described below) considered what level of disclosure was required from the taxpayer in order to defend the second test laid down in Taxes Management Act 1970 s 29, namely "the officer could not reasonably have been expected, on the basis of information made available to him prior to that time, to have been aware of an under-assessment to tax or an excessive amount of relief." The decisions in those cases indicated that the the level of disclosure needed to be detailed and extensive in order to draw an Inspector's attention to a potential insufficiency.

However the the judgement in the 2011 case of Charlton and others v HMRC ([2011] UKFTT 467 (TC)) appears to rein back on some of the practical implications of the decision in the Veltema case. Bearing in mind that the Veltema decision has been heavily relied on by HMRC it is likely that this case will be appealed.

In the meantime the professional bodies are in discussion with HMRC regarding the fact that the strict interpretation of the discovery legislation following the Veltema decision is at variance with reassurances about certainty given by Ministers at the time the legislation was drafted.

3.2. Langham v Veltema

www.bailii.org/ew/cases/EWCA/Civ/2004/193.html

A company had transferred a property to Mr Veltema for nil cost. The Company obtained a valuation of £100,000 from a firm of chartered surveyors and valuers. Mr Veltema used that valuation in the calculation of the assessable benefit in kind and the company subsequently used the same figure in its chargeable gains computation.

The Inspector of Taxes dealing with the company referred the valuation to the Disrict Valuer who argued that a higher figure was appropriate. A value of £145,000 was subsequently agreed, by which time the enquiry window had closed in relation to Mr Veltema's personal return.

Mr Veltema argued that the Inspector was precluded from making a discovery assessment.

Lord Justice Auld summarized the conditions set out in Taxes Management Act 1970 s 29 as follows:

"It seems to me that the key to the scheme is that the Inspector is to be shut out from making a discovery assessment under the section only when the taxpayer or his representatives, in making an honest and accurate return or in responding to a section 9A enquiry, have clearly alerted him to the insufficiency of the assessment, not where the Inspector may have some other information, not normally part of his checks, that may put the sufficiency of the assessment in question."

Following the Veltema decision HMRC issued Statement of Practice 01/06, see Appendix 1.

3.3. Judicial Review of the right to issue a s20 notice to Neil Pattullo - Scottish Court of Session

www.bailii.org/scot/cases/ScotCS/2009/2009CSOH137.html

In this case the taxpayer had provided a white space disclosure of aspects of a tax avoidance scheme he had used and the question was whether that disclosure was sufficient to defend the second test laid down in Taxes Management Act 1970 s 29, namely "the officer could not reasonably have been expected, on the basis of information made available to him prior to that time, to have been aware of an under-assessment to tax or an excessive amount of relief."

The taxpayer had used a marketed scheme to avoid a 2003/04 liability on £2.1m of capital gains which involved £2.6m of loans from a bank for contributions into a trust and subscription to capital redemption policies (a scheme known as SHIPS). He had disclosed in the white space the basic steps of the scheme and indicated that a capital loss of £2.6m arose as a consequence of TCGA92 s37(1). The 2003/04 tax return was submitted by 31 January 2005, with the enquiry period closing on 31 January 2006.

Counsel for the taxpayer pointed out that the tax return made reference to the particular section of the legislation said to give rise to the capital loss and he submitted that this would alert an officer to the taxpayer's thought process. He said that there was a full narration of the steps which had been taken and the facts of the transaction. In addition there was reference to the section relied upon by the taxpayer as giving rise to the capital loss. Thus he submitted that the white space contained a full and detailed disclosure of what had happened. It was his position that given this full disclosure a discovery assessment could not competently be made by an officer and therefore a discovery notice was ruled out.

Counsel for the taxpayer concluded that a discovery assessment should be an exception. In order to come within the exception it had to be shown that the information provided in the return was inadequate and that the officer having received new material had decided that there was an insufficiency in tax. It was his position that no new matter had been shown to have arisen in this case.

Counsel for HMRC submitted that the issue before the court was not whether HMRC are in a position to make a discovery assessment by reason of new or further information which had come to light since the closing of the assessment window. In his view the proper question was whether HMRC were prevented from making a discovery assessment by the taxpayer having made a proper disclosure in his tax return. It was his position that the only condition that foreclosed an investigation under Section 20 was if the taxpayer had given sufficiently frank disclosure to allow the Revenue to conclude that there was an insufficiency.

Counsel for HMRC argued that the taxpayer's return did not disclose that he had participated in a particular type of tax avoidance scheme. Nor did it disclose that the scheme may not be effective to avoid tax by giving rise to capital losses. The taxpayer did not disclose that there was anything in his self-assessment about which there was some doubt. It did not disclose that he took a different view of the legislation and its operation from that of the Revenue. In particular it did not state that the taxpayer's interpretation and application of Section 37 was different from that which the Revenue took and it did not disclose the interpretation of Section 37 which was being contended for by the taxpayer.

The judge agreed with the approach taken by Auld LJ in the Langham case:

"[94] In my view in approaching the construction of section 29(5) as he has done Auld LJ has arrived at a construction which is in line with the underlying purpose of the new scheme in that: the right is given to the taxpayer of early finality of assessment. However, that right is balanced by a corresponding duty incumbent upon the taxpayer namely: to clearly alert the officer to an insufficiency. It appears to me that if the section were read in any other way it would render the system of self assessment unworkable. In that without such a duty being incumbent upon the taxpayer the whole system would be open to the clearest abuse and would be likely to lead to material losses in tax to HMRC. It accordingly seems to me that he has correctly identified the key to the scheme.

[95] ...the test to be applied once the officer newly comes to the conclusion that there is an insufficiency in deciding whether a discovery assessment is competent is this: has the disclosure in the self assessment return clearly alerted the officer to the insufficiency?

[102] In my opinion the test has to be a two stage one to fit in with the underlying purpose of the scheme. The officer has to discover something new otherwise the underlying purpose of early finality of assessment would be defeated. His assertion of the newly discovered insufficiency is then tested against the adequacy of the disclosure by the taxpayer. It is only if the taxpayer has made a return which has clearly alerted the officer to the insufficiency that it will be considered adequate and will shut out a section 29 discovery assessment.

[104] On a proper understanding a discovery assessment can only be foreclosed if the taxpayer has clearly alerted in his return the officer to the insufficiency of tax which the officer has asserted he has newly discovered, thus rendering it not a new discovery but rather something on the information provided by the taxpayer the officer should have been aware of during the enquiry window. In my judgement on a proper construction the section clearly places the emphasis on the adequacy of the disclosure by the taxpayer. That fits in with the underlying purpose of the scheme. Thus the taxpayer is given the right of early finality. However, there is a corresponding duty on the taxpayer to clearly alert the officer to the insufficiency. If he does not the officer can newly discover an insufficiency.

[109] I am not satisfied that the information contained in the white space should have clearly alerted an inspector with the knowledge and skill as I have defined it to an insufficiency in tax.

The question for the court becomes: is there a clear alerting of an officer within the white space, that officer being one of ordinary knowledge and skill of the participation by Mr Pattullo in such a scheme of tax avoidance and of an insufficiency in tax arising therefrom?

The answer to the above question is that I have not been satisfied by Mr Johnston's submissions that there was such a clear alerting within the white space. As is pointed out in his affidavit by Dr Branigan the white space does not contain the following:

1. A statement that Mr Pattullo was a participant in the CRC Mark II tax avoidance scheme. Dr Branigan at paragraph 26 makes clear that had there been such a statement this would have guaranteed that an enquiry would have been opened and that Mr Pattullo's tax advisers would have been aware of this.
2. A statement that the petitioner and his advisers had adopted a different view of the law from that published as HMRC's namely: they had taken a view in respect of the tax treatment of Capital Redemption Contracts which is the opposite of that taken by HMRC Capital Gains Tax Manual at CG69004 dated 2 September 2003 (production 7/3) is not contained within the white space. The petitioner's tax return was not filed until 31 January 2005. The necessity to make such a declaration in order to comply with the duty to clearly alert has been held to exist in HMRC Commissioner v Household Estate Agents Limited page 712, paragraph 10 where it was held as follows:

"Taxpayers who adopt a different view of the law from that published as HMRC's can protect against a discovery assessment after the enquiry period. The return and accounts would have to indicate that a different view had been adopted by entering comments to the effect that they did not follow HMRC guidance on the issue or that no adjustment had been made to take account of it."

3. There is no explanation as to how Mr Pattullo contends that Section 37 operates in order to produce the capital loss.
4. The details other than the basics of the transactions which have been entered into are not contained within the white space.
5. There is no indication of any doubt in the disclosure that the petitioner is entitled to the loss. I accept Mr Johnston's position that the taxpayer does not require in order to clearly alert to say there is an insufficiency as of course that is not his position. However, in circumstances such as this a reference to doubt or as I have said to the fact that it is, a position contrary to HMRC's would be necessary to comply with the duty incumbent upon him.

In the absence of information of the type as above described an inspector of the skill and knowledge as I have earlier defined it could not in my judgment have been aware of actual insufficiency.

[115] I do not believe for the foregoing reasons that Mr Johnston's position that the full factual and legal position is set forth in the white space is correct. The full factual position would have included a statement that the petitioner was part of such a scheme and a full statement of the legal position would have included a statement of doubt or a statement that a contrary position to the HMRC was being insisted upon together with a clearer picture of the operation of the scheme. I believe it is a fair conclusion to hold that the disclosure in the white space is a carefully crafted disclosure seeking to pass through the initial checks carried out by HMRC but in no way meeting the test of clearly alerting to an actual insufficiency."

3.4. Dr Michael Charlton and Others v HMRC (TC01317)

www.bailii.org/uk/cases/UKFTT/TC/2011/TC01317.html

In this case a number of clients of a firm of accountants had participated in a tax avoidance scheme. It appeared that all individuals had made detailed disclosures in their tax returns about the scheme and had shown the DOTAS scheme reference number. In the majority of cases HMRC commenced enquiry proceedings before the deadline. However in three cases, including Mr Charlton, they failed to do so. On discovering the oversight later HMRC sought to raise discovery assessments on the grounds that whilst the returns included factual details of the scheme they did not flag up that there was an actual insufficiency in the return which was what the judge in the Veltema case had said was necessary to prevent a discovery assessment.

The judges found that the necessary requirements that would enable HMRC to raise a valid discovery assessment were not satisfied saying (in the following selected paragraphs from the decision):

"108. In Veltema the return gave no indication of what asset had been transferred, what it was worth and whether it might have been worth more than £100,000. Whilst there are a number of references in Lord Justice Auld's judgment to the requirement that the return must disclose that there was an actual insufficiency disclosed by the return, it was abundantly clear that all these references referred to the fact that it was the inadequate information that occasioned the doubt as to whether there was in fact an under-assessment. The whole feature that the case revolved around the interpretation of sub-section 29(6) and the feature that that subsection refers only to the factual information deemed to be available to the notional officer in considering the sub-section 29(5) test makes this absolutely plain.

114. Taking the facts of Veltema, where an employment benefit had been declared at £100,000, it must be self-evident that if the return had in fact also indicated (something that on the actual facts had not been identified until later) that the relevant house had been treated as disposed of by the company for Corporation Tax purposes for £145,000, and that the director had paid nothing for the house, it would have become instantly obvious that the self-assessment return by the individual revealed an under-assessment. If these facts had been revealed, but no statement had been inserted into the return to draw attention to the fact that the declared employee benefit might have been, or was bound to be, under-stated, we cannot think that in so obvious a case, the absence of those further disclosures would have been of the slightest significance.

115. At the other end of the spectrum, there may very well be cases where to derive the protection of subsection 29(5) the taxpayer would need to refer to the basis on which he had made his self-assessment, and it might indeed be necessary to go further and disclose that, whether or not HMRC's approach to the law was known, other views were also tenable. The situation that we have in mind here is that where there are complex issues of tax law involved, having nothing whatever to do with outright and obvious avoidance, and thus notably where the average HMRC officer, or indeed even the "distinctly above average" officer might have no idea that some features of the return might justify adjustments. In his own interests, if the taxpayer in that sort of situation wishes to achieve "finality" it might very well be prudent, and indeed necessary, to flag areas that any officer might very easily miss, without any discredit.

118. We first observe that the reason why an enquiry was not opened in relation to the tax returns of the three Appellants was not because any Inspector looked at the returns and missed points, but was due to administrative slip-ups, such that no-one of the appropriate seniority would have even looked at the three returns. HMRC admitted that there had been such slip-ups.

119. Anticipating the findings of fact that we are going to reach, we are going to conclude that:

"it was absolutely obvious from the information given in the white spaces of the returns, that the three Appellants had participated in artificial tax avoidance schemes to generate capital losses; and

the disclosure of the SRN reference number for the scheme, and the fact that the scheme had been implemented in the then current tax year, not only reinforced the point that the transactions were effected as part of a marketed tax avoidance scheme, but they also indicated that full disclosure would have been made to HMRC specialists of the workings of the scheme. From this information, it would have been obvious to any officer that those officers receiving the DOTAS disclosures in the AAG1 would have considered the scheme with those in HMRC responsible for the specialist areas in question, and a view would already have been reached as to whether (i) the scheme might be challenged successfully under existing law; or (ii) whether a change in legislation was required, or (iii) whether the planning was considered reasonably acceptable such that neither (i) nor (ii) was appropriate.

120. We have already suggested, in paragraph 115 above, that where the notional officer, or even the distinctly above average officer, might well not have been expected to perceive doubtful matters of tax law in relation to the type of situation canvassed in that paragraph, it would not be appropriate to expect the officer to question the return unless doubt was expressly drawn to the officer's attention in the return. Absent such a "flag" in the return, the officer could also not be assumed to have sought guidance from others into a matter that anyone could have missed. The fact that remote specialists within HMRC might have readily appreciated that the legal basis, on which the self-assessments had been submitted, were challengeable would be completely irrelevant. Thus in that situation, sub-section 29(5) protection might only be secured if the points were aired or flagged in some way by the return.

121. Where, however, as in this case, no officer could conceivably have missed the points made by the bullet points in paragraph 119 above, it is inevitably the case that the officer would either have considered the law himself or, more appropriately still in the light of seeing the SRN reference number, he would have sought guidance from specialist colleagues, who he would have known would have considered the scheme in depth. And he would consider their views before deciding whether or not assessments were justified.

122. We consider that the ban on raising further enquiries about the facts, implicit in the Court of Appeal's decision in Veltema, and indeed in sub-section 29(6), has no bearing on how we should expect the notional officer to approach his proper task of then considering the information and deciding whether or not he should raise assessments. And if it is glaringly obvious either that the relevant officer should consider the law, and possibly refer to published material or, where an SRN number is disclosed, simply send an e-mail or make a phone call to colleagues and ask for guidance, this is precisely how we should treat the notional officer as proceeding.

123. This approach does not fall into the error of attributing to the "notional average officer" the views and knowledge of specialists as such. It only has this effect in those cases where any officer would inevitably seek guidance, and indeed know precisely where to seek that guidance. It simply deems the notional average officer to approach matters realistically, as HMRC would inevitably expect him to operate, and it avoids the absurdity of consigning the officer to his dark room, without legislation, books or other information, and with no opportunity to seek guidance from colleagues.

124. The above approach would have no bearing on the simple case where we would postulate the notional average officer taking his own decision on whether to assess. It simply suggests that one just considers what the notional officer should and would have done in the relevant circumstances. It thus deals perfectly sensibly with the very simple cases, the distinct type of situation referred to in paragraph 115 above, and the manifestly obvious tax avoidance scheme that has already been disclosed to, and reviewed by, HMRC in this case. It deals with each in the appropriate way, and it avoids the consequence of HMRC's contention and acceptance that the test is crafted essentially for the simple scheme, and thus regrettably fails to work sensibly in a case such as the present case.

125. We are considering the proper application of subsection 29(5) in this case, and the issue of whether the test creates the right balance of fairness between HMRC and the taxpayer is entirely secondary. If we were to adopt the contentions and conclusions advanced in this case by HMRC, we cannot resist observing that a quite extraordinary imbalance would have been achieved between the taxpayer and HMRC. In this case the taxpayer has disclosed, with perfect accuracy, the essential features of the scheme, such that we understood immediately precisely what was involved. The notional officer might have been slightly slower in reaching such a conclusion, but could not have doubted that a very artificial scheme had been implemented. Equally clearly that scheme had been disclosed to HMRC under the DOTAS rules."

4. CONCLUSIONS

All three cases referred to above indicate that the level of disclosure will be crucial in achieving certainty once the self-assessment deadline has passed. HMRC can be expected to take a robust view of whether a disclosure is sufficient to comply with the provisions of Section 29. All three cases make it quite clear that merely alluding to a transaction will give no protection against later discovery.

In order for a white space disclosure to afford any chance of protection from a subsequent discovery assessment being raised in relation to a tax return that is outside the enquiry period, the disclosure will need to be sufficiently complete and comprehensive to enable a reasonable inspector to be able to understand what is being claimed.

In a case where the tax position is not clear cut it will be necessary to provide the full facts, explain why the matter is not clear and put forward a detailed argument that supports the figures shown in the tax return.

Where a return is being made on a basis that is contrary to the view held by HMRC, that position needs to be clearly stated so that a reasonable inspector would be alerted that, on the basis of the HMRC held view, there would be an insufficiency.

Statement of Practice 01/06 states that if a taxpayer includes a note in the tax return that they have taken a different view from HMRC and that no adjustment has been made, then provided the point is clearly identified and the position taken is not wholly unreasonable, HMRC accept that there can be no discovery, even though all the documents to quantify any shortfall in tax had not been submitted with the tax return.

5. APPENDIX

5.1. SP 01/06 - Self Assessment: Finality and Discovery

5.2. The following examples illustrate common situations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.