Courts and Tribunals: April 2012

Julian Harris, Busy Practitioner

May 4, 2012

Tax avoidance scheme survives challenge by HMRC

An attempt by HMRC to challenge arrangements made by a taxpayer who used a marketed tax avoidance scheme for the purpose of avoiding capital gains tax (CGT) failed after the First-tier Tribunal (FTT) allowed the taxpayer’s appeal. The scheme involved a ‘paper for paper exchange’ where the taxpayer acquired loan notes with a face value of £1.179 million in exchange for shares he held himself. The loan notes were transferred to a trust, and the taxpayer took a number of steps to avoid CGT on the disposal of the notes which operated (inter alia) as follows:

  1. The taxpayer transferred loan notes to the trustees of the James Albert McLaughlin 2003 Settlement and made a hold-over relief claim under TCGA 1992, s 165. The settlement was broadly an interest in possession trust for the taxpayer, subject to overriding powers of appointment.
  2. The trustees borrowed slightly less than £1.179 million from a bank and divided the trust into two parts – Part A consisting of the money borrowed from the bank, and Part B consisting of the loan notes subject to the liability of the bank.
  3. The trustees appointed Part B to a non-UK domiciled beneficiary, but without prejudice to the trustees’ lien and right to reimbursement in respect of their liability to the bank.
  4. It was intended that the appointment would be a disposal of the loan notes by the trustees to the beneficiary under TCGA 1992, s 71(1), but there would be no liability to CGT because hold-over relief under TCGA 1992, s 165 would again be claimed by the trustees and beneficiary.
  5. The loan notes would be redeemed or sold and the trustees would repay the bank. This would be a disposal of the loan notes by the non-UK domiciled beneficiary, but there would be no CGT due because either the loan notes were situated outside the UK and the disposal was by a non-UK domicile, or taper relief would apply and no chargeable gain would accrue on the later redemption or sale.

The central issue in the case was whether TCGA, s 71(1) applied to an appointment made by the trustees of the settlement in favour of AG, who had been added as a beneficiary of the settlement. Section 71(1) provides: ‘On the occasion when a person becomes absolutely entitled to any settled property as against the trustee, all the assets forming part of the settled property to which he becomes so entitled shall be deemed to have been disposed of by the trustee, and immediately reacquired by him in his capacity as a trustee within section 60(1), for a consideration equal to their market value.’ The taxpayer submitted that s 71(1) applied to the appointment, and the loan notes became invested in AG so that their subsequent disposal was a disposal by AG. As AG was non-UK domiciled, and the loan notes were situated outside the UK, no CGT was payable on the disposal. HMRC contended that the series of transactions was a ‘composite’, artificially designed for the purpose of avoiding tax. Under this composite AG had no right to call for and/or deal with the loan notes, which continued to be vested in the trustees who had made the disposal, and a tax charge therefore arose on the taxpayer on the transfer into settlement. The taxpayer appealed against HMRC’s conclusion. The FTT found that the appointment gave AG an absolute vested interest in the whole of part B of the trust fund (ie the loan notes) and he was the ‘absolute’ owner in the sense used by Millett LJ in the Lady Ingram case. The FTT then applied the approach in the BMBF line of tax avoidance cases, which required it ‘first, to decide, on a purposive construction, exactly what transaction will answer to the statutory description and secondly, to decide whether the transaction in question does so.’ Ruling that what was done answered to the TCGA 1992 description of the transactions to which s 71 applied, the FTT found that as a matter of both general and tax law AG became absolutely entitled to the loan notes as against the trustees within the meaning of s 71. The appeal was therefore allowed. The FTT also commented that ‘the fact that a person’s motivation for doing something may be to save tax does not of itself mean that the statute cannot apply.’

Employee recruited from US was not in temporary employment in UK

A Goldman Sachs employee who was recruited from the US by two partners in the company’s London office was not entitled to claim travel and subsistence expenses in the UK on the basis that his employment here was at a temporary workplace. The appellant did not expect to stay more than two years in London, and stated on his form P86 that he expected to remain in the UK for two to three years. After two years GS asked him to leave, and he stayed on for an extra two months. The appellant claimed over £222,000 in travel and subsistence expenses on his self-assessment returns over a period of three years under ITEPA 2003, s 339 in the belief he had been seconded from the US and that London was his temporary workplace. The expenses claimed were in respect of a rented house in London, the appellant’s daily travel to and from work each day, and his meals. His claims were disallowed by HMRC. The appellant produced a letter from a Goldman Sachs executive in London which he claimed proved that there was a tacit understanding his employment in London was temporary. He also referred to HMRC booklet 490 Employee Travel, para 3.17, and likened himself to the example given there of someone who qualified for tax relief for travel to a temporary workplace despite having no permanent workplace to go back to. The First-tier Tribunal found the appellant to have believed mistakenly that he had been seconded to London when during the period in question he was employed by GS in London, which was a new employment, after being recruited by two partners from that office. Relief under ITEPA 2003, s 338 was not available for the costs of ordinary commuting. ITEPA 2003, 339(5) states that a place is not regarded as a temporary workplace if the employee’s attendance is in the course of a period of continuous work at that place comprising all or almost all the period for which the employee is likely to hold the employment. The appellant’s travel and subsistence expenses were therefore not deductible, and his appeal was dismissed.

Director wins appeal against HMRC’s refusal to allow tax relief on loan interest

A director of two companies who lent money to one of them won his appeal against HMRC’s refusal to grant him income tax relief on the bank interest he paid on the loan. The appellant was a director of and shareholder in Andrew Pinchin Architects Ltd (APA), holding 50 per cent of the shares. He was also a director but not a shareholder in Vanfame Ltd, a property development company, and agreed to lend the company £100,000 when it experienced cash flow problems. The appellant re-mortgaged his house to raise the money, and Vanfame paid him £400 per month to reimburse him for the interest paid on the loan. He disclosed the interest received from Vanfame, and sought to neutralise those receipts claiming tax relief on the interest paid to the bank on the original £100,000 loan. HMRC assessed the appellant for tax on the basis that he could only claim relief on the bank interest payments if the two companies were ‘associated’ companies within the meaning of what is now CTA 2010, s 449 (previously ICTA 1988, s 416) and the appellant had ‘material interests’ as defined by what is now CTA 2010, s 449 (previously ICTA 1988, s 360A). The appellant appealed, and HMRC had initially admitted that the two companies were associated for s 416 purposes before seeking to resile their position before the First-tier Tribunal (FTT). The FTT found as a matter of fact that APA and Vanfame were associated companies. Mr Pinchin was the controlling shareholder of Vanfame, and although the issue of who controlled APA was less clear, although APA’s accounts showed that he was entitled to receive ‘the greater part’ of the company’s net assets on winding up. The legislation in CTA 2010, s 450(3)(d) (previously ICTA, s 416(2)(c)) states that a person in this position is deemed to have a controlling interest in the company. On the second issue, ITA 2007, s 394(4) (previously ICTA 1988, s 360A(1)(b)) provides that a person has a ‘material’ interest in a company if, upon liquidation, he is entitled to receive more than 5 per cent of the assets which, but for prior claims, would be available for distribution among the participators. The appellant was a loan creditor and therefore a participator in Vanfame, and he was owed £100,000 which gave him a right to much more than 5 per cent on winding up. The requirements for loan interest relief were met, and the appeal was allowed.

Application for judicial review of HMRC refusal to allow late claims is dismissed

An application by a number of claimants to seek judicial review of HMRC’s refusal to allow late claims for group tax relief was dismissed by the High Court. The claimants were wholly-owned subsidiaries of a property group, Daejan Holdings plc. In about 2004, the Daejan group was introduced to a tax saving scheme, referred to as the ‘Lloyd’s loss buying scheme’, which consisted of the purchase of losses of Lloyd’s underwriters. Special rules contained in FA 2000, s 107(4) enabled an insurer which had incurred a commercial loss in one year to shift this to year two for tax purposes. By acquiring a shareholding in an insurer which had suffered a commercial loss, the purchaser could utilise group relief for that loss on the basis that the loss would be deemed to have suffered for tax purposes after acquisition. Such schemes operated while the provision was in force between 1 January 2000 and 19 July 2007, and HMRC ultimately accepted that it could not challenge their effectiveness. Although straightforward in principle, application of the scheme was more complex, requiring surrendered losses to be applied against the profits of a company with sufficient profits to absorb them within a statutory time frame. Errors were made by Daejan Holdings in its claims for group relief, and after exchanges over several years involving the company, its accountants and HMRC a decision letter was issued on 28 April 2010 by HMRC which stated: ‘In the circumstances of this case, HMRC refuses the late claim to consortium relief by Bampton Property Group Ltd in respect of the year ended 31 March 2006 and the late claims to consortium relief by the six other subsidiary companies listed above in respect of year ended 31 March 2005.’ This decision letter was the subject of the application for judicial review by the claimants, who advanced four grounds:

  1. The defendant failed to give legally adequate reasons for the decision in the decision letter, and therefore a different person within HMRC should look at the issue again and the original decision should be quashed.
  2. The decision letter defeated the claimants’ legitimate expectation that their claims for group relief would be considered on their merits (ie that HMRC would not refuse to consider the claims on the basis of their having been made out of time).
  3. The decision-making methodology was flawed – a public body must have regard to all legally relevant considerations and no irrelevant ones in reaching a decision, and a failure to apply properly or have regard to relevant policy guidance will generally supply a ground for setting the decision aside.
  4. There was no rational basis on which HMRC could have rejected the claim for additional time within which to consider the claim for group relief (this was supported by a number of submissions relating to HMRC’s awareness of problems relating to various apportionment claims etc).

Mr Justice Blair rejected all four grounds. On the first ground, it was implicit in the decision that HMRC was not satisfied there were exceptional reasons why the claim had not been made within the specified time. The letter refused any time extension, and fairness did not require the officer to say more than that. On the second ground, there was no basis for the claimants’ belief that a letter from HMRC on 1 February 2008, by listing the matters which stood in the way of allowing Daejan’s claims for group relief, gave rise to a legitimate expectation that the relief would be forthcoming if these criteria were satisfied. On the third ground, a number of points raised by the claimants on the decision-making methodology were dismissed. On a sensible construction of HMRC’s Statement of Practice 5/01, it was irrelevant that the accountants responsible for errors in making claims may have been acting for the parent rather than the members of the group which were claiming the losses. HMRC did not misapply SP 5/01, and also did not fail to take into account when reaching a decision that one company in the group (Daejan Holdings plc) had already made the same claim for group relief as the claimants in the case within the time permitted. Furthermore, HMRC did not take account of irrelevant considerations, and there was no reason in principle why the tax avoidance factor should not be considered when deciding whether a late claim should be admitted. Finally, on the fourth ground the claimants’ submissions did not support the contention there was no rational basis upon which HMRC could have rejected the claim for additional time within which to consider the group relief claim. The application for judicial review was dismissed.

Discovery assessments based on a ‘presumption of continuity’ upheld

The allowance by HMRC of a claim for a self-employed individual’s expenses was upheld by the First-tier Tribunal (FTT), including discovery assessments to allow expenditure claimed in earlier years on the basis of a ‘presumption of continuity.’ The appellant appealed against a series of assessment notices concerning his income as a self-employed carpenter for the years 2003-04, 2004-05, and 2005-06, and against a closure notice for 2006-07. In August 2008, a tax inspector wrote to inform him that she was proposing to enquire into his 2006-07 return, attaching a schedule of information required, and notified his advisers accordingly. After hearing nothing from the appellant, the inspector was told by his advisers that their client had returned home to Eastern Europe in the summer and it was not known whether he would be returning to the UK. The required information was not sent by the appellant, and in February 2009 a penalty notice for £50 was issued against him by HMRC. A letter was sent in response by the appellant’s advisers appealing against the £50 penalty and stating, inter alia, that he was abroad and could not find the documents required. Further penalty notices were issued by HMRC in June and August 2009 in the sums of £300 and £525 respectively. A letter was received by HMRC in August 2009 from the appellant saying that he had just returned to the UK, had not seen any of HMRC’s previous letters, had been unable to contact his adviser, and did not understand why he had to pay the £525 penalty. This was treated by HMRC as an appeal against the penalty, but there was no basis for it. In the absence of any further information, assessments on the appellant for the years 2003-04 and 2005-06 were issued in October 2009, along with a closure notice in respect of 2006-07. In July 2010 HMRC received late appeals from the appellant’s advisers against the assessments raised which HMRC decided to accept. A review of the case was conducted by HMRC, which decided that the assessments had been raised correctly. This was not accepted by the appellant’s advisers, who appealed to the FTT and then made a belated request to postpone the hearing. The FTT said that, in accordance with TMA 1970, s 50(6) a taxpayer arguing that an assessment is excessive must prove this was the case, and the appellant had failed to do so. HMRC’s review of the case was properly carried out. The caseworker’s application of the discovery principle was correct, and having established in the course of the enquiry into the appellant’s 2006-07 return that the amounts claimed for expenditure were higher than might be expected for his type of trade or business, it was reasonable to assume that expenditure levels claimed for the other years would be the same (‘a state of affairs may be assumed to have continued’ – Jonas v Bamford ChD 1973, 51 TC 1 and Nicholson v Morris CA 1977, 51 TC 95). The FTT set out the background to the case in detail and the ‘unsatisfactory history of the appeal’ to support its criticism of the failure of the appellant’s then advisers to engage with HMRC and agree the appropriate amounts to be assessed on their client. In the absence of any evidence to persuade the FTT that the amounts assessed on the appellant for the relevant years should be reduced, the assessments stood and the appeal was dismissed.

Taxpayer received fair hearing despite unreasonable delays by the state

A taxpayer who claimed that his right to a fair trial within a ‘reasonable time’ under Article 6(1) of the European Convention on Human Rights had been breached the state failed in his attempt to have penalty assessments made against him set aside – even though the First-tier Tribunal (FTT) found that there had been unreasonable delays by the state. The FTT also reduced the level of penalties imposed. Seven assessments were raised by HMRC against the appellant for each of the tax years 1992-3 to 1998-99 inclusive in the belief that he had submitted incorrect tax returns. HMRC claimed that he negligently under-declared his income in the form of director’s remuneration derived from the under-declared takings of a restaurant and in the form of rental income and benefits in kind. The taxpayer appealed to the General Commissioners, who adjusted HMRC’s figures, and then by way of case stated to Lawrence Collins J who upheld the Commissioners’ determination in principle but reduced each year’s assessment on the basis that some of the assessed rental income had been declared and some mortgage payments wrongly included. HMRC then raised a number of penalty assessments, and the taxpayer appealed against them to the General Commissioners who incorrectly applied a criminal standard of proof and found that he had understated his income from rental income and benefits in kind for the full six years. They were not satisfied beyond reasonable doubt that he had negligently understated his own income from the restaurant, and determined the amount of penalties without giving reasons. HMRC appealed against the determination by way of case stated, and Mann J held that the General Commissioners should have applied the civil standard of proof applied to tax penalty proceedings, and not the criminal standard. The appeal was allowed, and the case was referred to the FTT to determine the appeal against the balance of the penalty assessments. The FTT rejected the argument that in the light of Gale v Serious Organised Crime Authority [2011] UKSC 49 the correct standard of proof was beyond reasonable doubt, finding that Gale did not apply to the current proceedings and that in any event the finding of Mann J that the civil standard of proof (balance of probabilities) should be applied was binding on the tribunal. The appellant then claimed his right to a fair trial within a ‘reasonable time’ under Article 6(1) ECHR had been breached, and that as a result a fair hearing was no longer possible and the penalty determination should be quashed. Both sides accepted that time would run from the date when there was ‘official notification…by the competent authority of an allegation that he has committed a criminal offence.’ The FTT accepted the appellant’s argument that the relevant starting date was June 2000, when he was told during an interview that HMRC was intending to pursue him personally, rather than the company, for unpaid tax. On the issue of whether there had been a breach of the ‘reasonable time’ requirement, the FTT found that it had taken 11 years for the penalty proceedings to reach the current hearing. However, for the tribunal to find there had been ‘unreasonable delay’ there must have been clear and unacceptable delays within the judicial process for which the state was solely responsible. Although the appellant had contributed to the situation by failing to expedite matters and pursuing endless appeals, there were other unacceptable delays for which he bore no blame. These included the delay in the first appeal to Lawrence Collins J; the delay by the General Commissioners hearing the penalty proceedings in releasing their decision; the delay in the preparation of case stated proceedings; and probably some part of the delay in the transfer period between the General Commissioners and the tribunal. The FTT concluded that there had been an unreasonable delay for which the state must bear responsibility, but there could be no question of quashing the penalties or staying the proceedings because the appellant had not been prejudiced by the delay and it had not prevented him from having a fair hearing. Furthermore, the tribunal had no jurisdiction to reduce the penalty to reflect any unreasonable delay. On the evidence the FTT accepted HMRC’s case that on the balance of probability the appellant submitted incorrect tax returns for the years 1993-94 to 1998-99 and there were undisclosed takings from the restaurant of which the appellant was the beneficiary. He negligently submitted incorrect tax returns, and was liable to a penalty (the FTT increased the penalty abatement for cooperation and applied a 60% abatement overall).The appeal was allowed in part.