Discovery assessments: the Court of Appeal in Tooth

• No 'discovery' if HMRC just find different reason for under assessment or different mechanism for assessing
• Inaccuracy in return as information in wrong box even though explained elsewhere
• Inaccuracy 'deliberate' as figures intentionally inserted in wrong box

The Court of Appeal's decision in relation to discovery assessments in the case of HMRC v Tooth [2019] EWCA Civ 826 represents a win for Mr Tooth because the judges decided that HMRC had not made a 'discovery' and so was out of time to assess him to tax. However, comments by the judges as to what constitutes an 'inaccuracy' and what amounts to deliberate conduct will not be good news for taxpayers in general.

The facts

Mr Tooth entered into a tax planning scheme, designed to generate employment-related losses. When Mr Tooth's accountants completed his self-assessment return, the software did not enable them to access the box within which they had been advised to record the losses, due to a technical issue. They recorded the losses in the partnership pages and included wording in the 'white space' of the return, making it clear that the losses were employment losses and not partnership losses.

HMRC opened an enquiry into Mr Tooth's loss claim under Sch 1A TMA 1970, which enables HMRC to open an enquiry into a claim which is not included within a return.

In HMRC v Cotter the Supreme Court said that in circumstances such as those of Mr Tooth, HMRC should open an enquiry under s 9A instead. As the time limit for such an assessment had passed, the only way that HMRC could challenge Mr Tooth's self-assessment was by making a 'discovery' assessment.

HMRC can only make a discovery assessment if it 'discovers' an underpayment of tax and that underpayment is due to careless or deliberate behaviour by the taxpayer or their agent. Alternatively, HMRC can make a discovery assessment if it discovers an underpayment and can show that at the time when an HMRC officer ceased to be entitled to open an enquiry into the return, or issued a closure notice in respect of an existing enquiry, the officer could not reasonably have been expected, on the basis of the information available to them at that time, to be aware of the under-assessment of tax.

The normal time limit for a discovery assessment is four years after the end of the year of assessment or six years in the case of carelessness. However, if the taxpayer's behaviour was deliberate, HMRC can go back 20 years. HMRC issued a discovery assessment alleging that Mr Tooth's return contained a deliberate inaccuracy that brought about an insufficiency to tax.

Tribunal decisions

The First-tier Tribunal (FTT) allowed Mr Tooth's appeal on the basis that, although HMRC had made a discovery, neither Mr Tooth nor any person acting on his behalf had done anything which deliberately brought about an insufficiency of tax.

The Upper Tribunal (UT) decided that there was no inaccuracy in the return as when considering whether a document was 'inaccurate', the whole document had to be taken into account. Even if there had been inaccuracies in the return, the judges said these would not be deliberate, because Mr Tooth took steps to draw them to the attention of HMRC.

On the question of whether HMRC had made a 'discovery', the UT considered that two HMRC officers could not make the same discovery and the FTT's conclusion that there was a discovery could not be justified. HMRC appealed to the Court of Appeal.

The Court of Appeal decision

Did HMRC make a discovery?

In the Court of Appeal, HMRC argued that the discovery was made after a letter from Mr Tooth's accountants in March 2014 pointed out that Mr Tooth's case was one where the Cotter decision said an enquiry should have been opened under s 9A, suggesting it was only then that HMRC discovered Mr Tooth's self-assessment was incorrect.

Floyd LJ agreed with the explanation of the law on discovery set out in the UT decision in Charlton v HMRC. He said that for there to be a discovery, the HMRC officer must have newly discovered that an assessment to tax was insufficient. It was not enough that the officer had found a new reason for contending that an assessment was insufficient, or decided to invoke a different mechanism for addressing an insufficiency in an assessment which he or she had previously concluded was present. HMRC had not shown that there had been a discovery and so this meant the assessment was invalid.

Lord Justices Patten and Males agreed with Floyd LJ that there had been no discovery and so HMRC's assessment was invalid. They did not need to opine on the deliberateness issue, but they decided to express a view. It was here that their views diverged and where the decision of the majority becomes unhelpful for taxpayers.

Was there an inaccuracy in the return?

HMRC relied on TMA 1970 s 118(7), which provides that references to a loss of tax brought about deliberately include a loss of tax that arises as a result of a 'deliberate inaccuracy in a document' given to HMRC. HMRC contended there was a distinction between an 'inaccuracy in a document' and an 'inaccurate document', arguing that including the losses in the partnership pages constituted an inaccuracy in the return.

Floyd LJ said s 118(7) was not sufficient to displace the normal approach to construction of documents, which is to read their individual parts in the context of the document as a whole. He concluded that there was no inaccuracy in Mr Tooth's return merely because he included his employment-related losses in the wrong box, given that he fully explained what he had done elsewhere in the return.

However, Lord Justices Patten and Males disagreed. They said that there was an inaccuracy 'in' a document given to HMRC, even though the inaccuracy was corrected in another part of the return.

Was the inaccuracy deliberate?

All the judges agreed that if there was an inaccuracy, it was deliberate. The figures were intentionally inserted on the partnership page.

Although Floyd LJ had not thought that s 118(7) helped HMRC in showing there was an inaccuracy, he said that s 118(7) was a deeming provision — which meant that once it was established that there was a deliberate inaccuracy in a document given to HMRC, no further enquiry about the taxpayer's intention was needed. The question to be asked was whether the inaccuracy was deliberate, and then, separately, whether this resulted, in fact, in the insufficiency of the assessment.

Floyd LJ said that the triggers for the 20 year time limit for assessments do not all require 'blameworthy conduct by the taxpayer'. Males LJ stressed that there was no question of Mr Tooth or his advisers having acted dishonestly or even reprehensibly, but said that was not relevant to the question of whether the inaccuracy was deliberate. This contrasts with the comments made in the UT that an allegation of deliberately bringing about a tax loss was 'tantamount to an allegation of fraud'.

Did the inaccuracy result in a loss of tax?

Although Males LJ said that human readers of the return would not think Mr Tooth was claiming a partnership loss, he agreed with HMRC that an inaccuracy resulted in an insufficiency of assessment because the partnership loss was forced into the tax computation by the software used to complete the self-assessment return.

What about 'staleness'?

Floyd LJ quoted with approval the UT's explanation of what constituted a discovery from the case of Charlton, including this passage: 'If an officer has concluded that a discovery assessment should be issued, but for some reason the assessment is not made within a reasonable period after that conclusion is reached, it might, depending on the circumstances, be the case that the conclusion would lose its essential newness by the time of the actual assessment.'

Delay between making a discovery and issuing an assessment, so called 'staleness', was not an issue in Mr Tooth's case as HMRC's pleaded case before the Court of Appeal was that the relevant 'discovery' was made, and assessment raised, in the course of 2014. The judge was using the passage to emphasise that a discovery requires the fact that there is an under assessment to have 'newly appeared'.

However, it is useful that the concept of staleness has been impliedly approved by a Court of Appeal judge. We will have to wait for the Court of Appeal judgment in the appeal from the UT decision in C Beagles v HMRC, scheduled to be heard in October, for more specific guidance from the Court of Appeal on the concept of staleness.

Implications of the decision

Although the Charlton decision set a low bar for HMRC as regards what constitutes a 'discovery', it is encouraging that more recent case law, including the Court of Appeal decision in Tooth, is ensuring that a more testing analysis of HMRC's pleaded case on the nature and timing of any alleged discovery is undertaken.

However, the views expressed by the majority in relation to what constitutes an inaccuracy in a return and what amounts to deliberate behaviour are very unhelpful for taxpayers.

There seems to be an increasing trend for HMRC to allege deliberate conduct in order to go back to earlier periods or to assess where failures on the part of HMRC have led to assessment deadlines being missed.

The circumstance which led to the figures being put in the wrong box in Mr Tooth's return was essentially a software glitch, and so the apparent watering down of what constitutes an inaccuracy in a return is worrying when more and more returns have to be filed online. From the perspective of taxpayers and agents, leaving the filing of a taxpayer's return until close to the online filing deadline potentially risks similar issues being encountered, while a white space disclosure of what has happened cannot be relied upon to remedy the matter.

The findings in this case could also have potential implications in the context of penalties for inaccurate tax returns.

The time limits for enquiring into returns and making assessments are designed to give the taxpayer some certainty that if they have made a full disclosure in their return there will come a time when they will know that HMRC cannot demand further tax from them. The Court of Appeal decision in Tooth makes it much more difficult for taxpayers to obtain this certainty.

Pinsent Masons acted for Mr Tooth in this case. This update is based on an article which appeared in Tax Journal on 24 May 2019.