Supreme Court clarifies law on tax ‘discovery’ assessments

The court also expressed views on the requirements for discovery assessments.

• An inaccuracy will only be deliberate if there is an intention to mislead HM Revenue & Customs (HMRC), or perhaps recklessness
• The concept of ‘staleness’ does not exist in relation to discovery assessments
• An HMRC officer can make a discovery even if they find out something already known to other officers
• HMRC v Tooth [2021] UKSC 17

Mr Tooth entered into a tax planning arrangement 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.

In 2009 HMRC opened an enquiry into Mr Tooth's loss claim under one statutory provision. However, in 2013 the Supreme Court said that in circumstances such as those of Mr Tooth, HMRC should open an enquiry under another provision   By this time the time limit for doing so had passed and the only way that HMRC could challenge Mr Tooth's self-assessment was by making a discovery assessment and claiming that Mr Tooth’s behaviour was deliberate, which they did in 2014.

Discovery assessments

HMRC can only make a discovery assessment if an HMRC officer 'discovers' an underpayment of tax and that underpayment is due to careless or deliberate behaviour by the taxpayer or their agent. Alternatively, although not claimed in this case, HMRC can make a discovery assessment if it discovers an underpayment and can show that at the time when the enquiry window for a return closed, or a closure notice was issued, the officer could not reasonably have been expected to be aware of the under-assessment.

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 is deliberate, HMRC can go back 20 years.

In order to assess Mr Tooth to tax, HMRC had to have made a valid discovery assessment and had to show that there was an inaccuracy in Mr Tooth’s return which had been brought about deliberately.

Each of the First-tier Tribunal  (FTT), the Upper Tribunal (UT) and the Court of Appeal decided that HMRC could not assess Mr Tooth to the tax, each court or tribunal did so on a slightly different basis.

The FTT decided that, although HMRC had made a discovery, there was no deliberate inaccuracy in Mr Tooth's return which brought about an insufficiency of tax. The UT decided that there was no inaccuracy in the return as when considering whether a document was 'inaccurate', the whole document had to be considered. The UT also held that even if that was wrong, Mr Tooth had not acted deliberately. Further, the UT found that there had been no discovery by HMRC in 2014 given that they had already formed their view of an insufficiency in 2009.

The Court of Appeal decided that there was no discovery so the assessment was invalid. However two out of the three judges said that there was an inaccuracy 'in' a document given to HMRC, even though the inaccuracy was corrected in another part of the return and all the judges agreed that if there was an inaccuracy it was deliberate.

The Supreme Court therefore had to consider whether there was a deliberate inaccuracy in the tax return, and if there was, whether HMRC had made a valid discovery.

Deliberate inaccuracy

The legislation provides that references to a loss of tax or a situation brought about deliberately by a person include a loss of tax or a situation that arises as a result of a deliberate inaccuracy in a document given to HMRC.

The Supreme Court said that the effect of this provision is that where the conduct which brings about or ‘results’ in a situation consisting of an insufficiency consists of an inaccuracy in a document given to HMRC by or on behalf of the taxpayer, then the deliberate condition is fulfilled even if the insufficiency itself was not deliberate, provided that the inaccuracy was.

Applying this to the facts of the case, the judges said that if Mr Tooth had entered the employment-related loss in the partnership box without providing any explanation of its true source and nature, this would constitute a deliberate inaccuracy in the return. However, this is not what happened.

They said that deliberate inaccuracy means a statement which, when made, was deliberately inaccurate and not, as HMRC contended, a deliberate statement which is in fact inaccurate, even though genuinely believed by the maker to be true, and not intended to mislead. The court said that for a statement to be deliberately inaccurate “there will have to be demonstrated an intention to mislead the Revenue on the part of the taxpayer as to the truth of the relevant statement or, perhaps, (although it need not be decided on this appeal) recklessness as to whether it would do so".

HMRC argued that the online tax return form would be read initially by a computer which would look at each part of, or box in, the return separately and so an inaccuracy in one box was sufficient to make the return inaccurate. On this basis they persuaded a majority of the Court of Appeal that it was enough if a deliberate inaccuracy could be found somewhere in the document, interpreted on its own and without regard to the rest of the document.

However, the Supreme Court agreed with the taxpayer’s argument that the accuracy of the return, read as a whole, had to be considered. The judges said that the meaning of each relevant part of the tax return had to be interpreted by reference to its place in the context of the document as a whole, just as is normally done when interpreting any other document.

The judges were not swayed by argument on the part of HMRC that the fact that a computer would read the return was a relevant consideration.

On this basis the judges said there was no inaccuracy in the return. They said that even if they could have been persuaded that there was an inaccuracy, they would not have been satisfied that it was deliberate.

This was sufficient to dismiss HMRC’s appeal and to render the discovery assessment invalid. However, the judges went on to express their views on the arguments raised on discovery.

Discovery and staleness

The 'staleness' of a discovery assessment was not the central issue in the case, but HMRC clearly saw the appeal to the Supreme Court as a way to test the concept.

The FTT found that HMRC had made a discovery in 2014, dismissing Mr Tooth’s claim that the discovery had been made in 2009 when the return had first been considered by HMRC and discussed in correspondence with Mr Tooth’s advisers. The FTT rejected the argument that it was appropriate to have regard to the collective knowledge of HMRC, including knowledge other officers had acquired in 2009.

The UT reversed the FTT’s decision on the timing of the discovery and took the view that if two different HMRC officers independently make the same discovery at different times, only the first discovery qualifies as a discovery. The UT held that a discovery would lose its quality as a discovery for, if no assessment was issued while it was new, and it was allowed to become ‘stale’. The Court of Appeal unanimously upheld the decision of the UT on the discovery issue.

The Court of Appeal and the UT based their decision on the UT’s decision in the case of Charlton which said: “The requirement for newness does not relate to the reason for the conclusion reached by the officer, but to the conclusion itself. 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".

The Supreme Court judges pointed out that there is no reference to a concept of staleness in the earlier cases on discovery dating back to 1938 and 1962. They said: “[T]here is no place for the idea that a discovery which qualifies as such should cease to do so by the passage of time. That is unsustainable as a matter of ordinary language and, further, to import such a notion of staleness would conflict with the statutory scheme".

The Supreme Court's view was that taxpayers were adequately protected by the statutory time limits and the availability of relief through judicial review proceedings on the basis of public law principles.

The judges rejected the submission that once a discovery is made by one person it cannot be made again by another. They said that the subjective nature of the test, by reference to the state of mind of a particular officer, means that there is the possibility that a series of HMRC officers might each make the relevant discovery if a taxpayer’s file is passed from one to another. The judges said there was no need for a further time limit as the statutory regime has clear time limits within which the taxpayer may be exposed to a discovery assessment, and they run from the end of the tax year concerned and not from the date of the relevant discovery.

They also said that the discovery condition in section 29(5) operates by reference to the state of mind of a particular HMRC officer dealing with the taxpayer’s case at a particular point in time and does not involve any concept of collective knowledge of HMRC.

The end of ‘staleness’?

Once the judges had decided that there was no inaccuracy in the return, they did not need to consider the concept of staleness and whether there was a qualifying discovery. Their views on this point are therefore strictly obiter dicta. However, the point had been fully argued before them and the judgment expressed the views of all five judges, so the chance of another taxpayer getting leave to appeal another case to the Supreme Court on this point seems remote.

This is based on an article by Clara Boyd and Ian Robotham, tax disputes experts at Pinsent Masons, the law firm behind Out-Law, which appeared in Tax Journal on 14 May 2021. Pinsent Masons acted for the taxpayer in this case.