In the First-tier tribunal (FTT) case of Brown and another (TC0207), published on 12 July 2012, the FTT determined that HMRC were entitled to raise discovery assessments.
HMRC issued discovery assessments to the two directors of a company (Phoenix) after they established that the directors had incorrectly treated the sale of shares in the company as a capital gains tax transaction rather than as a distribution subject to income tax, .
The accountant representing the directors accepted that the transactions should have been treated as subject to income tax but appealed against the assessments citing that HMRC were out of time to raise assessments and that the discovery provisions did not apply.
The FTT rejected the accountant’s submissions and dismissed the appeal having carefully considered the discovery provisions and the principles laid down in Veltema v Langham.
Section 29 TMA 1970 allows HMRC to make a 'discovery' where they establish there has been a loss of tax. In this case, it was not contested that tax had been lost and therefore the FTT had only to consider whether HMRC had in fact made a discovery which satisfied the conditions under section 29(4) and (5) TMA 1970.
Section 29(4) TMA 1970 provides for HMRC to establish that the admission was brought about as a result of negligent or fraudulent conduct on the behalf of the agent or taxpayer. In this case the accountant had already acknowledged that the transactions should have been subject to income tax.
The second condition, section 29(5) TMA 1970 was that an officer of the board could not have reasonably been expected, on the basis of the information made available to him, to be aware that the return was incorrect.
Section 29(6) confirms that information is made available to HMRC if it is contained in:
- the taxpayer’s return, accounts or information accompanying the return;
- any claim made by the taxpayer for the relevant year of assessment including any accounts or information accompanying the claim;
- any information which is provided to HMRC for the purposes of an enquiry; or
- information falling in paragraphs a) to c) above or notified in writing by the taxpayer to an officer of HMRC.
The FTT ruled that HMRC did not have the relevant information to realise that the return was incorrect and that the sale of the shares was subject to income tax during the enquiry window. When HMRC then established that the company had purchased the shares, the officer needed to make further enquiries and the legislative tools available to him were the discovery provisions.
It was for these reasons that the FTT were satisfied that HMRC could not have reasonably been expected to be aware there was an understatement of income tax from the information contained on the tax returns.
The case highlights the importance of ensuring that the information contained within the additional information space or submitted with the return is sufficient for HMRC to realise that the return may not be correct. If proper steps are taken then HMRC will find it difficult to make a discovery once the enquiry window (12 months normally) has closed.
There is, of course, a fine line between supplying sufficient information to allow the officer to check the return is correct and unnecessarily alerting HMRC to a particular aspect of the return (in effect, impliedly suggesting that the return may be incorrect).
If you would like further information on how to present the facts to limit the risks of a discovery or to check whether HMRC were correct to issue a discovery assessment, please contact TaxDesk on 0845 4900 509 and ask for John Hood or Noel Hankinson.