Mansworth Losses and Legitimate Expectation

On 30 July 2017 the Court of Appeal handed down its judgment in the case of The Queen on the Application of Ralph Hely-Hutchinson v The Commissioners for HM Revenue & Customs [2015] EWHC 3261 (Admin), which broadly sets out the limits of a taxpayer’s ability to force HMRC to follow guidance that it has subsequently withdrawn.

The case concerns guidance issued by HMRC following the case of Mansworth (HMIT) v Jelley [2002] EWCA Civ 1829 in 2003 and its subsequent withdrawal.

The tax issue

In Mansworth the courts decided that the exercise of an option should be treated as a transaction to which s17 TCGA 1992 applied, which meant that the option-holder was treated as having acquired their shares at their market value on the date of exercise for CGT purposes (HMRC quickly amended the law by inserting s144ZA TCGA in Finance Act 2003 so that s17 TCGA does not apply where an option is exercised by an employee).

Following Mansworth HMRC issued guidance to the effect that, for options exercised by an employee before the Finance Act 2003 changes came into force on 10 April 2003, the base cost for CGT purposes should be calculated as the sum of:

  • the market value of the shares on the date of exercise (following Mansworth); and
  • the value treated as taxable employment income when the option was exercised (following s120 TCGA).

This guidance meant that before s144ZA TCGA came into force on 10 April 2003, HMRC would calculate the base cost of shares acquired by an employee paying £100 to exercise an unapproved option over shares worth £10,000 by adding the £10,000 value of his shares when he exercised the option to the £9,900 that was taxed under the income tax rules: for CGT purposes his base cost in the shares would have been £19,900 and, if he sold the shares when he exercised the option, the employee would be treated as realising a CGT loss of £9,900, which could be offset against other taxable gains.

At the time this guidance was seen by the profession as a misreading of the law and in May 2009 HMRC announced that it had been advised by its lawyers that its original interpretation of Mansworth was wrong: amounts that had been treated as taxable employment income should not be added in to the calculation of base cost.

A large number of taxpayers returned losses on the basis of this guidance and many sought to carry forward those losses to utilise in future tax years.

HMRC announced that it would apply its new understanding of Mansworth to deny taxpayers the use of Mansworth losses for future disposals and that taxpayers should amend open returns to reflect the new guidance.

The case

In this case Mr Hely-Hutchinson had exercised share options in 1998/9 and 1999/2000 and had sold the shares that he had acquired. Following the publication of the 2003 guidance he sought to amend his tax returns to claim the deemed losses that would be calculated on the sale of the shares if the HMRC guidance was followed.

HMRC raised enquiries into these amended tax returns and issued closure notices instructing Mr Hely-Hutchinson to withdraw his loss claims. Mr Hely-Hutchinson sought a judicial review of the decision arguing:

  • He had a legitimate expectation that his loss claims would be considered and dealt with consistently with the 2003 Guidance;
  • The refusal to allow his claims and to withdraw the 2003 Guidance was unfair and an abuse of power; and
  • He was not being treated fairly and consistently with other taxpayers.

Mr Hely-Hutchinson was successful in the High Court, but the Court of Appeal was less sympathetic, holding that:

  • The 2003 Guidance had not been issued when Mr Hely-Hutchinson exercised his share options; he did not exercise them in reliance on the 2003 Guidance and the effect of the refusal of his loss claims was only to return him to the position that he had been in when he entered into the transactions in the first place – this lack of reliance was fatal to his claim that he had a legitimate expectation that the 2003 Guidance would be followed;
  • It is open to a public body to change a policy if it has acted under a mistake – the only limit on the public body doing so is if the change of policy would be ‘outrageously or conspicuously unfair’;
  • Taxpayers who had made claims in closed years were in a fundamentally differently position to taxpayers, like Mr Hely-Hutchinson, who had claims in open years – there is no fairness in allowing an administrative error to be perpetuated where it was remediable.

The court also held that the fact that HMRC had taken a long while to reach a decision on Mr Hely-Hutchinson’s claims was not material.

The case is of interest because it does provide us with a snapshot of the courts’ views on legitimate expectation and taxpayers’ ability to claim reliance on guidance given by HMRC.

For further information please contact the TaxDesk on 0845 4900 509 and ask for Thomas Dalby.