In John Herbert v HMRC [2015] TC 04395 the First-tier Tribunal (FTT) has dismissed a taxpayerʼs appeal against various discovery assessments and penalties.
The facts
Mr Herbert was made bankrupt in the tax year 1991/1992. Between 1992 and 2005, he submitted no income tax returns. Then, on 31 January 2005, he submitted a tax return for the tax year 2003/2004. He subsequently submitted a number of other tax returns going back to the tax year 1996/1997 as well as a return for 2004/2005.
From around 2004 or 2005, the appellant was advised by Christopher Lunn & Company (“CLAC”), a firm of accountants and tax advisers. In 2010, HMRC seized a number of CLAC’s files. HMRC also refused to deal with CLAC as a tax agent and CLAC instigated procedures for judicial review of HMRC’s actions in this regard. All of those factors meant that the First-tier Tribunal (“FTT”) now had to adjudicate on a dispute involving events taking place over 20 years ago. Mr Herbert was represented by Christopher Lunn.
Points at issue
HMRC issued the appellant with assessments to income tax, Class 4 NIC and related penalties in respect of each of the tax years from 1992/1993 to 2004/2005. The appellant disputed these liabilities for a variety of reasons and with some of the assessments, and all of the penalties, he denied that requisite threshold conditions (such as a “discovery” of loss of tax, or his own negligence) were satisfied. The taxpayer gave evidence and was cross-examined.
The Law
HMRC issued assessments under s29 of the Taxes Management Act 1970 (“TMA 1970”) in relation to the tax years from 1992/1993 to 1998/1999 and the appellant disputed that HMRC were entitled to do so. These assessments were made in February 2008. HMRC also sought penalties under s7 TMA 1970 in relation to tax years from, and including, 1992/1993 to, and including, tax year 1995/1996. For tax years starting with 1996/1997, HMRC sought penalties, instead, under s95 TMA 1970. The appellant disputed that HMRC were entitled to a penalty under either s7 or s95 TMA 1970.
The burden of proof
The FTT said:
‘We consider that it is long-settled law that, where a “discovery assessment” is made under s29 TMA 1970, the burden is on HMRC to establish that the requisite “discovery” has been made. Similarly, where HMRC’s ability to raise an assessment depends on the satisfaction of a threshold condition (such as the taxpayer’s “fraudulent or negligent conduct” and a loss of tax that is attributable to that conduct), the burden is on HMRC to establish that the relevant threshold requirement is satisfied. However, where a taxpayer is disputing the amount of an assessment, it is the taxpayer who has the burden of establishing what the correct amount of the assessment should be. The standard of proof is the ordinary civil standard……Johnson v Scott (Inspector of Taxes) [1978] STC 48 and Hurley v Taylor (Inspector of Taxes) [1999] STC 1.’
The motor business
In respect of his motor business, Mr Herbert disputed the validity of discovery assessments issued by HMRC for 1997/1998 and 1998/1999. On 31 January 2005, the appellant submitted a tax return for the tax year 2003/2004 that included entries relating to a motor business known as “S&B Cars” that he conducted. That tax return was submitted within the applicable time limits for that tax year. Box 3.24 of the return showed that the motor business had a turnover of £12,520 in that tax year and that the appellant had incurred allowable expenses of £15,129. The appellant deducted expenses from turnover and claimed a trading loss of £2,609 for the year.
Tax returns for the years 1997/1998 to 2002/2003 were submitted later. Unlike the return for 2003/2004, they were not submitted within the requisite time limits.
HMRC enquired into the appellant’s 2003/2004 tax return and earlier returns with reference to the profits of the motor business. In due course, HMRC completed their enquiries and made assessments based on adjustments to the figures contained in those returns.
HMRC’s position, which they explained to the appellant in a letter of 30 June was that, in view of what they regarded as the inadequacy of supporting information, in particular the lack of bank statements for certain years, that the appellant had provided during the course of the HMRC enquiries, HMRC had not choice but to derive “revised” figures for these tax years from the bank statements for S&B Cars which the appellant had supplied.
The FT’s conclusion
The FT found that the appellant had not kept adequate books and records and may not have submitted all the records that he had to HMRC. The FTT said:
‘We find that the appellant calculated the figures for inclusion in his tax returns by seeking to identify the number of cars with which he was involved and the fee he received per car. If the appellant had kept careful records of each fee he received, that process could have produced accurate figures. However, in the absence of such records, and given the appellant’s own admission that there were occasions on which he received payments in cash and spent that cash before it was paid into a bank account, we find that the process amounted to nothing more than an educated guess as to his level of taxable income…… For the reasons set out in this section, the appellant has failed to discharge the burden of proving that HMRC’s assessments in relation to profits of the motor business were wrong.’
The discovery assessments
The assessments for the tax years 1997/1998 and 1998/1999 were “discovery assessments” under s29 TMA 1970. In relation to these the FTT said:
‘In relation to those assessments, HMRC have the burden of establishing:
(1) that an officer of HMRC has “discovered” that income of the appellant that should have been assessed has not in fact been assessed;
(2) that situation is attributable to the appellant’s fraudulent or negligent conduct; and
(3) that the assessments were issued within the applicable time limits.’
Charlton and another v Revenue and Customs Commissioners [2012] UKUT is authority for the proposition that the condition as to “discovery” is satisfied if:
“… it has newly appeared to an officer, acting honestly and reasonably, that there is an insufficiency in an assessment.”
In the hearing, Mr Shepherd (the HMRC officer who appeared at the FTT) made no submissions as to what constituted the “discovery” in question for these tax years. We have found…that the appellant had understated taxable income of the motor business for the tax years 1997/1998 and 1998/1999 (and indeed for all tax years up to 2004/2005). The bundle of documents that Mr Shepherd prepared contains a letter written by Mr Drury of HMRC dated 19 December 2007, explaining how he had calculated the assessments relating to the motor business. That letter was written precisely because HMRC had become aware that the appellant had taxable income that had not been assessed to tax. The authenticity of that letter was not in dispute and we find that it demonstrated that there had been the requisite “discovery” for the purposes of s29 TMA 1970.’
…….the process by which the appellant calculated profits of his motor business in all tax years amounted to nothing more than an educated guess given the inadequacy of the books and records that he kept. We consider that to be a negligent course of conduct and that the shortfall in the amount of the appellant’s income assessed to tax was attributable to that negligent conduct. Therefore, the condition set out in s29(4) TMA 1970 is satisfied.’
Comment
This is a classic example of HMRC ‘breaking the books’ by demonstrating that the taxpayer had failed to provide accurate evidence of his true business takings. In such cases, provided HMRC provides a reasonable methodology, it is extremely difficult for the taxpayer to undermine HMRC’s conclusions. It is even harder to demonstrate that HMRC have failed to make a ‘discovery’ within the terms of s.29 TMA 1970. The records of the business are therefore key to a successful defence to any form of assessment raised by HMRC.
Levy and Levy – the tax resolution and investigations specialists in London and Tunbridge Wells.
