HMRC win again on carry back losses
For those advisers who have the difficult task of guiding clients who have entered into tax avoidance arrangements, the decision of the Supreme Court in De Silva v CRC [2017] STC 2483 may be familiar. For the uninitiated, in that case the Supreme Court held that TMA 1970 s.9A gave HMRC the power to enquire into a taxpayer’s carry-back claims (s.12AC for partnership returns had the same effect). Crucially, HMRC did not have to start an enquiry under Sch 1A to challenge a claim. Now, a new decision of the Court of Appeal in Barry Knibbs v CRC [2019] EWCA Civ 1719 has provided further success for HMRC in the area of carry back claims.
The facts
The claimants participated in tax avoidance schemes, either directly or through partnerships, mainly involving investments in films. They made claims to set losses sustained in one year of assessment (Year 2) against income of one or more previous years (Year 1) (carry- back claims).
The claimants argued that HMRC did not enquire into these claims under schedule 1A to the Taxes Management Act 1970 (TMA), and in the absence of such enquiries within the relevant time limits, the carry-back claims became final and HMRC were obliged to give effect to them. The claimants accepted that the ‘De Silva decision applied to deny claims to claimants whose Year 2 was 2006/07 or earlier, but not to those claimants whose Year 2 was 2007/08 or later, as a result of the Income Tax Act 2007 (ITA). It was pleaded in the particulars of claim that the carry-back claims fell within schedule 1A to TMA and that in all cases the claims were made by letter or by filling in boxes on their self- assessment tax return forms (whether by amendment or otherwise) for a prior year or for Year 2. In some cases, the claimants’ income tax self-assessments for the year in which the loss was said to have been suffered included relief in respect of the loss.
The particulars of claim pleaded that none of the claimants had received a notice of enquiry pursuant to paragraph 5(1)(a) of schedule 1A to TMA and that the periods in which such notices could have been issued had expired pursuant to paragraph 5(2). There was no dispute that enquiries were not opened under schedule 1A in most cases. The issue under dispute was whether HMRC were entitled to open enquiries under sections 9A and, in the case of partnership claims, under section 12AC.
In the Supreme Court
The Court analysed the relevant provisions. The Court stated that difficulties largely stemmed from the need to adapt the old rules for making and determining claims by taxpayers to the new rules for the machinery of self-assessment. Thus the basic procedure for making claims is still set out (as it was in the days of direct assessments to tax made by officers of HMRC) in section 42 of TMA, but the section has been extensively amended, and is also supplemented in crucial respects by two schedules (schedule 1A and schedule 1B) which (although enacted at different times) both came into effect from 1996/97, at the same time as the modern self-assessment regime for individual taxpayers.
The effect of section 42(2) is that, in all cases where a taxpayer is required to submit a personal or partnership tax return, any claim that could be included in the return must be so made, and cannot (for example) be made outside the return by means of a letter. It is therefore only when a claim is made outside a return, and could not be included in a return, that the provisions of schedule 1A come into play. If so, paragraph 5 provides that HMRC may enquire into a schedule 1A claim within specified time limits, and paragraph 7(2) provides that on the completion of the enquiry, HMRC may amend the claim. By virtue of paragraph 9(1), the taxpayer may appeal to the FTT against any such amendment.
In terms of Schedule 1B, this provided for claims for relief involving two or more years.
Paragraph 2 of schedule 1B is headed “Loss relief” and materially provides as follows:
“2(1) This paragraph applies where a person makes a claim requiring relief for a loss incurred or treated as incurred, or a payment made, in one year of assessment (“the later year”) to be given in an earlier year of assessment (“the earlier year”).
(2) Section 42(2) of this Act shall not apply in relation to the claim.
(3) The claim shall relate to the later year.
(4) Subject to sub-paragraph (5) below, the claim shall be for an amount equal to the difference between –
(a) the amount in which the person is chargeable to tax for the earlier year (“amount A”); and
(b) the amount in which he would be so chargeable on the assumption that effect could be, and were, given to the claim in relation to that year (“amount B”).
…
(6) Effect shall be given to the claim in relation to the later year, whether by repayment or set-off, or by an increase in the aggregate amount given by section 59B(1)(b) of this Act, or otherwise.”
For 2007/08 onwards, the calculation of a person’s liability to income tax for a tax year is prescribed in exhaustive detail by Chapter 3 of Part 2 of ITA (sections 22 to 32).
Relevant case law
In Cotter v Revenue and Customs Commissioners [2013] UKSC 69, the case concerned a claim by Mr Cotter to have sustained an employment-related loss of £710,000 in 2008/09 (Year 2), which he claimed to carry back and set against his income of the previous tax year (Year 1). The claim was made on the face of his (amended) tax return for Year 1, by making appropriate entries in boxes on the form. HMRC opened an enquiry into the claim under TMA schedule 1A, which as we have seen applies only to claims not included in a return. Mr Cotter therefore argued that schedule 1A did not apply, because his claim had been made on the face of his return for Year 1. He further argued that the appropriate course would have been for HMRC to open an enquiry into his return for Year 1 under TMA section 9A.
53. The Supreme Court rejected Mr Cotter’s arguments, and accepted HMRC’s submission that a claim is included in a “return” for the purposes of sections 8(1), 9, 9A and 42 of TMA only if it affects the calculation of tax payable in respect of the year of assessment for which the return was made. As Lord Hodge explained:
“The word “return” may have a wider meaning in other contexts within TMA. But, in my view, in the context of ss 8(1), 9, 9A and 42(11)(a) of the TMA, a “return” refers to the information in the tax return form which is submitted for “the purpose of establishing the amounts in which a person is chargeable to income tax and capital gains tax” for the relevant year of assessment and “the amount payable by him by way of income tax for that year” (s 8(1) TMA).”
It was common ground that Mr Cotter’s carry-back claim did not affect his self- assessment for Year 1, because by virtue of paragraph 2 of schedule 1B the claim related to Year 2, and effect had to be given to it in Year 2, even though the amount of the claim was ascertained by the counterfactual calculation mandated by paragraph 2(4). Accordingly, Mr Cotter’s claim did not form part of his return for Year 1, and could not be affected by an enquiry into that return under TMA section 9A. As Lord Hodge said:
“The Revenue was accordingly entitled and indeed obliged to use Sch 1A of TMA as the vehicle for its enquiry into the claim (s 42(11)(a)).”
In R (on the application of De Silva and another) v HMRC [2017] UKSC 74 the two taxpayers were limited partners of various limited partnerships in implementation of marketed tax avoidance schemes, aiming to give the taxpayer the right to set off losses in the current year of assessment or any of the previous three years [pursuant to the provisions of sections 380 and 381 of ICTA]. The partnerships lodged tax returns for various tax years, claiming that they had suffered substantial trading losses and claiming relief. The revenue initiated inquiries into the partnerships’ tax returns under section 12AC(1) of [TMA], as substituted, and disallowed certain claims for expenditure. The taxpayers brought a claim for judicial review, contending that the revenue was obliged to give effect in full to their claims because it had not opened an inquiry into those claims under paragraph 5 of Schedule 1A to [TMA], as inserted, within the relevant time limit and, therefore, could no longer do so”. Their main argument, based on Cotter, was that the carry-back claims did not form part of their “returns” for Year 2, because the claims fell within TMA schedule 1B and as such could not affect the amounts in which they were chargeable to income tax for either Year 1 or Year 2, but were instead free-standing claims for an amount quantified by paragraph 2(4) of schedule 1B. If that analysis was correct, it would follow that the claims could not be the subject of a deemed section 9A enquiry into the claimants’ Year 2 returns, or an amendment to those returns made under section 28B(4)(a).
This argument was, however, rejected by Lord Hodge. His Lordship said:
‘If a taxpayer wished to claim to offset all of his share of partnership losses in Year 2 against his other income in Year 2 by invoking section 380(1)(a) of ICTA… he would have to include that claim in his return for Year 2. Schedule 1B would not apply as the claim for relief would involve only one year of assessment. Section 8(1AA)(a) would allow him relief, for which he had included a claim in the return, giving rise to the net sum in which he would be chargeable to income tax for that year.
If a taxpayer wished to carry back part of the losses incurred in Year 2 to set off against his income of Year 1 by invoking section 380(1)(b) of ICTA…, he would also have to make the claim in his return for Year 2. This is the combined effect of section 8(1AA)(a) and Schedule 1B, paragraph 2(3)(6). As shown in para 18 above, those paragraphs provide that the claim for relief relates to Year 2 and effect is to be given to that claim in relation to Year 2. If HMRC had already given effect to part of the claim under Schedule 1A in Year 1 by giving relief, for example by repayment, the return for Year 2 would still have to state the loss, the claim and the relief already given in order to establish the amounts in which the taxpayer is chargeable to income tax in Year 2. Similarly, if the taxpayer had already received full relief under Schedule 1A in Year 1, he would have to state the same information as to the loss, the claim and the relief already given. By so doing he enables the return to “take into account”, as section 8(1AA)(a) requires, both the relief which is claimed in the return and that which he has already received. In each case that information is a necessary part of his return for Year 2 as it is information required “for the purpose of establishing the amounts” in which the taxpayer is chargeable to income tax for that year of assessment: section 8(1).
In summary, section 8(1AA)(a) defines the amounts in which a person is chargeable to income tax in a year of assessment as net amounts taking account of any relief, a claim for which has been included in the return. The claims to carry back losses relate to Year 2 and effect is given to them in relation to that year: Schedule 1, paragraph 2(3)(6). It follows, therefore, that the taxpayer must make a claim in his tax return in respect of Year 2 and state the extent to which the relief claimed has already been given in order to establish the amounts in which he is chargeable to income tax for that year of assessment. If too much has already been given as relief, the self-assessment can take that into account by adjusting the amount in which the taxpayer is chargeable to income tax for Year 2: section 9(1)(a).
HMRC may inquire into a return under section 8 or 8A if an officer gives notice of his intention to do so (section 9A(1)) and that enquiry may extend to anything contained in the return, or required to be contained in the return, including any claim: section 9A(4). HMRC were therefore empowered under section 9A to inquire into the taxpayers’ carry back claims contained in their Year 2 tax returns. HMRC were not required to institute an inquiry under Schedule 1A in order to challenge the taxpayers’ claims.’
This reasoning therefore provides clear authority, at the highest level, that where a claim to carry back trading losses is made, the taxpayer must make a claim in his tax return in respect of Year 2, and state the extent to which the relief claimed has already been given.
In R (on the application of Derry) v HMRC [2019] UKSC 19, the case was not about trade loss relief but rather about share loss relief, under Chapter 6 of Part 4. Entitlement to share loss relief is conferred by section 131, and arises where an individual incurs an allowable loss for capital gains tax purposes on the disposal of qualifying shares, by way of a bargain made at arm’s length or in certain other specified circumstances. The machinery for making such a claim is set out in section 132, in terms very similar to those of section 64 relating to trade loss relief. The claim may thus be carried back, in whole or in part, to the previous tax year. If the taxpayer chose to make a carry-back claim, it might therefore be thought that the provisions of schedule 1B to TMA would similarly come into play; but, in contradistinction to Chapter 2 of Part 4, no express cross-reference to schedule 1B is to be found in Chapter 6. In other words, there is no equivalent to section 60(2): see [34] above.
In the 2010/11 tax year (Year 2), Mr Derry sold shares that he had bought during the previous tax year (Year 1), making a capital loss of £414,500. In his online tax return for Year 1, he claimed share loss relief for that amount against his income for that year. HMRC later made a demand under section 60 of TMA for income tax alleged to be due for Year 1, on the footing that Mr Derry’s right to deduct the share loss relief in calculating his net income and consequent tax liability for that year was overridden by paragraph 2 of schedule 1B, with the result that the loss had to be treated as relating to Year 2. Mr Derry then sought judicial review of the decision to issue the demand.
The issue was whether Mr Derry’s claim to share loss relief under section 132 of ITA was subject to the provisions of schedule 1B, notwithstanding the absence of any cross-reference or “signpost” to that schedule in Chapter 6 of Part 4 of ITA. The Supreme Court held that the absence of a signpost was indeed fatal, and that this court had been wrong to start with the clear wording of schedule 1B, which as it stood was clearly apt to cover carry-back claims under section 132, rather than with the comprehensive and self- contained code for the treatment of a claim to such relief in sections 23 and 132 of ITA. In those circumstances, the claim to relief had properly formed part of Mr Derry’s return for Year 1, and it could only have been challenged by a notice of enquiry served within time under section 9A of TMA.
The claimants accepted that the Supreme Court was bound by De Silva to dismiss the appeals of those claimants whose Year 2 was 2006/07 or earlier, but argued that the words “or otherwise” in schedule 1B paragraph 2(6) could not authorise an adjustment to the amount chargeable to income tax in Year 2, where Year 2 is a tax year to which ITA applies. For those years, section 23 and the other provisions contained in Chapter 3 of Part 2 of ITA set out exhaustively how a taxpayer’s liability to income tax for Year 2 is to be calculated. Paragraph 2(6) of schedule 1B is not listed in section 24 of ITA as a provision conferring a relief deductible at Step 2; nor is it included in section 26, as conferring a tax reduction deductible at Step 6; and nor again is it included in section 30, as a provision imposing a charge to income tax to be added in at Step 7. Accordingly, on the true construction of Chapter 3 of Part 2 Parliament did not intend the calculation of liability to income tax for a tax year to be affected in any way by paragraph 2(6) of schedule 1B.
The Supreme Court were not persuaded.
‘In our view, it would clearly be wrong to construe sections 23 and 24 of ITA in hermetic isolation from the rest of ITA, when section 24 itself requires one to look at section 64, and section 64 is expressly made subject to paragraph 2 of schedule 1B where the claim to trade loss relief has a carry-back element. Accordingly, the calculation of the taxpayer’s income liability for Year 2 under section 23 must, where appropriate, take account of and give effect to the provisions of paragraph 2 of schedule 1B. Equally, the taxpayer must give full information about the claim in his Year 2 return, precisely because it may impact on the amount of tax for which he is liable in that year; and HMRC may then open an actual or deemed enquiry into the Year 2 return under section 9A of TMA. All of this was settled by the Supreme Court in De Silva, and once the necessary link to schedule 1B has been identified within ITA itself, we can see no possible basis for distinguishing post-2007 claims from pre- 2007 claims.
Mr Ewart (Counsel for the taxpayer) accepted that, if his submissions were correct, the consequence would be that a carry-back claim could never be made in a Year 2 return where Year 2 is 2007/08 or later. Although apparently logical, this would in our view be a strange and unrealistic conclusion to have to reach, bearing in mind the express link to schedule 1B which we have identified. Since the claim must of necessity relate to, and be given effect in, Year 2, and since on any view the claim would have to be made in the Year 2 return if it involved no carry-back element, and since the losses available for carry- back must also be entered in the Year 2 return, it would indeed seem paradoxical if the carry-back claim itself had to be treated as a standalone claim which fell outside the scope of the Year 2 return. It seems to us that these wider considerations form an important part of the approach and reasoning of Lord Hodge in De Silva, and we would be most reluctant to conclude that the statutory scheme of Chapter 3 of Part 2 of ITA somehow made them irrelevant.’
Conclusion
The arguments advanced by the taxpayer were an ingenious ‘black letter law’ attempt to distinguish their case from the failed claims in ‘De Silva.’ That they failed is perhaps a comment both on the use by modern courts of a ‘purposive approach’ to the construction of legislation, and the reluctance of the Courts, in these economically constrained times, to allow such claims to succeed. Given the worldwide slump caused by Coronavirus, we suspect that the public interest, as perceived by the Courts, in protecting the Exchequer from appeals and claims by taxpayers in all areas of UK fiscal legislation can only become more pressing. HMRC will also be under severe pressure to maximise tax take in these most difficult of times, setting them against cash strapped taxpayers struggling for economic survival. The stage is set for some difficult times ahead.
Levy and Levy – the tax resolution specialists.