Challenging Information Notices - Andrew Gotch examines the facts

as published in Tolley's Practical Tax Newsletter

Is resistance futile?

As HMRC's familiarity with its powers under FA 2008, Sch 36 grows, HMRC officers are becoming increasingly quick to issue statutory notices in pursuit of information or documents to expedite their compliance checks of taxpayers and their returns. Dealing with such notices can be stressful, time-consuming and costly. Tax advisers are also often justifiably concerned that the wide and exhaustive nature of the material sought is at least in part piscatorial, and will give rise to additional irrelevant queries that prolong the checking process unnecessarily and unacceptably. What can be done to resist such notices?

Reasonably required

The statutory power is a potent one. Documents and information can be obtained if they are reasonably required for the purpose of checking a taxpayer's tax position (FA 2008, Sch 36, para .1). There is no requirement for an enquiry to be open or for something to be wrong. "Checking" is a neutral term (although of course in practice HMRC officers will not ask for information where they think everything is fine!).

The power is also extremely broad and intrusive: "tax position" is defined to embrace a wide range of financial transactions with HMRC going well beyond tax, and includes the position in the past, the present and the future - in other words, it covers everything. All that is required is that the information is reasonably required.

The burden of proof in demonstrating that material is "reasonably required" for the purpose of checking a tax position falls on HMRC, and that seems a light burden - given HMRC's statutory role it is unlikely that many requests will be adjudged unreasonable, although it can happen.

Appointment diary

In the case of Dr Kathleen Long v HMRC [2014] UKFTT 199, HMRC were enquiring into Dr Long's return and requested sight of her appointments diary, a familiar request from HMRC. Dr Long appealed against a notice requiring its production on the grounds that it was not reasonably required for the purpose of checking her tax position, because the diary contained no financial information, was not an accurate record of patients who were actually seen and contained confidential medical data. At paras 18-20 Judge Reid decided, without reference to the confidentiality issue, that:

"It seems to me to be impossible to hold that the business appointments diaries are reasonably required in order to check the taxpayer's position. They contain no financial information. They are not necessarily an accurate record of patients seen and services provided or charged for . .. It was suggested that some sort of calculation could be made by reference to numbers of patients to identify a minimum turnover. However, given the variety of services provided by Dr Long that seems to me to he a remote and speculative possibility which does not make the requirement for the production of the business appointment diaries reasonable"

Careful consideration of the nature and content of the information and documents sought is clearly essential if the reasonableness of a request is to be challenged.

Statutory safeguards

There are familiar restrictions relating to possession or poweri information relating to pending appeals, personal information, documents more than six years old and privileged and some professional material (FA 2008, Sch 36, paras 18-20, 23-26).

Of much greater interest and practical use is the far-reaching restriction contained in FA 2008, Sch 36, para 21. This highlights the fact that the powers in FA 2008, Sch 36 relate primarily to information and documents for years for which returns have not been submitted. Where a return has been submitted, no notice can be given unless certain conditions are satisfied. This is an important safeguard for taxpayers: so what are the conditions?

In summary, once a return has been submitted, a notice can be given if:

In any of those circumstances, a taxpayer's only remedy is to argue on appeal that the information is not reasonably required.

Reason to suspect

What happens if, as is often the case, a return has been submitted, the enquiry window has closed, and the information requested relates solely to IT, CGT or CT? The answer is that the HMRC officer has to show that he has "reason to suspect" that there is an under-assessment (FA 2008, Sch 36, para 21 (6), condition B).

At first blush that might seem to be a low hurdle for HMRC to clear - its officers are generically a suspicious bunch. However, the case of Kevin Betts v HMRC [2013] UKFTT 430 shows that in fact Parliament, while giving HMRC extensive and invasive information powers, has also imposed a stringent test to protect taxpayers from vexatious and inappropriate requests.

Betts win

ln that case, Mr Betts claimed to be not resident in the UK in 2008/09. He supplied some information supporting his claim, and HMRC conceded that the information provided gave no grounds to doubt his claim to non-residence. HMRC then requested sight of his bank, building society and credit account accounts and when Mr Betts declined to supply those, an information notice was issued requiring their production. lt was common ground that no enquiry was open.

Mr Betts appealed against the notice on the grounds that the information was not reasonably required for the purpose of checking his tax position and that HMRC had no reason to suspect that there was an under-assessment. The Tribunal agreed with HMRC that the information was reasonably required for the purpose of checking Mr Betts' tax position. Judge Perez observed at para 124 that the test of reasonable requirement:

"... does not need HMRC to show that there is any reason to doubt the information provided. It suffices if the statements sought are reasonably required for the purpose of checking the appellant's tax position, if only to verify the information provided."

However, that was not enough to win the day for HMRC. Was there reason to suspect that there was an underassessment, i.e. was FA 2008, Sch 36, para 21 (6), condition B, satisfied?

Interest only?

The Tribunal reviewed in detail nine matters which HMRC claimed gave them reason to suspect that there was an under-assessment. ln each case the Tribunal held to the contrary: the fact that an HMRC officer had reason to be interested did not automatically mean that the officer had rcason to suspect. lmportantly, the Tribunal held that seeking information in order to establish a reason to suspect was impermissible. Judge Perez said at para 90:

"But it is clear, in our judgment, that ... there has to be reason to suspect that an amount that ought to have been assessed to relevant tax for the chargeable period may not have been assessed as regards the appellant. That is the plain and ordinary meaning of paragraph 21 (6)(a), and we see no reason to go behind that. Seeking information or documents in order to tty to meet condition B is simply the wrong way round ..."

Conclusion

Where a return has been submitted and HMRC seek information about ll CCT and CT without an enquiry being open, Eetts emerges as a strong bulwark against information notices that are, to coin a phrase, "fishing expeditions". Something far more than mere suspicion is required, in the form of a substantive reason giving rise to suspicion: a gut feeling is not enough. Using a notice to obtain material to give an officer reason to suspect subverts the very safeguard that Parliament has afforded and all such requests should be carefully scrutinised.

Tax practitioners should also be aware that by FA 2008, Sch36, para28, exactly the same safeguards apply to requests to inspect documents for earlier years in the course of live compliance inspection check visits, and should take care to resist any request by an HMRC officer to access such documents in the absence of a substantive reason to suspect that there is an under-assessment for the earlier year.

The Betts penny might take some time to drop at the front line. Recently the author explained the implications of Betts to an HMRC officer and received the following reply:

"Obviously until the facts have been established I am unable to form an opinion and therefore condition B is satisfied because I have reasons to suspect there may be an additional tax liability."

Hopefully the implications of Betts will become better understood as time passes!

HMRC are, quite rightly, quick to use the extensive powers that Parliament has afforded them in FA 2008, Sch 36. Tax advisers should be just as assiduous to use Parliament's safeguards to protect their clients against the unwarranted or inappropriate use of those powers.

Andrew Gotch BA MA CTA (Fellow) is a consultant for TaxAction Consulting Limited,
0800 222 9992 or action@taxaction.org.uk

Andrew Gotch, Disincorporation Relief – find out about the pitfalls!

as published in British Tax Review Issue 4, 2013

Section 58: disincorporation relief—a missed opportunity

Much tax-relieving legislation serves to facilitate the passage of a business into incorporated form and the transfer of a business from one company to another. Unfortunately, reversing a business through the corporate veil to unincorporated status has been a different proposition entirely, achievable only at a considerable tax cost that almost invariably acts as a disincentive to doing so.

Yet many advisers know that a significant number of unincorporated businesses were inadvisedly enticed into corporate form by what proved to be the specious and short-term attractions of the 10 per cent and 0 per cent corporation tax starting rates offered by the Government in 2000–2005 (stories of lemming-like mass incorporations of taxi-drivers are by no means apocryphal). Similarly, all advisers know businesspeople who have no undue need of limited liability, and who, by reason of their aversion to administration, paperwork and compliance costs or by their relaxed attitudes to drawing money from their businesses, are temperamentally wholly unsuited to business life within a corporate framework. They generate a genuine rolling risk of compliance failure with employment tax obligations and Companies Act requirements without gaining any material commercial advantage from containing their business within a company.

The unfair and, in the view of many, incomprehensible skewing of the legislation against disincorporation has been raised many times but has been met, in the end, with indifference by HMRC and Government. Awareness of this unsatisfactory state of affairs prompted the Office of Tax Simplification (OTS) to explore the issue more thoroughly and to publish Disincorporation Relief as part of its Small Business Tax Review: Final Report in February 2012. ¹ Indeed, John Whiting noted in the Foreword:

"It is not a new question: a disincorporation relief has been regularly mooted over at least the last quarter of a century. Discussions and formal consultations have taken place but nothing further has happened".²

The OTS commissioned or undertook research which indicated that there was a real appetite amongst taxpayers and their advisers for a disincorporation relief, and by no means just in relation to the micro businesses who were seduced by the prospect of a 10 per cent or 0 per cent tax rate.

The OTS's conclusion was that the relief should be available to micro businesses, which is to say those businesses with fewer than 10 employees and a turnover or balance sheet total of less than £2 million. Its proposals were that the relief should comprise:

Appendix C of the OTS report sets out a "Schematic of Legislation"³ describing a form that such proposals might take.

So what resemblance does the disincorporation relief provided by sections 58–61 of Chapter 5 Part 1 of the Finance Act 2013 (FA 2013) bear to the OTS proposals? In one respect, it reflects exactly the OTS requirements. The OTS suggested that three pages of simple legislation would suffice, and that is exactly what the FA 2013 provisions provide. Beyond that, any resemblance is disappointingly superficial.

The legislation makes no mention of any restriction on the size of the company that can take advantage of the relief. There is also no stipulation that the relief is limited to trading companies, so that regard should be had to the decision in Elizabeth Moyne Ramsay v HMRC ⁴ when considering the scope and meaning of the word "business" in the context of the legislation. However, that apparently enlightened approach, opening the relief up to most companies wishing to disincorporate, is then subverted by limiting the aggregate market value of the qualifying assets within the scope of the relief to £100,000. The qualifying assets are land and goodwill.

The policy rationale behind that decision is hard to discern, because it makes the relief effectively available only to those companies that either do not own land and/or whose businesses have failed to generate material goodwill during the period of incorporation. With property prices at present levels, few companies owning land will fall comfortably within the £100,000 limit on that asset alone; and when combined with the value of any goodwill even fewer will be able to limbo-dance beneath the limit. There is unfortunately no option to apply the relief to only one asset with a value of up to £100,000 and it is a condition of the relief that all assets of the business other than cash must be transferred, so the aggregate value of land and goodwill must be taken.

The requirement also imports in its wake the cost and trouble of establishing values for the assets transferred—a requirement notably absent on transfers of land to companies under section 165 of the Taxation of Chargeable Gains Act 1992 (TCGA). That valuation cost alone will be a disincentive to disincorporate for many smaller companies and is an entirely avoidable imposition of a burden on business.

There is an added procedural difficulty with valuation. Given the frequency with which HMRC contest values of land and goodwill and the very low statutory threshold, a properly-advised company will wish to agree the values with HMRC before disincorporating, not just to avoid a compliance check of the values but to decide whether disincorporation is prudent in the first place. Disincorporating without certainty over valuation will mean that the shareholders and the company assume the risk of unfunded tax charges arising that—if the value is close to the £100,000 limit—could be substantial. The CG34 procedure ⁵ is a post-transaction facility and will not suffice, because the disposals and distributions will already have been made and the consequent tax consequences accrued; but there seems to have been little or no thought on HMRC's part as to this very practical issue.

The relief itself is structured in a way that could penalise taxpayers unfairly. By new section 162B(2) TCGA the qualifying assets are taken to be disponed and acquired for a consideration equal to the lower of the deductible cost under section 38 TCGA and market value. Thus should one or both of the qualifying assets have a market value below indexed cost, the capital loss arises in the company but there is unlikely to be any gain against which to relieve it; but the shareholders take the asset at a market value that increases their eventual gain in relation to the original cost of the asset. Quite why this subliminal financial penalty should have been thought appropriate to a relief that deals with business continuity and should have been economically neutral is hard to fathom, the more so because if the goodwill is subject to the intangibles legislation, new section 849A Corporation Tax Act 2009 (CTA 2009) adopts the same measure of value, but gives rise to a deduction which would be set off against income in the final period to cessation. That startling disparity of treatment seems inexplicable, and could be material since many prospective candidates for disincorporation will be businesses in decline that wish to revert to an unincorporated format but acquired the goodwill when the business was in its heyday and its correspondingly higher value reflected in its cost.

An even less attractive aspect of HMRC's version of the OTS proposals is the total absence of any relief at the shareholder tier. The OTS recognised that transfers of assets at an undervalue to shareholders would give rise to a distribution, either income or capital depending on whether the distribution took place before or during a liquidation. Since that would be an unfunded tax charge, the OTS proposed that there should be relief for transfers of qualifying assets to shareholders by providing that the value of such transfers should not be distributions for tax purposes.

The requirement at section 59(2)–(3) FA 2013 for the business to be transferred as a going concern with all of its business assets other than cash suggests that most disincorporations will take place before appointing a liquidator or undertaking an informal winding-up, and in any case few small companies would be likely to want to incur the disproportionate expense of appointing a liquidator when disincorporating.

So in practice most distributions would be income distributions: but disincorporation relief provides no relief at all to shareholders. This glaring omission is justified by HMRC on the basis that the companies taking advantage of the relief will be likely to be so small that any distribution would be unlikely to give rise to a tax liability for the shareholder. That generalising assumption does not sit easily with a £100,000 limit on qualifying assets, where there could plainly be a substantial unfunded tax liability. Indeed any taxpayer with other income in excess of the basic rate-band in the year of disincorporation would face an unfunded tax liability however small the value of the disincorporated assets. The position is compounded by HMRC's decision to exclude plant and machinery from the list of qualifying assets, as the OTS proposed. While such a relief would have duplicated the effect of an election under section 266 of the Capital Allowances Act 2001, a relief from a distribution charge for qualifying assets would have embraced the transfer of plant and machinery as well.

The position is in fact far worse than it seems, because it is not just qualifying assets that are a problem. Exclusion of a relief for distributions at the shareholder tier means that a further valuation has to be undertaken of all the assets of a business that will be transferred otherwise than in exchange for a payment of their market value to the company by the shareholders. The aggregate total market value of those assets—land, goodwill, stock, plant and machinery, debtors—will all be taken into account as a distribution to the shareholders, notwithstanding that, paradoxically, elections could be made for stock and plant and machinery to pass at no tax cost to the transferor company at the business tier. In a real sense, the legislation imposes a substantial charge to income tax on a distribution as the opportunity cost of accessing disincorporation relief. It is likely to be a cost that few, if any, will choose to bear.

It comes as no surprise in the context of such restrictive legislation to find that the OTS proposal to review the operation of disincorporation relief after five years has found its statutory expression in the "sunset clause" at section 58(1)(c) FA 2013 which limits its application to disposals on or before March 31, 2018. There is no formal commitment to review; and of course its very terms mean that the take-up of this benighted relief is likely to be so small that lack of use will be used as a justification for its departure from the fiscal scene.

When one stands back and looks at the negative way in which this enlightened proposal has been legislated, the only conclusion that one can draw is that somewhere in HMRC's institutional DNA there is an engrained disinclination to do anything positive to facilitate a move out of the corporate sphere, despite the manifest benefits it would provide to many small businesses. One is reminded of another OTS proposal—the cash basis for small businesses—that has been similarly rendered unfit for purpose by larding it with anti-avoidance provisions and hyper-inflating it to an extent that makes it unsuitable for use by anyone other than the naïve, the brave or the extremely well advised, rather than the honest small business community that both proposals were designed to help.

By adopting such a negative, unimaginative and minimalist approach to the OTS proposal, subtracting essential elements of it and adding nothing new, HMRC have allowed the Government to legislate a relief that very few taxpayers will be inclined or able to use, despite the fact that they should, for perfectly commercial reasons, be allowed to carry on their businesses in unincorporated form. Disincorporation relief raises the question of whether the Government's, and HMRC's, much-bruited commitment to helping small business is anything more than lip service. Small business deserves much better.

¹ Office of Tax Simplification, Small Business Tax Review: Final Report. Disincorporation relief
(February 2012)(the OTS Report), available at https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/199181 /03_ots_small_business_tax_review_disincorporation_280212.pdf [Accessed September 2, 2013].

² The OTS Report, above fn.1, 3.

³ The OTS Report, above fn.1, 3, App C, 27.

⁴ Elizabeth Moyne Ramsay v HMRC [2013] UKUT 226 (TCC).

⁵ HMRC, Post-transaction valuation checks for capital gains—CG34.

Andrew Gotch BA MA CTA (Fellow) is a consultant for TaxAction Consulting Limited,
0800 222 9992 or action@taxaction.org.uk

One of the hardest parts of dealing with HMRC investigations is the negotiation of the settlement.  We all know the scenario.  The records are not brilliant but the client is adamant they have done nothing wrong.  The officer working the case believes they have ‘broken’ the records whereas all they have done is cast limited doubt on their veracity and then used that doubt to jump to unrealistic conclusions.  A case of 2 + 2 making 22!  What do you do?

In a recent case of mine, a builder had purchased large quantities of tiles and stone from another builder.  The purchase had been in cash and not documented although the client knew the name of the other builder.  The money was drawn out of the bank account in cash.  The builder had sales of material to his clients.  The other builder had sadly died so was not able to verify the deal (but might not have wanted to because they had fallen out anyway).  The HMRC officer simply did not believe any of this was true and thought the money was being squirreled away for private use.  So how do you defend that position?

Discussions with the client about this deal lead to him suggesting that the material had come from the demolition of a pub in the West Country.  Indeed the money was always taken out on a Friday – the client explaining that the material was brought up on a trailer from the site.  The amount was always the same.  He knew roughly where the pub was and he knew when this was taking place.

Some detective work on the internet identified the pub and led to the current owner being approached.  He had photos of the site and a copy of an invoice from the builder who had done the work – which matched the name provided to HMRC by the client.  Of course, this proved nothing but it did support the explanation being provided by our client and made it harder for the HMRC officer simply to dismiss the argument.  It helped the negotiation and the client ended up with a much more acceptable settlement.

The main message here is that in dealing with any type of negotiation it is vital to be creative in considering how evidence can be collected which supports the position of the client.  Although it does demonstrate also that good record keeping goes a long way in protecting a client when it comes to HMRC scrutiny!