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How much disclosure is enough?
Feb-12-2010
The Pattullo decision suggests that taxpayers should be clear in their "white space" disclosures about taking a different view from HMRC when they have undertaken a tax scheme if they wish to achieve finality
How much disclosure is enough?
The recently reported decision of the Court of Session in R (on the application of Pattullo) v Revenue and Customs Commissioners [2010] STC 107 raises a concern about the effectiveness of disclosure letters which seek to avoid the issue of a “discovery” assessment at some time in the future where the taxpayer has participated in the tax avoidance scheme.
This decision suggests that unless the disclosure letter states that the taxpayer has entered into a tax scheme and that the tax paid may be insufficient, then it will not be effective.
Background
Currently in SDLT, HMRC may enquire into a return for any reason within nine months of the filing date. Beyond this nine month period HMRC may issue a “discovery assessment” if they later “discover” that tax has been underpaid. A “discovery assessment” can be issued normally within six years of the transaction but this is extended to 21 years in the case of negligence or fraud. Leaving aside cases of negligence or fraud, HMRC can only issue a “discovery assessment” when by the end of the nine month enquiry window they could not have been reasonably expected, on the basis of the information made available to them before that time, to be aware of the underpayment of tax. The point about writing a disclosure letter (sometimes called a Veltema letter after the leading case which considered these rules which was reported at [2004] STC 544) is to provide sufficient information to HMRC at the time the return goes in to alert HMRC to the possibility of an underpayment so that they cannot later on, say five years down the line, claim to have only just “discovered” the possibility of an underpayment and issue a “discovery” assessment. In other words a properly drafted Veltema letter should bring finality to the taxpayer’s return.
The Veltema decision worried HMRC because it suggested that to obtain finality and be immune from a “discovery assessment” the taxpayer had to effectively confess in the return that he had paid less tax than the law required. This was because the judgment of the Court of Appeal said that it was the objective awareness of the inspector of taxes which counted and not what the inspector could reasonably have been expected to do with the information disclosed. HMRC were concerned that this decision would lead to a tsunami of disclosure information accompanying tax returns that would make their task in risk assessing returns so much more difficult. The judgment also seemed to go against common sense by implying that a taxpayer who had filled in his form and signed it believing it to be correct, should then have to add a disclosure statement which suggested that the return may well be wrong and could have understated the tax payable. The result was Statement of Practice 1/06 which sought to restrict the full effect of the Veltema judgment and provide a kind of compromise about how much disclosure was required in order to achieve finality. HMRC accept that SP1/06 applies in SDLT even though it expressly applies for income and corporation taxes only (see SDLT Technical News Issue 4, March 2007). SP1/06 quietly rowed back from the “objective awareness” test of the Court of Appeal and said that it was necessary to put “the HMRC officer… in a position to determine whether or not there is an insufficiency” and if this was done then the conditions set by the Court of Appeal in Veltema would have been met and the return would not have been open to discovery on that point.
In fact of course Veltema went further and said that it was not what the inspector could be expected to do with the information but rather that the return had to clearly alert the inspector to the actual underpayment. In other words it was not sufficient to provide information which a reasonable inspector could then have been expected to look into in more detail and see that there was an insufficiency. A subtle but important difference which SP1/06 sought to elide.
SP1/06 also went on to say that “taxpayers are encouraged to submit the minimum necessary to make disclosure of an insufficiency”, which perhaps reveals the true tension between Veltema and the ability of HMRC to process information.
Helpfully, SP1/06 also stated that where the taxpayer had taken a different interpretation of the law from that of HMRC, then all the taxpayer had to do was to say so in the disclosure and that it was not necessary to provide all the relevant documents. If the taxpayer made such a statement and clearly identified the point at issue, then the taxpayer achieved finality.
Has Pattullo turned back the clock?
So far as I can gather, Pattullo seems to have been argued without the benefit of SP1/06.
In Pattullo the taxpayer sought judicial review of a decision by HMRC to issue a notice under section 20 Taxes Management Act 1970 (power to call for documents) on the ground that HMRC were prevented from making a “discovery assessment” since the taxpayer had made a proper disclosure in his tax return. The taxpayer had carried out a tax avoidance scheme involving capital redemption contracts which he claimed gave rise to an allowable capital loss of £2,665,000. The relevant return disclosed in the white space information under the heading “Capital Redemption Contract” all the relevant steps in the transaction and made reference to the relevant statutory provision. The taxpayer argued that this should have alerted the HMRC officer to the possibility of an under assessment and therefore ruled out a “discovery assessment” now that the 12 month enquiry window had expired (9 months of course in SDLT).
However the judge, Lord Bannatyne, disagreed with the taxpayer and essentially followed the Veltema decision. As part of his reasoning he said that as well as a statement of the full factual position, the taxpayer’s return should have included a statement that the taxpayer had undertaken a tax scheme, that he had taken a contrary interpretation to that of HMRC and given a clearer picture of the operation of the scheme.
He cannily perceived that “the disclosure in the white space is a carefully crafted disclosure seeking to pass through the initial checks carried out by HMRC but in no way meeting the test of clearly alerting to an actual insufficiency”.
It is perhaps unfortunate that SP1/06 appears not to have been placed before the Court although it is probably true to say that this did not affect the outcome because SP1/06 also requires that the point at issue be clearly identified and a statement that a different view of the law has been adopted. Lord Bannatyne however arguably went further than SP1/06 and said that the taxpayer should state expressly that he has undertaken a tax scheme.
Conclusions
Had Lord Bannatyne had the benefit of SP1/06 he may not have gone quite so far. Be that as it may the message from his decision is that “carefully crafted disclosures” need to be treated with caution because they may not achieve finality. It is better to be open with HMRC and say in the disclosure why they may wish to enquire further or at least to explain that the disclosure is being made under SP1/06 with the express intention of achieving finality. Whether or not the disclosure should say “I have done a tax scheme” is open to some doubt and could surely be prejudicial.
In SDLT the disclosure is in any event to a specialist HMRC officer and not to an ordinary inspector as in Pattullo. This provides some protection to the taxpayer because part of the rationale in Pattullo was that test was related to the general knowledge and skill attributed to the HMRC officer. Clearly an SDLT specialist should be more capable of spotting an SDLT scheme than a general HMRC caseworker.
Patrick Cannon
12th February, 2010
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