R (HAWORTH) V HMRC: FOLLOWER NOTICE QUASHED

What has happened?

In something of a rare victory for the taxpayer in a follower notice case, the Court of Appeal in R (Haworth) v HMRC [2019] EWCA Civ 747 quashed a follower notice and the accelerated payment notice that was based on it. HMRC had misdirected themselves when deciding to issue the follower notice to Mr Haworth because they had proceeded on the basis that the principles or reasoning in the Smallwood case would be more likely than not to deny the tax advantage in Mr Haworth’s tax scheme.  This was too weak a test, and in order to justify the issue of a follower notice, HMRC had to be of the opinion that the principles or reasoning in Smallwood would deny the tax advantage.  In other words, HMRC should have a substantial degree of confidence in the outcome before they can use a previous ruling to justify the issue of a follower notice.  This judgment sets an important limitation on the power of HMRC to use a previous ruling to justify the issue of a follower notice.

What had Mr Haworth done?

Mr Haworth had set up a trust to hold shares for the benefit of himself and his family.  It was decided to dispose of the shares, and a substantial capital gain would arise.  Mr Haworth was advised that the gain could be sheltered from capital gains tax if the existing Jersey trustees resigned in favour of trustees resident in Mauritius where there was no capital gains tax.  The shares would then be disposed of, free of capital gains tax, by the Mauritian trustees who would then retire and the UK trustees would be appointed in their place.  This plan was duly implemented during the course of 2000.  The scheme was known in the tax scheme trade as the “Round the World” scheme.

However, in 2010 the Court of Appeal had, by a majority, ruled in favour of HMRC in Smallwood v HMRC [2010] STC 2045 in the case of another “Round the World” scheme.  The court found in Smallwood that the Special Commissioners in that case had been entitled to find that the place of effective management of the trustees (as a single and continuing body of person per section 69(1) TCGA 1992) was in the UK during the tax year in question.  This was because the steps in the tax scheme had been carefully orchestrated throughout from the UK, and there had been a scheme of management of the trust that went above and beyond the day to day management exercised by the trustees for the time being and so control was located in the UK.  This finding, of course, meant that the gains on the disposal of the shares had not escaped UK capital gains tax, and so the scheme failed.

The Smallwood case revolved around a specific finding of fact by the Special Commissioners that the puppet masters in that scheme, KPMG and Quilter, had, in the UK, pulled the strings and carefully orchestrated the management of the scheme.  However, the “Round the World” scheme was not a single, marketed scheme using standard-form paperwork, but an avoidance device with a number of possible variations, and so it was quite possible for the facts in one iteration of that scheme to differ from the facts in another iteration.

What did HMRC decide?

Between 2014 and 2016, HMRC considered whether follower notices should be given in relation to arrangements similar to those defeated in Smallwood.  In May, 2016, it was decided to issue a follower notice in relation to Mr Haworth’s arrangements.  HMRC’s internal records showed that the basis for issuing the follower notice was advice from the Solicitor’s Office that “the Tribunal is likely to find similarly [to that in the Smallwood] if the following facts were present …”.  On this basis, HMRC considered that Smallwood was a relevant judicial ruling which could justify the issue of a follower notice in Mr Haworth’s case.

Statutory Framework

Section 205(3)(b), FA 2014 provides that a judicial ruling is relevant to the chosen tax arrangements (in order to justify the issue of the follower notice) if:

“(b)  the principles laid down, or reasoning given, in the ruling would, if applied to the chosen arrangements, deny the asserted advantage or a part of that advantage, …”

Where a follower notice is given and not withdrawn, the recipient is likely to pay a penalty of up to 50% of the tax advantage if the recipient does not concede within 90 days of the notice or if the representations are made, within 30 days of the notice being confirmed: section 208, FA 2014.  There is no appeal against the issue of a follower notice, although an appeal is available against a penalty and the grounds of appeal include that the judicial ruling specified in the follower notice is not one which is relevant to the chosen arrangements.

What the Court decided

First, the Court of Appeal agreed with Sir Ross Cranston in the court below that the words “principles laid down, or reasoning given” in section 205(3)(b), FA 2014 contained two separate and alternative concepts, and that both were relevant.  The phrase “or reasoning given” did not have a narrowing effect on the meaning of “principles”, but actually extended what HMRC can draw from the ruling.  This meant that HMRC were not constrained to have regard only to the ratio of a case, but can also take into account other reasoning to be found within it.

Second, the Court considered the meaning of “would” in the phrase “the principles laid down, or reasoning given in the ruling would, if applied to the chosen arrangements, deny the asserted advantage or a part of that advantage”: section 205(3)(b), FA 2014.  The Court held that it was not enough for HMRC to consider that ruling relied on would be more likely than not to deny the advantage because:

1. The word “would” implies that HMRC must be of the opinion that if the point be tested, the principles or reasoning will deny the advantage;
2. Parliament had not said that it is good enough to use the “more likely than not” test;
3. A “more likely than not” test would allow HMRC to give follower notices in a surprisingly wide range of cases and might lead to HMRC using follower notices routinely in relation to appeals before the FTT, and there was no indication that follower notices were meant to be available to HMRC otherwise than in relatively exceptional circumstances;
4. The serious consequences of the taxpayer being exposed to the risk of a penalty of up to 50% suggested that Parliament intended the follower notice regime to be applicable to only a limited class of cases;
5. The fact that a follower notice may deter a taxpayer from resorting to the FTT provided another reason for regarding section 205(3)(b) as calling for more than just a 51% chance of the earlier case being held to apply to the case in hand;
6. There was also a remote analogy with the Kittel[1] principle in VAT where the right of a registered person to deduct input tax can be refused where the taxable person know, or should have known, that he was participating in a transaction connected with the fraudulent evasion of VAT – the fact that the trader knew or should have known that a transactions was more likely than not to be connected with the fraudulent evasion of VAT would not be sufficient.

Accordingly, the Court held that to give a follower notice, HMRC must be of the opinion that the principles or reasoning in the ruling in question would deny the advantage, not merely that they would be more likely than not to do so, and this implied a substantial degree of confidence in the outcome.

Misdirection by HMRC

On this basis, in Haworth, HMRC had misdirected themselves.

First, because they had proceeded on the basis that the Court of Appeal in Smallwood had held that the place of effective management was in the UK, when the court had actually said no more than that the Special Commissioners had been entitled to arrive at that conclusion on the facts of that case.  HMRC had therefore overstated what Smallwood had decided and so had misdirected themselves.

Second, HMRC made a further misdirection by proceeding on the basis that Smallwood would be likely to deny the advantage if the same facts were present, instead of correctly asking whether the principles or reasoning in Smallwood would deny Mr Haworth the tax advantage.

As a result of these misdirections, the Court of Appeal quashed the follower notice and the accelerated payment notice that was based on it.

Human Rights Act?

The Court of Appeal’s decision is noteworthy in not mentioning the Human Rights Act and its application to follower notices.  In the court below at [2018] STC 1326, Sir Ross Cranston had held that a follower notice did not by itself interfere with the taxpayer’s possessions, and even if it did, it had a legitimate aim and was proportionate so that there was no interference with the taxpayer’s rights under article 1 of the First Protocol.  It appears that this argument was not raised in the Court of Appeal, but it is interesting that the judges expressly referred to the draconian powers conferred on HMRC and that they should be carefully circumscribed, not least because of their impact on access to the courts and the rule of law: see for example, Cross LJ at [66].  It may be that in time the application of the Human Rights Act to follower notices will be considered in depth, and a judgment given by the ECHR.

[1] Kittel v Belgium; Belgium v Recolta Recycling SPRL [2008] STC 1537.