Analysis
This was the conjoined appeal of two taxpayers against penalty determinations issued against them by HMRC. The taxpayers, who were both business people who held directorships in a number of UK companies, had realised capital gains on the disposal of an entity known as Efforsenrab Ltd and land and buildings in Essex in the UK. They participated in a capital redemption policy scheme and claimed a capital loss arising from that scheme to be set against the capital gains which they had realised. They both signed a professional services agreement with a tax adviser under which it agreed to provide tax advice in respect of UK capital gains tax and the acquisition of a capital redemption policy to generate the loss. The capital redemption scheme was not effective, the taxpayers attempted to conclude a negotiated settlement with HMRC and the full amount of the tax and interest due was paid in July 2009. In 2012 HMRC issued penalty determinations against the taxpayers for the relevant tax year for negligently delivering an incorrect return. The taxpayers appealed against those penalties.
The taxpayers argued that they had included all the information which was considered relevant to the capital losses claimed in their tax returns on the basis of advice by their professional advisers and none of their actions could be considered negligent. HMRC had been given all the relevant information and had every opportunity to raise enquiries into the returns. The test to be applied was what a reasonable taxpayer exercising due diligence in the completion and submission of the return would have done. In the context of a packaged scheme, the taxpayers had no alternative but to rely on their adviser to implement the transactions on their behalf and could not be expected to carry out any due diligence on the implementation of the scheme themselves. The taxpayers had properly relied on professional advice and so could not be treated as negligent. Further the taxpayers were diligent in responding to HMRC queries and cooperated fully when asked to give further information about the scheme, suggesting they were reasonable and would not have acted in a negligent way in completing their tax returns.
HMRC argued that the penalties were due because the taxpayers were negligent in failing to enquire into the commercial reality of the acquisition of the capital redemption policies and their subsequent sale. The scheme documentation was flawed, contained glaring omissions and did not demonstrate that the transaction portrayed was actually carried out, or not in the way described in the documents and the taxpayers should have been aware of this. There was no evidence available to the taxpayers that the transactions described in the documents actually took place or that some of the documents could have been signed at the time when they were purported to have been signed. The transaction was a sham and the taxpayers should have been aware of this and not put in a tax return on this basis without doing further investigation. Failure to establish the commercial reality was failure to take reasonable care. The taxpayers had a duty of care to ensure that entries in their tax returns were correct. Both taxpayers were business people who understood complex contractual issues and should have been in a position to establish that the entries on their tax returns reflected what actually occurred. Accordingly, the taxpayers had been negligent.
Held, dismissing the appeal but decreasing the amount of the penalties due to mitigation:
- 1) An innocent error can amount to negligence but ignorance of technical areas of law does not amount to negligence.
- 2) A taxpayer is entitled to rely on technical advice but the circumstances in which advice is given is important.
- 3) Entering into a packaged avoidance scheme is not in itself a negligent act and the taxpayers should not be expected to understand the legal and tax implications of the trust arrangements and the capital redemption policy acquisition and redemption, the order in which documents needed to be signed, or the basis on which HMRC might argue that the transactions should not be respected for tax purposes. Those were matters in relation to which a reasonable taxpayer might properly be expected to rely on its professional advisers.
- 4) In the present case, the taxpayers were not negligent in not understanding the details of the acquisition and disposal of the capital redemption policies, the timing of the signing of the relevant documents or how the tax losses were actually being generated. The test to be applied was what a reasonable taxpayer exercising reasonable due diligence would have done. In defining what was meant by a ‘reasonable taxpayer’ the comparator here was with a taxpayer who was knowingly buying into a packaged avoidance scheme. The level of due diligence required of a taxpayer in respect of the technical and legal aspects of a packaged scheme in which advice had been provided by professional advisers and all documents have been drafted by them is low where the relevant areas of law are technical.
- 5) However the taxpayers were negligent in signing their tax returns reflecting transactions which had relied on significant levels of financing which they had no evidence had ever been advanced or repaid. No statements or advice from their professional advisers could or should remove the obligation on a taxpayer to consider whether the proposed transactions stand up to some basic commercial scrutiny. The question here was whether it was reasonable for a relatively sophisticated investor who knew that a loan was required for the purchase of a scheme to rely on low-level advice from its advisers (and to complete his tax return relying on their assurances) in order to be satisfied that this did not require any entries on the taxpayers’ bank accounts, let alone any actual movement of cash, on the premise that this was a packaged scheme to which the normal commercial rules did not apply. The question of whether the financing to make the acquisitions on which the transactions relied had actually been put in place was one of those elements which a taxpayer should understand. It was not accepted that, even in the circumstances of a packaged transaction, it was reasonable for the taxpayers to have done no basic due diligence in respect of the payment flows or to ascertain whether a loan had in fact been made and to have acted on so little in the way of advice. So fundamental a question as to whether the financing had actually been provided to the taxpayers to enable the acquisition of the capital redemption policies was something which was reasonable to expect a taxpayer to ascertain for themselves and not something for which reliance could be placed solely on their advisers. Failure to enquire into the basic commercial reality of the transactions entered into by the taxpayers was negligence for these purposes and a reasonable taxpayer, including one prepared to enter into a packaged scheme like this, would have ensured that the commercial elements of the transaction, including the loan in particular, stood up to some commercial scrutiny and had been properly implemented. The taxpayers should not have claimed the capital losses on their tax return without at least some understanding that an actual transaction had been entered into, that some money had moved and that the transaction was not a sham.
- 6) The fact that the taxpayers were advised that it was a notifiable transaction under the Finance Act 2004 rules which required specific disclosure on their own tax returns and that the taxpayers had made this disclosure did not make any difference to the analysis.
- 7) The level of co-operation demonstrated by the taxpayers during the enquiry was not relevant to the question of whether the tax return was completed negligently, that test had to be applied at the time when the returns were made and any later actions could not retrospectively colour the taxpayers’ activities at the time.
8) However, the penalty reduction awarded by HMRC for disclosure in returns should be increased as the taxpayers did make full disclosure in their tax returns. Further the reduction for co-operation and seriousness should be the same for both taxpayers, the cases being factually identical.
Judgment JUDGE RACHEL SHORT: [1] This is an appeal against a penalty of £35,069.50 for Mr Litman and £23,629.20 for Mrs Newall determined under s95(1)(a) Taxes Management Act 1970 (TMA) being 25% of the tax payable in respect of Mr Litman and being 20% of the tax payable for Mrs Newall for the 2004/5 tax …Continue reading "Litman & anr v HMRC [2014] UKFTT 089 (TC)"