Relying on HMRC’s guidance – is it safe to do so?

R. (on the application of Aozora GMAC Investment Ltd) v HMRC [2019] EWCA Civ 1643

In this case, HMRC had refused to grant a UK company (Aozora UK) unilateral credit relief under the Income and Corporation Taxes Act 1998 s.790, even though a statement in HMRC’s international tax manual stated that such relief would be available. Aozora UK challenged HMRC’s decision by bringing a judicial review claim to the High Court, arguing that it had a legitimate expectation that it would receive the relief, despite the statement in HMRC’s manual being incorrect. Both the High Court and the Court of Appeal (Court) upheld HMRC’s refusal of the relief.

Background to the case

Aozora UK provided loans to its wholly-owned US subsidiary (Aozora US), and received interest payments in respect of those loans. On the face of it, those interest payments were taxable in both the UK and the USA. However, Aozora UK wished to deduct the amount of tax it paid in the USA from the amount of tax it owed in the UK by claiming the benefit of a unilateral credit relief. HMRC refused to allow the relief, even though its manual contained a statement (which was in fact incorrect) saying the relief would be available.

Upon considering the case, the Court held that Aozora UK did not have an enforceable legitimate expectation arising from HMRC’s incorrect statement.

Was there a clear representation by HMRC?

Given that HMRC’s essential function is to enforce the law correctly, the first question for the Court was whether a representation by HMRC could ever give rise to a legitimate expectation that HMRC would keep to that representation, in circumstances where it meant misapplying the law. The Court confirmed that, where HMRC’s guidance contains “a clear and unambiguous representation”, devoid of relevant qualification, taxpayers are entitled to rely on it; they would have a legitimate expectation that HMRC would act in accordance with its stated position. 

In rejecting HMRC’s arguments on this point, Lady Justice Rose noted that “I do not accept the contention that because the ordinarily sophisticated taxpayer knows that HMRC apply the law but do not make the law, there can never be a legitimate expectation arising from a statement by HMRC in published guidance as to what the law is.”

Having established that it is possible for HMRC to make a statement that gives rise to a legitimate expectation, the Court then considered whether HMRC had, in fact, done so.

The Court determined that the representation in question was sufficiently clear and unambiguous to give rise to a legitimate expectation that it would be followed.

The statement in HMRC’s manual was not correct because it did not distinguish between express provisions in the US/UK Double Tax Treaty (where the statement was accurate) and, as was the case here, provisions implied by domestic statute (where it was not). However, the ordinarily sophisticated taxpayer would not have appreciated that there was such a distinction.

Further, the broader caveats contained in HMRC’s manual, which warn readers that representations in the manual cannot be relied upon for tax avoidance, were not in issue here.

Legitimate expectation - when can HMRC resile from its representation?

Having determined that HMRC’s representation was clear and unambiguous, the Court then had to consider whether it had given rise to a legitimate expectation. Lord Kerr’s explanation of legitimate expectations in the case of In the matter of an application by Geraldine Funicane for Judicial Review (Northern Ireland) [2019] UKSC 7 summarises the position: “where a clear and unambiguous undertaking has been made, the authority giving the undertaking will not be allowed to depart from it unless it is shown that it is fair to do so”.

When will it be fair to depart from the undertaking?

The court is the arbiter of fairness, but how does it reach such a decision?

The Court cited the test set out in R (Hely-Hutchinson) v HMRC [2017] EWCA Civ 1075, [2018] 1 WLR 1682, where it was held that “if HMRC finds that they need to resile from guidance, a taxpayer can only rely on the legitimate expectation that the guidance created where, having regard to the legitimate expectation, it would be so unfair as to amount to an abuse of power”.

The Court explained that Aozora UK had to show it would suffer a “high degree” of unfairness, because HMRC’s primary duty was to collect and not to forgive taxation. There is a profound public interest in HMRC’s collection of taxation and a high degree of unfairness to the individual taxpayer is therefore necessary to override that public interest.

An important factor in assessing whether it would be unfair to allow HMRC to resile from its representation is if the taxpayer relied on HMRC’s representation to its detriment. 

What amounts to reliance?

The Court confirmed that, if the taxpayer is not aware of HMRC’s incorrect guidance, or only becomes aware of it after committing to the transaction or course of action giving rise to the tax dispute then, clearly, it cannot be said that the taxpayer relied on it and it will be difficult to sustain the argument that HMRC should be held to it. The question of whether Aozora UK had relied on HMRC’s representation was therefore central to determining whether it would be unfair to allow HMRC to depart from that representation.

Aozora UK had benefited from independent advice from a specialist firm of accountants when setting up the structure pursuant to which it loaned funds to Aozora US in return for interest payments. One of the questions before the courts was therefore whether obtaining advice from independent tax specialists automatically prevented Aozora UK from relying on HMRC’s guidance (because they were relying, not on HMRC statement, but on the expertise of their advisors).

The judge at first instance concluded that the fact that Aozora UK had obtained specialist tax advice meant it could not have relied on HMRC’s representation.

The Court did not agree and said that it “could not accept the … view that recourse to an outside specialist adviser rules out reliance”.

The Court of Appeal’s decision

Although the Court accepted that advice from a tax specialist did not preclude reliance on a statement by HMRC, it was necessary to consider whether it was fair to say that the taxpayer did actually rely on HMRC’s statement.

Critical to that question was the type of statement that HMRC had made. The Court noted that, in general terms, there are two categories of representations that HMRC may make when discussing statute in its manual.

• The first is a statement as to what HMRC thinks the law means; it is HMRC’s opinion on the legal position.
• The second goes beyond a mere expression of HMRC’s opinion, and is an explanation as to how HMRC will apply statute in practice where the language is inherently uncertain. For example, where statute says something must be done in “reasonable time”, HMRC may explain the criteria by which it will apply the concept of “reasonable time” in practice.

In making a statement in the second category, HMRC is in a uniquely privileged position because, as the tax authority tasked with applying the law, it can say how it will do so. No tax adviser can say with certainty how HMRC will apply uncertain elements of statute in a practical context.

This differs from the first category because tax advisers are as well placed as HMRC to interpret the law. 

The Court held that the statement in question fell into the first category – it was HMRC’s opinion as to the current legal position. As a result, on the facts, the Court concluded that Aozora UK’s reliance on HMRC’s representation was “weak” because the representation in this case, although clear, unambiguous and unqualified, was merely HMRC’s opinion on how the law should be interpreted.

The Court accepted that HMRC can be considered to bring considerable expertise when interpreting tax statute. However, in this instance, HMRC and the tax adviser were both equally well placed to consider the statute and determine its applicability to Aozora UK’s circumstances. It was not the case that HMRC had a unique advantage over the tax adviser, as would be the case if the issue was the criteria by which HMRC would apply uncertain statutory language. The tax adviser was encouraged to come to its own conclusion about how the law would apply to their client and not merely to repeat HMRC’s own guidance.

Having determined that the appellant’s reliance on HMRC’s representation was weak, the Court then considered whether it would nevertheless be unfair to allow HMRC to resile from its representation. This involved assessing the detriment which Aozora UK had suffered from HMRC’s refusal to allow it credit relief.

The Court concluded that Aozora UK had not shown that it would not have entered into the transaction with Aozora US had it known that the credit relief would not be available. As such, Aozora UK had not suffered serious detriment. Due to the weak reliance on the representation and the limited degree of detriment suffered, the Court held that the high degree of unfairness required for it to intervene and protect a legitimate expectation had not been met.

The Cobalt case – further application of the principle of legitimate expectation

Macfarlanes LLP recently acted for the appellants in R (on the application of Cobalt Data Centre 2 LLP and Cobalt Data Centre 3 LLP) v HMRC [2019] UKUT 0342 (TCC). 

In that case, the Upper Tax Tribunal upheld a claim by the taxpayers that HMRC could not resile from statements that had been made in the mid-1990s regarding developments in Enterprise Zones.

The taxpayer argued that HMRC’s statements established a blueprint according to which developments in Enterprise Zones should be carried out in order to obtain Enterprise Zone Allowances. It was argued that HMRC’s statements were clear and unequivocal and, indeed, the very intention was for them to be relied upon. As a result, taxpayers had a legitimate expectation that, if they followed this blueprint, the tax rules would be applied by HMRC in accordance with HMRC’s statements. 

In Cobalt, the Tribunal held that the statements on which the taxpayers relied amounted to HMRC’s “confirmation as to how the law would be applied in an area where its application was open to debate”. 

HMRC’s statements addressed issues including how developments should be undertaken and the appropriate value of developments for tax purposes. These were inherently practical points regarding how HMRC would approach Enterprise Zone developments and the processes HMRC would adopt in determining whether allowances would be given. 

Although the recent decision in Aozora had not been issued when the Cobalt case was heard, the statements in question in Cobalt were effectively second category statements. That is, they are more than a mere expression of opinion but are instead an explanation of how HMRC will apply the relevant legislation.

There had not been a change in the law and HMRC had not simply got the law wrong. Rather, HMRC had changed its mind about how it would practically implement the legislation, contrary to a practice it had followed for many years since the 1990s.

In the Aozora case, Aozora UK had not been able to satisfy the Court that it had relied on HMRC’s statement to its detriment. However, in Cobalt, it was clear that the taxpayer had satisfied its burden in showing a clear and unequivocal representation on which it relied to its detriment. Having shown that degree of unfairness, the Tribunal held there was “no good, proportionate reason why HMRC should be permitted to resile from their guidance” and the appellants’ legitimate expectation was upheld.

Concluding points

Although the judgment in the Aozora case helpfully confirms that there will be circumstances in which HMRC’s guidance can give rise to a legitimate expectation, it is also clear that the scenarios in which a taxpayer will be able to bring a successful claim for a breach of that legitimate expectation are limited, reflecting a general reluctance to make decisions which are contrary to the public interest in enabling HMRC to collect taxes within its legal parameters.

Engaging independent tax advisers will not necessarily be fatal to a taxpayer’s claim based on legitimate expectation. In particular, as in Cobalt, it may be possible to establish a legitimate expectation where the statement on which the taxpayer seeks to rely constitutes an explanation by HMRC as to how it will apply legislation in practice, i.e. a statement in the second category set out above. 

However, in many circumstances (in particular, where the statement falls within the first category set out above), the court will consider the tax adviser to be just as well placed to arrive at the correct interpretation of the law as HMRC, and so reliance may be hard to demonstrate. 

Taxpayers and their advisors should therefore be aware of this risk and will need to consider what guidance they are relying on, why they are relying on it and what would be the consequences if that guidance were withdrawn or found to be incorrect. In the event that HMRC guidance is used as a basis for taking a certain course of action, it will be crucial to demonstrate that each of the conditions for relying on that guidance can be satisfied. This will likely include retaining contemporaneous evidence that can show detrimental reliance and unfairness in the event that HMRC attempts to resile from the guidance in the future.