Private client review for January
This month, we examine several recent case decisions, starting with a challenge to the validity of the loan charge legislation (the "no score draw" in Labeikis). There have been two recent tribunal decisions on entrepreneurs’ relief: Thomson (in which relief was available for a disposal that was found to be part of the wider business asset sale) and Allam (with insight on the test for trading activities). HMRC has also been defeated on deductibility of expenses for legal fees (Rogers) and penalties where the taxpayer had relied on the advice of her tax return preparer (Quinn).
Challenging legislation: justice delayed is justice denied?
When HMRC seeks to triage the reasons why the government may not have successfully levied a certain amount of tax, it uses the potentially loaded term "behaviour". The tax gap statistics reveal that the second largest slice on the pie chart after the behaviour termed carelessness is lumped under the heading "legal interpretation", in other words a divergence of opinion on the application of the law to the facts resulting in an outcome unfavourable to HMRC, but which does not involve avoidance. HMRC estimate its losses here at £5.8bn or 16% of theoretical losses (or under 1% of theoretical liabilities). It is worth noting in passing that "evasion" is pushed into third place at 15%, whilst "avoidance" languishes at the bottom of the chart at 4%.
This may explain a new trend, starting with the announcement in the Budget papers that the government proposes to reverse the results of certain court decisions with which HMRC disagreed (see also review in Tax Journal, 19 November), an early foray into the realms of the new annual "Interpretation Bill" idea which has received some adverse comment. HMRC’s disagreements with the judiciary look to be far from over if the High Court decision in Labeikis and ors v HMRC  EWHC 3237 (QB) is anything to go by. Labeikis is unusual because cases founded on tax normally need to be taken through the tax tribunals and require an executive act which the taxpayers want to challenge.
In Labeikis, the taxpayers had nothing concrete to contest: no assessments had been made. The taxpayers, however, are potential objects of HMRC’s attack under the loan charge legislation; their claim was that this is invalid as being incompatible with EU law (the claims were filed just prior to the UK’s exit from the EU), both constitutionally and in the human rights field (the only real grounds to challenge a law passed by Parliament). HMRC rejected the European and human rights law angles: the taxpayers would have an effective remedy in the tax tribunals (eventually), if assessed. The taxpayers contended that they (a) remained in limbo until HMRC assessed and (b) could put themselves in a difficult position potentially indefinitely if HMRC chose to delay assessment or enforcement action. In a detailed judgment, Master Dagnall concluded that the High Court (exceptionally) did have jurisdiction to hear the claim, albeit it arguably should have been brought by way of judicial review.
So, the case counts as something of a "no score draw" with HMRC broadly losing the jurisdiction argument and the taxpayers finding themselves stayed and told to go for judicial review. The tax exclusivity of the tax tribunals has been found to be leaky, but, tempting as it is to re-label this "behaviour" as "HMRC got the law wrong", note that the issue about the loan charge rules remains undecided.
Protected sale qualifies for entrepreneurs’ relief
In Thomson v HMRC  UKFTT 453, the First-tier Tribunal (FTT) allowed an appeal regarding the availability of entrepreneurs’ relief (ER) on the disposal of office premises held by a partnership in which Thomson (T) was a partner. Between 1996 and 2017, T undertook a protracted retirement from his accountancy partnership, with his profit entitlement decreasing from 99.9% in 1996 to 20% in 2017/18. There was no specific documentation of this transfer and the process took much longer than anticipated. In 2017, the partnership disposed of its office premises, and T claimed ER in his 2017/18 tax return. HMRC subsequently rejected the claim, arguing T had not made a disposal of business assets within TCGA 1992 s 169I(1)(a). Section 169I(8) applies the provisions to partnerships; it confirms that ER can apply to part disposals. HMRC argued that T had only sold the building premises, i.e. only one of the partnership’s assets. HMRC accepted that separate disposals in different tax years could be a disposal of the whole or part of a business, but that the long-winded nature of the transfer did not justify treating this as one transaction. T argued that the conditions for ER were satisfied since the property was sold as part of the retirement process, so constituted part of the wider business asset sale.
The FTT found T’s evidence compelling and it was not disputed by HMRC. It allowed the appeal, finding that the conditions for ER do not have any time limits imposed by the legislation, so its availability depends on the facts. Nonetheless, the FTT confirmed that the disposal of a single asset, without the disposal of other assets, would not satisfy the conditions for ER.
The case is a win for the taxpayer, but it demonstrates that, in situations involving a protracted sale, it is sensible for taxpayers to document the transaction so as to reduce the risk of challenge by HMRC.
Trading activities test
Allam v HMRC  UKUT 291 (TCC) is an appeal from a 2020 FTT judgment concerning a number of close companies controlled by the taxpayer (in some cases with his wife). He undertook a series of transactions involving a group reorganisation and claimed ER in respect of the share disposal. Separately, he claimed business investment relief (BIR) on loans of unremitted income and gains to a UK company in respect of a football club investment.
HMRC denied the claims for ER and BIR, and it issued a transactions in securities (TIS) counteraction notice on the basis that the taxpayer had obtained an income tax advantage and that advantage was the main or one of the main purposes of the transaction. The FTT dismissed the appeals against the closure notices denying ER and withdrawing BIR, but allowed the appeal against the TIS counteraction.
On appeal, the Upper Tribunal (UT) concluded that the FTT had not erred in deciding that the taxpayer’s personal company was not a trading company for ER purposes because its activities were not substantially trading activities, so ER was not available.
The UT held that HMRC was entitled to withdraw BIR as the taxpayer’s actions were a part disposal of a qualifying investment (and, therefore, a "potentially chargeable event") in respect of which the taxpayer had failed to take appropriate mitigating steps within the permitted grace period (45 days). As a result, the funds were treated as remitted to the UK at the end of that period.
However, the UT found that a main purpose of the taxpayer’s involvement with the transaction had not been to obtain an income tax advantage. The availability of alternative structuring methods with different tax consequences did not necessarily mean that the transaction was implemented for the main purpose of avoiding income tax; HMRC had not provided other evidence of the taxpayer’s intention to avoid income tax.
In the context of ER, it was not appropriate to apply any sort of numerical threshold (as HMRC’s guidance does) in determining whether or not activities are, to a substantial extent, trading activities, and the UT endorsed the FTT’s view that, in this context, "substantial" should be "taken to mean of material or real importance in the context of the activities of the company as a whole".
Legal expenses were deductible
In Rogers v HMRC  UKFTT 458 (TC), the FTT found – on the basis that a conviction would have made it impossible for the partnership to continue trading – that legal expenses in excess of £500,000 which were incurred by a partnership in defending criminal charges against two partners were incurred wholly and exclusively for the purpose of the partnership’s trade.
The partnership ran a scrap metal business. Following a police operation which involved undercover police officers attempting to sell property that was implied to be stolen, criminal charges were brought against two of its partners. One partner was found guilty but acquitted on appeal, the other was found not guilty.
ITTOIA 2005 s 34 denies a deduction from trading profits where expenses are not incurred wholly and exclusively for the purposes of the trade. Although accepting that an element of the fees was incurred in defence of trade, HMRC disallowed the legal fees incurred in defending the criminal charges under this head because they considered that the fees were also incurred to protect the partners’ personal reputations and prevent custodial sentences.
The FTT found in favour of the partnership on the basis that:
- a conviction would have made it impossible for the partnership to continue trading. In particular, if one of the partners had been convicted, it was likely that the partnership would have had its licence to trade and its banking services withdrawn, its lease terminated and have become uninsurable;
- given that the partner had been advised that he was unlikely to go to prison, the FTT rejected HMRC’s argument that the partners were concerned about losing their liberty; and
- most of the damage to the partners’ personal reputation was caused by the press coverage of the police operation, so the FTT also rejected HMRC’s argument that the partners were incurring the fees to prevent damage to their personal reputation. As such, any positive impact on the personal reputation of the partners was an effect of the legal fees being incurred rather than a reason for the expenditure.
The FTT noted that, if a custodial sentence had been contemplated, the taxpayer could not have been indifferent to it and as a result, the professional fees for the defence of criminal charges would not have been incurred wholly and exclusively for the purposes of their trade.
Careless not deliberate
In Quinns and Queen-Rose Green v HMRC  UKFTT 454 (TC), the FTT has partly allowed appeals against HMRC assessments and penalties because the appellant’s behaviour was careless, not deliberate, where the taxpayer relied absolutely on their accountant.
The second appellant was a shareholder and director of the first appellant and approved its tax returns (prepared by an accountant). HMRC issued closure notices, discovery assessments and penalty assessments to both appellants because of numerous mistakes in the returns, which HMRC considered were brought about deliberately.
The FTT agreed with HMRC that (among other errors):
- the first appellant had claimed deductions for expenses where there was no evidence of payment and for expenditure on properties that it did not own (and which were personally owned by the second appellant); and
- the second appellant had claimed losses for rental properties that were not available to rent (although this had been pointed out to the accountant, who said it was right to include them) and had under-declared rental and employment income.
Applying the principles from Auxilium Project Management Ltd v HMRC  UKFTT 249 (i.e. the test is subjective) and Clynes v HMRC  UKFTT 369 (i.e. an inaccuracy can be deliberate if the taxpayer intentionally chooses not to determine the correct position), the FTT concluded that the second appellant’s lack of understanding of the business structure, ignorance of the law and reliance on the accountant meant that her conduct could not be described as deliberate.
The discovery assessments for two of the tax years in question were therefore out of time and the related penalties should be cancelled. However, while HMRC could not assess the lost tax because those discovery assessments were out of time and so invalid, HMRC could rely on the conclusions arising from them to deny the losses that the appellants sought to carry forward to subsequent periods.
The penalties for the in-time assessments had to be recalculated based on careless conduct, which significantly reduced the penalties from 70% less a 5% discount to 29.25% (for the first appellant) and 30% (for the second appellant).
Another "no score draw", this case is a reminder of the implications of a taxpayer failing to take responsibility for their tax affairs: absolute reliance on accountants may help reduce the potential penalties but it is not a "get out of jail free" card.
This article was first published in the Tax Journal.