Case review: Phillip & Debra Cox

Introduction

This is an application by the taxpayers for permission to appeal against an FTT decision regarding conditions for penalty suspension.

The UT considered the FTT’s analysis regarding when and on what basis careless penalties can be suspended in cases where the transaction(s) resulting in the errors was unlikely to be repeated. It also considered HMRC’s use of discretion and the meaning of the tax legislation (FA 2007, Sch 24 (14)) in relation to suspension of penalties.

The FTT had decided that HMRC’s guidance did not constitute overreach of its powers and that the department was correct in its analysis that in this particular case, suspension of penalties was inappropriate. The UT dismissed the taxpayers’ appeal though it did not agree with the entirety of the FTT’s decision.

What was the case about?

The taxpayers were shareholders in company and they intended to sell their shares to other existing shareholders. Both taxpayers had over 6% shares in the company and initially intended to sell the shares in one tranche. The 5% minimum share requirement and all other conditions being met, the transaction was eligible for Entrepreneurs’ Relief (ER). The taxpayers obtained written advice to this end.

In reality, the shares were disposed of in two tranches. The first was a gift, which took each taxpayers’ shareholding below the 5% threshold. The second transaction disposed of the remainder of the shares. The taxpayers claimed ER on both disposals (though no written advice was obtained). HMRC opened enquiries, disallowing ER on the basis that the 5% threshold was not met and applying careless penalties.

Finance Act 2007, Schedule 24, paragraph 14(3) states in reference to careless penalties that “HMRC may suspend all or part of a penalty only if compliance with condition of suspension would help P to avoid becoming liable to further penalties … for careless inaccuracy.”

The taxpayers first proposed penalty suspension condition was “[the taxpayers] always appoint separate Advisers dedicated to their particular circumstances and, secondly, that any advice given at client meetings is always confirmed in writing.” HMRC refused on the basis that

• it “cannot see any future careless error(s) that could be avoided by setting a suspension condition in this case”;
• the suggested condition was contingent on another event (e.g. share sale) which may not occur; and
• the suggested condition was in any case the minimum required of a reasonable taxpayer.

The taxpayers then suggested an alternative condition that “each year, with immediate effect, our client should have a formal minuted, in-person meeting with a partner in this firm specifically to review each entry on the return before the return is submitted.”

HMRC refused on the same grounds as previously and the case went before the FTT. The FTT is only required to consider whether HMRC’s decision was flawed in respect of judicial review principles¹ (FA 2007, Sch 24(17(6))).The FTT determined that:

• the condition for suspension proposed by the taxpayers was no more than a basic requirement
• even if this conclusion was incorrect, HMRC’s exercise of its discretion was not flawed;
• there should be a link between the type of inaccuracy for which the penalty had been levied and the inaccuracy that might result in future penalties. The purpose of the legislation is to encourage taxpayers to change their behaviour to reduce future carelessness and the link between the event and behaviour that resulted in the error is relevant; and
• A one-off error would not normally be suitable for a suspended penalty.

The taxpayers appealed on four grounds, that the FTT:

1. “was wrong to conclude … that HMRC had not unreasonably fettered their discretion in following the rule that a penalty cannot be suspended where it is not possible to set conditions because a similar inaccuracy is unlikely to happen in the future”..;
2. “erred in concluding that there must … be a link between the type of inaccuracy giving rise to the penalty and any future inaccuracies, and therefore that a “one-off” error would not be suitable for a suspended penalty”;
3. “was wrong to conclude that HMRC had not unreasonably fettered their discretion by applying the SMART² criteria (insofar as these criteria are deemed to exclude the possibility of suspension in cases of one-off inaccuracies).”
4. “erred in applying the rule that the conditions applied must amount to more than “the actions of a reasonable and prudent taxpayer” … and in concluding that the proposed conditions for suspension were inappropriate as they were “no more than a basic requirement” … that future returns should be free from careless inaccuracies”.

What did the UT decide?

Grounds 1 and 3

The UT agreed that paragraph 14 does not require there to be a link between the existing penalties (or inaccuracy that led to them) and ‘further penalties’ (or inaccuracies that lead to them) but also said that the FTT did not assert this when coming to their conclusions. The UT also highlighted that this does not mean that there is “no link” between the existing inaccuracy or a possible future one.

Although the FTT may have erred in law in agreeing that there must be a link between the two, this was not the basis of HMRC’s refusal and therefore is not material to the FTT’s conclusion that HMRC’s decision was not flawed.

In respect of the SMART criteria that HMRC apply, the UT concluded that they do not exclude the possibility of suspension in one-off cases. The FTT had not found this was the case and had concluded that HMRC had not taken a rigid approach to the guidelines.

Ground 2

The UT reiterated the point at Ground 1 above, that the legislation does not require a link between existing and potential penalties. The FTT erred in law in stating that there is an implied link. The FTT stated that a ‘one-off’ error “would not normally be suitable” for a suspended penalty, however the UT concluded that it would be more correct to say that “suspension is not automatically precluded where the careless inaccuracy which has resulted in a penalty is a one-off event”.

Although the FTT made errors in coming to the above conclusions, the UT considered that the errors were not material as it was not “satisfied that it might have made a difference to the outcome”.

The salient point was that the “FTT found that HMRC had not adopted a rigid approach and had not decided that the one-off event automatically precluded suspension.” The appellants had not been given permission to appeal this conclusion.

Ground 4

The UT found that the FTT had made an error in law when concluding that the second proposed condition was no more than a ‘basic requirement’ and that in appropriate cases, this could be a valid condition for suspension.In this particular case however, where the taxpayers had a record of filing correct returns and the process in place worked well, it was difficult to see how the condition would improve the taxpayers’ behaviour and preclude future errors from arising.

Accordingly, the UT agreed that this situation is one where no appropriate condition can be specified, rather than one where HMRC had unreasonably rejected a particular proposal.

What are the key takeaways for tax advisers and their clients?

The legislation for penalty suspension is to encourage taxpayers to improve ‘behaviour’ in respect of their tax affairs.

For clients who make one-off careless errors and otherwise have no weakness in their record keeping or tax affairs, it may be difficult to identify conditions to suspend the penalties.

However, an error relating to a one-off transaction does not automatically mean penalties cannot be suspended. The key is to identify the failing(s) that led to the error and consider whether this could lead to another penalty in future, albeit unrelated to the transaction in question. If this weakness exists, SMART criteria for resolving the failing can be applied to suspend the penalty.

Footnotes:

1. principles applicable to Judicial Review, i.e. that the decision process was flawed, or that it was “so unreasonable that no reasonable authority could ever have come to it.”
2. Specific, Measurable, Achievable, Realistic and Time bound

Share: