Contentious Tax: 2023 mid-year review

This article was originally published in Tax Journal on 14 July 2023 and is reproduced with permission from the publisher.

The year started with the House of Commons Public Accounts Committee (PAC) hearing live evidence from senior HMRC officials for the purposes of preparing their report on managing tax compliance following the pandemic, which was duly released on 3 May 2023.

 

PAC report

The PAC report was prepared against a backdrop of a GBP9bn reduction in HMRC's 'compliance yield' (essentially the amount of tax collected in addition to that paid voluntarily by taxpayers, resulting from HMRC's compliance activities or interventions) during the pandemic (FYs 2020/21 and 2021/22); and around 1,000 less criminal prosecutions, compared to pre-pandemic levels.

The PAC report's recommendations for HMRC include learning from the experience of staffing challenges in the pandemic and specifying how it can respond more quickly where it looks likely compliance work will not keep pace with levels of non-compliance; developing a better understanding of the deterrent effect of its compliance work (including prosecutions); setting a clear target of the compliance yield required to make up the shortfall during the pandemic; and ensuring it is providing sufficient support to taxpayers (big and small) who want to pay their tax.

The 2023 HMRC Charter annual report is due imminently and it will be interesting to see if any of the recommendations feature within the report. HMRC's Charter pledges to treat taxpayers fairly, such that HMRC will work within the law to make sure everyone pays the right amount of tax. In the 2022 HMRC Charter annual report, Jim Harra, HMRC's chief executive and permanent secretary, stated: 'Going into financial year 2022 to 2023, I don't underestimate the challenges and uncertainties ahead of us in the current economic and political environment. To successfully navigate these, it's vital that we maintain public trust and work hard to provide a supportive customer experience.'

Mr Harra's words remain equally pertinent one year on. Given resourcing constraints, HMRC service levels are often a cause for complaint among taxpayers and two recent developments will not inspire confidence that material improvement is on the horizon. 

First, HMRC announced last month that from 12 June 2023 it will close the self-assessment helpline for three months (with taxpayers directed to use its digital services instead) to redeploy resources elsewhere: an indicator that HMRC are finding it extremely difficult to keep pace with demand.

Secondly, on the same day that the helpline closed, the National Audit Office reported that the repeated delays and rephasing of Making Tax Digital have undermined the programme's credibility and increased its costs – some five times the original forecast in 2016 (in real terms) – and that further robust business plans were required if value for money was to be achieved from the remaining spend (forecast at GBP620m in March 2023).

 

Transfer pricing

Earlier this year, HMRC published its transfer pricing and diverted profits tax (DPT) statistics for 2021/22.

These will be of interest to many multinational groups who, as part of their transfer pricing considerations, face the question of whether to seek to obtain an advanced pricing agreement (APA) on their cross-border arrangements. The average time to reach an APA in the UK peaked at 58.3 months or nearly five years. This could be explained, at least in part, by the UK's preference to seek to agree bilateral or multilateral agreements with other tax authorities. Whether an APA is the right option will need to be carefully considered, and for many businesses it will be. In this regard, it is noteworthy that the number of APA applications made during 2021/22 (40) is a significant increase compared to previous years.

Mutual agreement procedure (MAP) showed a more positive outlook in 2021/22 with 131 cases being resolved and the average time to resolve a MAP case reducing from 34.4 months in 2020/21 to 21.1 months in 2021/22. With around 100 new cases being admitted per year however, to ensure as efficient a process as possible, it will still be important for businesses to provide a robust methodology supporting their technical position and complete information and responses to the competent authority in a timely manner and to follow-up on progress.

The statistics also showed a further 26 cases having been resolved through the profit diversion compliance facility (PDCF), introduced in January 2019, as a disclosure facility to enable MNEs to bring their UK tax affairs up to date. Feedback obtained (from independent market research commissioned by HMRC) found that businesses preferred to use the PDCF, rather than risk an HMRC enquiry and the majority felt it was an effective approach to resolving tax uncertainty because the business was driving the investigation and reporting.

Finally, the same market research also sought views from businesses concerning the DPT enquiry process. DPT was introduced by FA 2015 to encourage companies using contrived arrangements intended to reduce UK profits to pay additional tax, or risk being hit with a higher rate (increasing this year to 31% following the main rate for corporation tax rising to 25%). The feedback from businesses was mixed, with around half feeling that the HMRC evidence gathering process was targeted and focused but with a similar number feeling that it was unfocused and exhaustive. Further, the majority suggested that there was room for improvement by HMRC in how the enquiry had been conducted. Note that, HMRC opened a consultation on 19 June 2023 (closing 14 August 2023) requesting views on potential reform to the DPT legislation, with the proposed measures including removing DPT's status as a separate tax and bringing it within the corporation tax framework, whilst still retaining the essential features of the DPT framework.

 

Non-statutory clearances

Where a taxpayer is uncertain about HMRC's interpretation of legislation, guidance can be sought in certain circumstances from HMRC via its non-statutory clearance process. However, the case law is clear that the taxpayer can only gain certainty on the appropriate tax treatment as set out in an HMRC clearance letter where they have 'placed their cards face up on the table'.

That position is not new and is restated in the recent judicial review proceedings in Airline Placement Ltd [2023] EWHC 1191 (Admin), which also confirms that the full and frank disclosure required of the taxpayer should generally be 'within the four corners of the request and the materials attached' in order for the taxpayer to be able to rely on a legitimate expectation that a tax treatment set out in an HMRC clearance letter will not be withdrawn without fair notice or with retrospective effect.

The court rejected the taxpayer's argument that it had disclosed the information through other means, i.e. by cross-referencing to other material, including a previous non-statutory clearance request provided to the Commissioners of Customs & Excise (as it then was) some years previously. The conscious decision not to refer to certain arrangements within the request itself was a failure to fulfil its duty of complete frankness and rendered the request materially inaccurate.

 

Appealable decisions/standing

When considering whether to pursue tribunal proceedings it is essential that a taxpayer understands what constitutes an appealable decision of HMRC and whether they have standing to bring the appeal.

In the case of Isle of Wight NHS Trust and others [2023] UKFTT 23 (TC), the legal representative of various NHS and other healthcare organisations had written to HMRC asking that it review its policy on the VAT treatment of the supply of locum doctors by agencies as they believed such supplies should be exempt from VAT under VATA 1994 Sch 9 Group 7 item 5 ('the request'). The request referenced that VATA 1994 s 80 claims for overpaid VAT would follow but, in the meantime, sample figures were included in the correspondence to give an idea of the scale of the claims. HMRC responded, inter alia, referencing its current policy and guidance ('the reply'). The reply did not offer a review or mention the taxpayer's right to appeal.

The appellants appealed the reply and HMRC lodged strike out applications on the basis that the FTT lacked jurisdiction as there was no appealable decision. HMRC's position was that it had simply issued a letter responding to what HMRC viewed as a speculative, theoretical and general enquiry; and it had not made a decision on the VAT liability of a specific supply or for a particular taxpayer.

The FTT considered para 12 of Olympia Technology Ltd (2006) VAT Decision 19984 which confirmed that for it to have jurisdiction, there must be an issue between the parties which has been 'sufficiently crystallised' to constitute a decision falling within one of the paragraphs of VATA 1994 s 83. The FTT considered the request set out, at considerable length, what the NHS trusts perceived to be a discrete and crystallised issue, namely the VAT treatment of the supply of locum doctors. Further, the FTT regarded the following wording in the reply – 'For the avoidance of any doubt, HMRC does not share the views set out in your letter/ report' – to be crucial, as this made it clear that the technical submission had been considered and rejected, and clearly expressed a concluded view.

The FTT also referred to the UT decision in SDI (Brook EU) Ltd [2017] UKUT 327 (TCC) which held that s 3(1)(b) appeals must be construed broadly and that there is no need to identify a specific supply or for an amount of VAT to have been determined. Appeals can proceed on questions of principle which are related to the chargeability of VAT, as was the case here.

A separate issue of standing was raised by HMRC in respect of a category of appellants who were not the clients of the legal representatives at the time of the request and reply. Those taxpayers relied on the wording of s 83G(1)(a)(ii) which they argued makes explicit that someone other than a taxpayer who had been notified of a decision can bring an appeal if they have standing (i.e. a legal or financial interest). The FTT agreed and rejected HMRC's argument that it could open a floodgate, stating that this was not a material consideration.

 

FTT appeals: material error of law

It is a well-established principle that an appellate court should exercise caution before interfering in a multi-factorial evaluation (essentially, a value judgment) made by a court of first instance, recognising that the evaluation of primary facts is the expertise of the judge hearing the evidence.

However, the scope of the principle was considered by the Upper Tribunal in WM Morrisons Supermarket PLC [2023] UKUT 20 (TCC) – specifically whether failing to take into account a relevant factor, or taking into account an irrelevant factor, in a multi-factorial evaluation constituted a 'material error of law'.

The case concerned whether Organix Bars and Nakd Bars sold by Morrisons were 'confectionary' and therefore excepted from zero-rating for UK VAT purposes under VATA 1994 Sch 8 Group 1 item 2. The FTT found in favour of HMRC, and Morrisons appealed to the UT on the grounds that the FTT had made an error of law in treating two factors as irrelevant (the healthiness of the products and related marketing; and the absence of traditional confectionary ingredients).

HMRC argued that there would only be an error of law if it could be shown that no other tribunal properly instructed would have left the factor out of account (i.e. perversity); and, in assessing the materiality of the error, it is necessary to show that the error would have made a difference to the decision.

The UT held that, in line with the Court of Appeal's approach in Proctor and Gamble [2009] EWCA Civ 407, perversity needs to be shown in relation to challenges of findings of fact based on the weight of evidence, the weighting given to factors or matters of degree in making an overall assessment. However, it is not necessary to show this where it is demonstrated that the FTT has failed to consider a relevant factor. On the issue of materiality, the UT concluded that, in accordance with the Court of Appeal's decision in Degorce [2017] EWCA Civ 1427, a tribunal cannot properly allow the decision of a lower tribunal to stand once it is satisfied that an error of law might have made a difference to that decision. The UT concluded that the FTT had made a material error of law and remitted the case to the FTT.

 

Appeals: new arguments

In Altrad Services Ltd [2023] EWCA Civ 474, the Court of Appeal (CA) granted HMRC permission to argue a new ground that it had not previously raised before the FTT or the UT on the condition that, in so far as the new ground raised any issues of fact, any prejudice to the taxpayers would be mitigated by making certain assumptions in the taxpayers' favour.

The substantive issue in this case was whether the taxpayers were entitled to capital allowances arising in connection with a complicated scheme involving the sale and subsequent re-purchase of assets. The UT found in favour of the taxpayers and HMRC applied for permission to appeal on two grounds: permission was granted on the first ground, but permission on the second ground was adjourned to an oral hearing because there was a dispute on whether the ground raised a new point and, if so, whether there would be prejudice to the taxpayers if HMRC were granted permission to argue it at this stage in the proceedings.

The CA concluded that the ground did raise a new point that had not previously been raised on the basis that there was no statement in any of the documents before the FTT, including HMRC's statement of case, or the FTT's decision concerning it. It appeared that HMRC had raised the point for the first time in its grounds of appeal following the UT's comments in its decision that HMRC had not argued the point before it.

The question then was whether the taxpayers would be prejudiced if the ground was introduced at this stage, either because they would wish to rely on evidence to deal with the point, or because the FTT hearing would have been conducted differently if the point had been raised before it. The taxpayers submitted that they would be prejudiced because they would likely have called oral evidence and submitted documentary evidence on the point and invited the FTT to make findings of fact reflecting that evidence.

HMRC countered that the FTT had already made all relevant findings of fact in relation to the scheme.

The CA applied the principles set out in Singh v Dass [2019] EWCA Civ 360 and concluded that in so far as the ground raised issues of law, it would not cause any prejudice to the taxpayers if it were to be admitted at this stage. In so far as the ground raised issues of fact, any prejudice could be mitigated by making certain assumptions as to the evidence that the taxpayers would have adduced on this point in the FTT in the taxpayers' favour; and should the taxpayers consider that there are relevant documents on the point which were not before the FTT, they could make an application for the CA to consider. Accordingly, the CA granted HMRC permission to appeal on the new ground, subject to these protections afforded to the taxpayers.

 

Open justice: Interlocutory decision publication

Open justice is a principle described as being at the heart of our system of justice and vital to the rule of law. The FTT considered its application in A Lillicrap [2023] UKFTT 72 (TC) in the context of a third party application for publication of an unpublished interlocutory decision.

The interlocutory decision had been issued by the FTT on 1 November 2021 and had lifted the stay in Mr Lillicrap's appeal against HMRC's decision to reject his claim for repayment of national insurance contributions paid in respect of a car allowance by his employer. Shortly before the listed hearing, Mr Lillicrap and HMRC settled their dispute, and the appeal was withdrawn.

A third party, Mr Messore, wrote to the FTT explaining that he had been working with Mr Lillicrap on his appeal and had been provided with a copy of the interlocutory decision. He applied for the interlocutory decision to be published so that it could be referred to in other similar ongoing cases, and provided detailed supporting submissions. Mr Lillicrap did not object, but HMRC did.

The judge noted that rule 35 of the tribunal rules (which relates to notices of decisions and reasons) does not apply to interlocutory decisions because they do not dispose of all issues in the proceedings, nor do they decide an identified 'preliminary issue', i.e. they are not 'substantive decisions'. In terms of the FTT's practice on interlocutory matters, it did not publish those which relate to routine matters as they tended to only be of interest to the parties. However, it was stated that where the line is to be drawn between routine decisions and other decisions is a matter of judicial discretion, to be exercised in the light of the principle of open justice.

The FTT granted Mr Messore's application and concluded that the interlocutory decision should be published on the following grounds: (i) the principle of open justice requires that judgments are accessible to the public and, in this instance, the interlocutory decision was of interest to persons other than just the parties; (ii) the decision was already in the public domain because it had been handed down to the parties; and (iii) the length of time that had passed since the decision had been given should not be an issue because readers always have to take into account subsequent legislative and case law developments when reading decisions.

Judge Redston also commented on an important issue of fairness in the context of reliance on unpublished tribunal decisions. In particular, whilst the Judge would allow a taxpayer to rely on an unpublished decision provided that HMRC had due notice, she would not allow HMRC to do the same because, as the respondent in all tax appeals, HMRC has an 'entire and complete' library of all tax decisions. If HMRC were permitted to rely on unpublished judgments at the tribunal, the taxpayer (and the tribunal panel) would not know whether other contradictory or conflicting unpublished judgments existed. By contrast, if a taxpayer relies on an unpublished judgment, HMRC will know whether it is atypical, an outlier or reflects the consensus view of previous tribunals who have considered similar issues.

 

Costs

Readers of our earlier article ('Contentious tax: procedure and practice in 2022' (Jason Collins, Stuart Walsh and Clara Boyd), Tax Journal, 16 December 2022) may recall reference to the case of SNM Pipelines [2022] UKFTT 231 (TC) which determined that 'starting proceedings' was not the same as 'entertaining' or 'proceeding' with an appeal. The case of B Patel [2023] UKFTT 128 (TC) has now considered a successful party's entitlement to costs in the period prior to it being determined that the appeal can be entertained.

HMRC issued assessments to the taxpayer, which were appealed in 2013. The appeal was then stayed from 2014 to 2020. The FTT determined that hardship should be granted to Mr Patel in April 2022 and then allocated the appeal to the complex category in June 2022. The taxpayer did not opt out of the costs regime. Prior to the appeal being allocated to the complex category, there had been a number of contentious issues between the parties (involving some hearings) relating to the taxpayer's application for hardship and the appropriateness of the stay prior to HMRC filing its Statement of Case. When HMRC withdrew the assessments in September 2022, Mr Patel withdrew the appeal and made an application for costs.

HMRC contested the costs application on various grounds, including that no costs should be awarded (i) prior to the determination of hardship; or (ii) prior to the appeal being allocated to the complex category. The FTT disagreed. In awarding costs, the FTT stated in relation to (i) that whilst an appeal could not proceed pending the determination of hardship, the appeal had nonetheless been started such that it was not prevented from making an award in respect of costs incurred prior to hardship being granted, citing SNM Pipelines; and in respect of (ii) referred to the UT decision in Capital Air Services [2011] STC 617 which held that once a case has been allocated as complex, the FTT has power to make an order for costs in the case whenever those costs were incurred, and that, in exercising what is a wide discretion, will no doubt have regard to whether it is just and fair to make such an order with retrospective effect.

 

HMRC guidance: LSS and ADR

In February 2023, HMRC published guidance in its internal manuals on how it should apply its litigation and settlement strategy (LSS) (i.e. the framework within which HMRC resolve tax disputes through civil law procedures); and its approach to alternative dispute resolution (ADR) (which ordinarily means a facilitated mediation).

LSS

The practical guidance contains welcome content for taxpayers and their advisers. For example, it notes that an open and early dialogue should be entered into with taxpayers in tax disputes, explaining what HMRC is checking, and what it considers could be wrong and why, as this will help to 'resolve uncertainty', 'eliminate any potential dispute about these matters' (i.e. regarding the scope of HMRC's enquiry or investigation) and 'avoids unnecessarily wide-ranging open enquiries' (see HMRC's Litigation and Settlement Strategy Manual at LSS20700 and LSS30200).

Taxpayers should feel confident to refer HMRC to these statements if they feel HMRC is not acting in accordance with its own guidance and seek further explanation as appropriate.

The guidance also acknowledges that the enquiry process can be lengthy and costly for taxpayers and therefore, where agreement cannot be reached, at least some of the hard work and effort should be leveraged. The guidance proposes that a number of timetabled steps are built into enquiries to establish the facts, seek specialist advice, communicate positions and look for points of agreement. Even where disputes have reached an impasse, the case team is being urged to agree the key questions for the next stage and seek to narrow down the points in dispute. This could prove useful to ensure that taxpayers are not 'starting again from scratch' with HMRC by re-opening all issues if agreement cannot be reached and the matter needs to proceed to the tribunal.

The ADR guidance is altogether less positive. One of the key features of a mediation is that the information and communications connected with the mediation are confidential and on a without prejudice basis.

 

ADR

The ADR guidance is altogether less positive. One of the key features of a mediation is that the information and communications connected with the mediation are confidential and on a without prejudice basis. This encourages open communication with a view to resolving a dispute without the need for a court hearing. However, the ADR guidance notes a proposed ability for HMRC to rely on 'tax facts' obtained through ADR processes in tribunal proceedings and in support of assessments for any other tax or duty.

A 'tax fact' is not an established concept and is described rather opaquely within the guidance as 'a fact which has legal and technical implications for a taxpayer's liability' (see HMRC's Alternative Dispute Resolution Guidance Manual at ADRG01700). The guidance gives some examples of what may constitute a 'tax fact': the receipt of a payment, the making of a supply, the identity of a customer, the place of supply (ADRG01900). These could be material issues in a dispute and taxpayers may be reluctant to disclose details if they can be used against them, either in current or future proceedings. Consequently, rather than promoting the increased use of ADR, the current guidance could have the opposite effect, resulting in more disputes requiring resolution through litigation than needs be the case.

The authors thank Jason Collins and Stuart Walsh, partners in the tax controversy team, and Randall Fox, international head of transfer pricing, at DLA Piper for their contributions to this article.