Martyn Arthur, the forensic accountant who successfully represented the taxpayer in a Tribunal case which should cause HMRC pause for thought, reflects on the key flaws in HMRC’s approach.
Preface – Client Confidentiality
The case illustrated some very important fundamentals and in discussing it, it is important first to make clear that we always respect client confidentiality. Everything referred to in this article is in the public domain as recorded by Judge Roger Berner in his written decision on 13 December 2013 (UKFTT/TC/2013/TC03120).
The Newells’ £500,000 Case
This case involved a small takeaway business selling West Indian food. Following a local compliance inspection HMRC had raised a charge to underpaid tax in respect of 2006/07. Relying on continuity principles HMRC had extrapolated back ten years to 1996/97 and forwards a further four years to 2010/11 bringing charges to tax, interest and penalties approaching £500,000.00 for the 15 year period.
This was one of far too many of those cases where HMRC’s arguments were prima facie sound but their underpinning calculations were fundamentally flawed. Technically, therefore, HMRC was entitled to – and did – raise assessments.
For general background on the circumstances of the case, here is a copy of the Daily Mail article.
Tribunal Hearing; Principles
This case was an outstanding example of the function of the Tribunal Service. Totally independent of both parties, the facts are considered and an objective conclusion reached. Of critical importance is the basis on which decisions are reached: on the balance of probabilities. This involves an assessment of all the data and a decision based on the most likely correct situation overall. This concept of a decision on the overall facts, is well exemplified in this case.
The Tribunal is, in general terms, able to review and, if appropriate, overturn any decision made by HMRC to bring tax or penalties to charge. It is able also to direct that HMRC should close investigations in circumstances where it is not satisfied with HMRC’s progress. The Tribunal is a “Court” in every sense but proceedings are relatively informal. The taxpayer need have no fears about attendance and I have never yet encountered a case where a taxpayer has been made to feel uncomfortable.
Experience has shown that whilst Judges are frequently willing to assist parties to the hearing, a thorough understanding of procedures and the law is however absolutely essential in preparing and presenting cases. Equally important is a thorough understanding of the case, an ability to proactively cross examine the HMRC witness(s), and the ability to react to evidential and other situations as they develop.
The numbers in the brackets below relate to the paragraph numbers of the Tribunal’s Decision.
HMRC Assessments 1996/97 – 2005/06 Withdrawn by HMRC at Outset of Hearing
The assessments for the period 1996/97 – 2005/06 were withdrawn by HMRC at the inception of the hearing because of legal issues associated with the nature of the assessments raised (4).
HMRC Test: Till Roll Retention Requirement (Not Upheld by Tribunal)
We frequently see situations where HMRC rely on the absence of till rolls to challenge the reliability of the records and this occurred in this case. I had challenged this concept from early on in my involvement on the basis that there was no statutory requirement, in the circumstances of this case, for them to have been retained (55). In this case, as agreed by Tribunal, the taxpayers’ statutory record keeping requirements were satisfied by the records maintained (78 – 80).
It is important to note that this is not a general sanction that till rolls need not be retained. Each case needs to be considered on its merits in relation to the nature of records maintained and the nature of the trade.
HMRC Test: Comparison with Similar Businesses (Not Upheld)
Another favourite with HMRC is a comparison with other “similar” businesses in similar circumstances, in this case a lower profit than that of comparable local businesses. The Tribunal’s position was clear: “We do not have any difficulty in accepting that the partnership’s profits were likely to be lower than those of other takeaway businesses” for the reasons stated (81).
Again this conclusion does not constitute a global disenchantment with the test and each case must be considered on its merits. In addition to those in this case there can be many different reasons for a lower profit margin. In the “Swindells" hairdresser case from which HMRC withdrew before the tribunal hearing for example, the reason was that the customers were old long standing customers with “little hair” and were charged a reduced price.
A useful challenge to this is to prepare a matrix that, by reference to purchase and sale prices, establishes the trader’s true profit margin.
HMRC Test: Negative Cash (Demonstrated as Fundamentally Flawed)
As the first day of the hearing progressed it became apparent that there were issues of concern relating to the documentation in HMRC’s bundle of data. I also became uncomfortable about the data underlying HMRC’s Negative Cash Test. This was particularly the case during my cross examination of the HMRC witness. I sought and received the consent of the Tribunal to undertake further work on this data. On the second day of the hearing, I was able to inform the Tribunal that, on the basis of work undertaken I had identified issues that I believed eliminated the errors in HMRC’s negative cash test. HMRC did not challenge the errors identified (54).
HMRC Tests: Generally
It is important to remember always that these tests are just that: “tests” about the viability of situations. There are strong arguments against their being feasibly used in isolation or as a basis for assessment purposes.
HMRC Case Law Quoted: (Noted by Tribunal as Inappropriate)
HMRC frequently quote case law; in our opinion often out of context and inappropriately. In this case the Tribunal reflected that in relation to Brimelow v Price “all cases of this nature have to be decided on the facts and the facts of this case are very different from those in Brimelow” (87).
HMRC’s “Fantasy” (Circumstances of the Business)
This is a very important point, because it reflects a fundamental flaw in HMRC’s approach to small businesses. HMRC alleged that this small enterprise managed to achieve a profit in 2006/07 of £61,563 – which was £54,475 more than the returned profit of £7,088. In discussing this Judge Berner interestingly quoted my reference to HMRC’s contentions as to profit as a fantasy (60). He was very clear in rejecting the notion as an “improbable hypothesis”, “in favour of the clear compelling evidence of Mrs Newell which we accept in all respects” (68 – 70)”.
The Importance of the Client’s Evidence
The importance placed by Tribunal on witness statements supported by verbal evidence is notable – in this case where the taxpayer gave evidence in relation to the nature of trading activities and the lack of potential for profit over and above that returned (67). The evidence provided by the taxpayer was accepted “in all respects” and HMRC’s “notion” of a higher level of sales was rejected (68 – 70). The Tribunal decision went on to reflect the taxpayer “to be a transparent honest person” (78).
When asked if this is an ‘exceptional case’ I have to say that unfortunately in my experience, it is all too common. HMRC is happy to publicise its successes in dealing with high-profile avoidance cases but seems to place much less emphasis on cases like the Newells’, which probably matter far more to the millions of small businesses in the UK. Here, as in previous examples, I have found HMRC’s case was fundamentally flawed, and lacking in diligence.