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Peter Vaines of Squire Sanders considers the findings of the recent Charlton hearing in the Upper Tribunal.

Introduction

The case of Charlton published at the end of 2012 is seriously important. I know I am always going on about discovery assessments but this is the most significant case on the matter for some time.

Discovery and the Enquiry Window

HMRC are entitled to raise an assessment outside the enquiry window only if they discover that an assessment to tax is insufficient. There is a balance here between the taxpayer's entitlement to finality which is the cornerstone of self assessment, and the right of HMRC to correct a possible under assessment of tax. This balance was explained by Park J in the case of Langham v Veltema
as follows:

"[Self Assessment] imposed new burdens on taxpayers by requiring them to submit fuller tax returns than had previously been required…. The new burdens were balanced by new protections for taxpayers who conscientiously comply with the system, in particular by new and tighter time limits on the power of the Revenue to make further tax assessments."

For HMRC to be able to make a discovery assessment without significant regard to the enquiry window deprives the taxpayer of any protection and the whole idea of finality becomes a cruel illusion.

The Charlton Case

In the case of HMRC v Charlton [2012] UKFTT 770 the Upper Tribunal reviewed all the relevant issues relating to discovery assessments. They started with the meaning of a discovery and confirmed that a discovery assessment can be made merely when the original officer of HMRC changes his mind or where a different officer takes a different view.

The more important part of the decision related to TMA 1970 s 29(5) which enables HMRC to make a discovery assessment outside the enquiry window if an officer of HMRC could not have been reasonably expected, on the basis of the information made available to him before the deadline, to have been aware of the insufficiency in the self assessment. It is this "awareness" test which causes all the trouble.

Awareness

The first issue to consider is the characteristics of the tax officer. The officer who has to be aware of the insufficiency is not the officer who is in possession of all the information - it is a completely hypothetical officer. (This makes it irrelevant how HMRC decides to organise itself into separate departments and specialist areas - the practices of HMRC cannot affect the proper interpretation of the statute.)

This is a really difficult concept. It is necessary to assume a tax officer of reasonable knowledge and understanding but there is no uniform standard. The test of reasonable awareness must be applied to the particular context in which the question arises. The officer must be assumed to have such level of knowledge and understanding that would reasonably be expected of an officer considering the particular information provided by the taxpayer. We are not looking here at an officer of only general capability and experience, nor of an ordinary competent inspector. What is reasonable for an officer to be aware of will depend upon a range of factors affecting the adequacy of the information provided. This will depend upon the circumstances of the particular case and the complexity of the issues.

This formulation is impossibly subjective and seriously unhelpful to the taxpayer. However, as the subject matter of the dispute in Charlton was of extreme complexity - being a tax scheme (with a DOTAS scheme reference number) which needed the attention of one of the very small number of HMRC specialists on the matter - this probably represents the high water mark so maybe all the problems arising from such a subjective test will not arise in the majority of cases. It is not necessary for the hypothetical officer to understand precisely how the scheme worked. All that is needed is for him reasonably to be expected to be aware of the insufficiency such as to justify an assessment. In this particular case once a DOTAS number had been allocated to the tax scheme, the form concerning the relevant scheme information provided all the information necessary to satisfy this test.

Tribunal Disagrees with HMRC Guidance

Another important feature regarding this decision is that it conflicts directly with the HMRC practice statement on discovery SP1/06. The statement of practice places much too great a burden on the taxpayer (and far too little on HMRC). In addition, HMRC have always insisted that if the taxpayer takes a view of a matter contrary to the published view of HMRC, this must be highlighted with full relevant particulars if the taxpayer is to be protected from a discovery assessment outside the enquiry window. This view has been the subject of adverse judicial comment before, but in Charlton the Upper Tribunal clearly stated that there is no requirement that the taxpayer must specify that the view adopted is different from that taken by HMRC.

Having regard to the robustness of this decision and the clear conflict with established HMRC practice, one can expect this case to go further.