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Peter Vaines of Squire Patton Boggs considers some recent tax cases which should give taxpayers and advisers pause for thought.

CGT : Contingent Liabilities

The recent Court of Session judgment in Morrison v HMRC [2014] 113 might give you a fright.

Mr Morrison had sold his shares in Morrisons Plc at a capital gain in 2000/01. Some time later the purchaser bought an action for damages against Mr Morrison claiming that he had misrepresented the profitability of the company at the time of the sale. The action was eventually settled by the payment of £12 million and Mr Morrison claimed a deduction by way of adjustment to the calculation of his capital gain in 2000/01.

The general rule regarding such computations in TCGA 1992 s 48 is that in calculating the gain:

“The consideration for the disposal shall be brought into account without any discount for postponement of the right to receive any part of it and, in the first instance, without regard to a risk of any part of the consideration being irrecoverable or to the right to receive any part of the consideration being contingent.”

This general rule is modified by TCGA 1992 s 49 which provides that where a contingent liability subsequently arises and is enforced, an adjustment can be made to reduce the capital gain.

HMRC denied the deduction on the grounds that the settlement payment was not part of the consideration for the sale. They said that the liability was not directly referable to the value of the consideration received by the taxpayer on the disposal of his shares.

The Court of Session took the view that for this purpose, a contingent liability is a liability which depends for its existence upon an event which may or may not happen – and includes liabilities which emerge after the disposal but arise as a consequence of a state of affairs existing at that time.

The Upper Tribunal had suggested that the liability had to be incurred by the taxpayer in his capacity as seller, on the disposal of the asset concerned and had to be relevant to the computation of the gain in that it reduced the value of the consideration received on the sale of the asset.

The Court of Session did not necessarily agree that these were the right tests but they concluded that Mr Morrison satisfied them anyway. They held that the representations made by the taxpayer (which gave rise to the claim) were made on the disposal of the shares and the reality of the payment was that it reduced the gain made on the disposal.

Although the Court of Session was clear on the principles involved here, an uncertainty arose because they found it necessary to remit to the First Tier Tribunal the question of how much of the payment was referable to the representations made and whether part of the payment had been in respect of other matters.

It is not easy to ensure that every conceivable contingency which might give rise to a settlement payment can be attributed to the sale – particularly in the face of HMRC’s argument that such a payment is not a contingent liability at all but a payment for a completely different reason. Indeed, Mr Morrison had not been sued in contract, but in tort. Although the Court of Session found for Mr Morrison, it is clear from the decision of the Upper Tribunal, that this could so easily have gone the other way.

VAT Penalties

It is clearly my month for being sympathetic. I have been reading the case of Sam Smith v HMRC TC 4237. Captain Smith was a helicopter pilot who carried on a VAT registered business. He had discussions with HMRC regarding the deduction of input tax on some expenses. The VAT officer advised that they were disallowable. Captain Smith did not agree and said that he would include the input tax on his VAT return so that he would be able to appeal against the VAT position taken by HMRC.

The response of HMRC was to say that his return was a false or inflated claim to a repayment of tax and he was therefore liable for a penalty. Worse still Captain Smith had made an active choice to claim VAT “that he had been advised was not claimable” and it was therefore a deliberate false claim giving rise to a higher penalty.

Pausing there for a moment, one might wonder how a taxpayer is supposed to make a claim to input tax. They must claim it on their return – there is no other way. Obviously, they do it deliberately – to suggest otherwise is absurd. If HMRC disagree then the procedure is for the matter to be heard by the Tribunal for adjudication. As far as I was aware, just disagreeing with the advice of HMRC did not make you liable to a penalty.

Actually, Captain Smith (and his accountant) were wrong. The rules did not allow an input tax deduction for the amount he was claiming – but I cannot see that makes any difference. It was not a vexatious or frivolous claim.

Nevertheless, the Tribunal confirmed the penalty.

The only conclusion that can be drawn from this case is that if HMRC are able to disallow any input tax, you must be liable to a penalty. You must have deliberately made the claim (you cannot say that you did not deliberately make the claim, otherwise you would be careless, and culpable on that ground) and the claim must inevitably be excessive. This surely cannot be right.

One gets the feeling from the judgment that the Tribunal was not entirely comfortable with this penalty but concluded that unless they could say that the input tax was allowable or that Captain Smith had not made his claim deliberately, there was nothing they could do.

I think that something is not quite right here.