Certainty? What Certainty?

Certainty? What Certainty?

KEVIN SLEVIN discusses the implications of Langham v Veltema on discovery assessments.

DO NOT WORRY, 'there will not be a problem in practice' or at least this was the message from the Revenue when the self assessment provisions were being debated in 1994 and 1995; the issue recently heard by the Court of Appeal was just a theoretical problem which should not arise in practice.

In the mid-nineties, many of us in the tax world argued that special treatment was required in connection with self assessment and the tax treatment of asset transfers between connected persons (therefore requiring a judgment to be made as to the value of an asset). Our calls went unheeded. Some expressed the view that, as a result of the shape of the Taxes Management Act 1970 provision introduced to facilitate self assessment, ( a ) the vast majority of cases involving such acquisitions or disposals would be the subject of an enquiry notice under section 9A, Taxes Management Act 1970 ; and ( b ) that, in any case where the valuation was not enquired into by the Revenue, there would be doubts about the finality of the assessment because the Revenue could raise a section 29 assessment outside the enquiry window.

In other words, the concern was that if the Revenue did not enquire into the basis of a valuation under section 9A, an Inspector could come along well after the enquiry window had closed and pursue extra tax from an individual taxpayer if, at that later date, the 'officer of the Board' could demonstrate that the initial valuation was insufficient. Indeed, a discovery assessment could be raised at any time in the period ending five years after 31 January following the end of the tax year to which the assessment relates.

The problem with self assessment

In the final analysis, self assessment is all about disclosure of the relevant facts. The facts of the case determine the taxable income or capital gains arising in any given tax year and the quantum thereof determines the tax liability, taking into account, of course, the further facts disclosed in the self-assessment return in relation to the reliefs and exemptions available. Self assessment copes well with facts, but does not cope at all well with the 'statutory fiction' which applies in so many situations where it is necessary to ascertain a so-called open market value of a particular asset.

This matter was raised by me in lectures regarding the introduction of self assessment and discussed informally, as I recall, with the Revenue during the consultation process. As indicated above, no one seemed concerned; 'it will be alright on the night' was the theme of the responses. Possibly, the Revenue's approach to the matter was shaped by the fact that the Inspectors driving the self-assessment consultation process forward were, though consulting from time to time with their colleagues within Shares Valuation Division and the District Valuer's Office, not familiar with the process by which valuations were agreed in practice by these departments. Could these officials have been under the impression that when an Inspector referred a valuation matter to, say, a district valuer and asked the question 'what was asset X worth on the date in question?', there was always a right answer and it was the district valuer's job to establish the right answer? Did they not know that there are no such thing as 'right answers' when it comes to fiscal valuations? There are simply answers which cannot be said to be wrong and answers which can be said to be wrong. There may be no case law to support this assertion, but nevertheless this is the reality of the situation.

The law needs changing, as Langham v Veltema demonstrates, but I wonder if the only certainty left in this matter is that nothing is going to change; despite the uproar caused by the Revenue's decision to take the case to the Court of Appeal and, what is more, to win comprehensively on the issue of the proper construction of the legislation.

Brief facts of the case

A detailed analysis of the Veltema case is not necessary to enable discussion of the implications. Suffice to say that Mr Veltema's tax advisers, when calculating a taxable benefit-in-kind for 1997-98, relied upon an informal professional valuation provided to Mr Veltema in respect of a property transferred to him as a director of a company that he and his wife controlled. His tax return was submitted and in the Court of Appeal it was made clear that the taxpayer complied with all his obligations under the law by disclosing all relevant information. He could have said more, but he had said all he was required to.

It must have been clear to the Inspector that Mr Veltema had acquired an asset from his company for no consideration and that a benefit-in-kind of £100,000 was, accordingly, being declared as taxable income. The only reason why a benefit in kind could arise in the particular circumstances recorded on the return was if the price paid by Mr Veltema to the company for the asset was less than the open market value of the asset acquired. In fact, the price paid was nil, as was made clear on the return. There was a clear implication arising from the return that there was a need to value the asset acquired from a connected person who was also his employer in order to calculate his income tax liability and that the judgment of that value by Mr Veltema was that the asset was worth £100,000.

The reasonable expectation of the tax advisers must have been that the Inspector would have wished his valuation colleagues to advise him as to the acceptability of the £100,000 valuation used in the self-assessment return and that, to start the ball rolling, the Inspector would issue an enquiry notice under section 9A. He would then request full details of the acquisition asset in question and the circumstances of the acquisition in order to consider whether ( a ) the transaction properly gave rise to a benefit-in-kind (this was not disputed) and ( b ) to enable the matter of the valuation to be referred to the appropriate valuation specialist so that the quantum of the benefit-in-kind could be confirmed in the sum of £100,000 or challenged and then negotiated in another figure — higher or lower as the case might be. Mr Veltema's tax return was filed on 30 July 1998. The company's form P11D for 1997-98, fully completed, was filed on the due date thereof.

Essentially nothing of note happened. We know not why. The self-assessment calculation was acknowledged and no corrections were required, but other than this nothing happened apart from the tax being paid in full. If ever there was a case where an enquiry was certain to be opened by the Revenue, it was this one. But nothing happened on the section 9A front. The Inspector's deadline of 31 January 2000 came and went. It turned out that the Inspector need not have been concerned at all because he knew (or possibly discovered as a matter of great relief subsequent to 31 January 2000) that if there was anything wrong with the valuation, he could seek the extra tax under section 29, Taxes Management Act 1970, i.e. whether or not the enquiry window under section 9A was closed.

However, matters progressed to a new stage. The tax Inspector dealing with the company's tax return — which was also submitted in good time — went about things in a more conventional way. The question of the valuation was referred to the appropriate district valuer's office in order to verify the accuracy of the company's calculations of its liability in connection with its capital gain and the need to substitute the correct fictional open market valuation. The district valuer's initial response was to suggest that the property had a value of £160,000 at the time it was transferred to Mr Veltema (not the £100,000 put forward by the company). Subsequent negotiations were concluded with an agreement of a value for the property on the given date of £145,000.

Mr Veltema's personal tax district was notified of this agreed valuation shortly before 31 January 2000 by the corporation tax district. It was, seemingly, accepted by the parties that the Inspector dealing with the personal tax return was not considered to have knowledge of the revised valuation as of 31 January 2000, i.e. the day on which the enquiry window closed and, more importantly in this case, the day which is the focus of the test laid down in section 29(5), Taxes Management Act 1970. The Inspector turned to section 29 to pursue the correct tax liability.

Discovery

Section 29 allows the Revenue to raise so-called discovery assessments in permitted circumstances; in particular section 29(1) (b) permits such assessments to be raised where it is discovered by an officer of the Board that an assessment to tax is, or has become, insufficient.

Having failed to make any enquiries into the tax return (the reason for this inaction was not explained) the Inspector decided to raise a discovery assessment under section 29. It was necessary for the Revenue to show that either (or both) the 'first condition' or the 'second condition' laid down in section 29 (subsections 4 and 5 respectively) had been satisfied.

The focus of the first condition is fraudulent or negligent conduct on the part of the taxpayer or a person acting for him and which gave rise to the insufficiency in the assessment. There was no suggestion of fraudulent behaviour, but initially the Revenue seemingly argued that the taxpayer, by relying on the advice received from an independent valuer when completing his tax return, was negligent in accepting this advice. Presumably, the thought was that as the valuation was later shown to be inadequate, the taxpayer was negligent in not knowing this in the first place? Or was the Revenue's thinking that Mr Veltema should have sought two or three professional valuations — and relied upon the least attractive? On the face of it, proceeding with such an argument in this case took some gall on the part of the Revenue, but it was thrown out by the Commissioners when they heard the taxpayer's appeal against the section 29 assessment. The Revenue did not raise the point again when an appeal was lodged with the High Court and so presumably the error of judgment in taking this point was accepted by the Revenue? Nevertheless, it would have been nice to have heard the view of a higher court and to have received confirmation that Mr Veltema was not negligent, providing it could be shown he took reasonable care to ensure that the valuer was properly briefed as to the precise nature of the asset being transferred (and as to Mr Veltema's prior interest therein). It should be noted that, assuming Mr Veltema already had some right of occupation under property in law, this would impact on the company's valuation of its interest in the residence, although section 19, Taxation of Chargeable Gains Act 1992 — provisions relating to assets disposed of by a series of transactions — might have an impact on the outcome.

In the appeal by the Revenue against the Commissioner's decision, heard by Mr Justice Andrew Park in the Chancery Division ( [2002] STC 1557 ), the Revenue focused on the second condition referred to above. The Revenue argued, as had been argued by the Inspector before the Commissioners, that this condition — which requires the Revenue to show that the officer handling the return could not have been reasonably expected, on the basis of the information made available to him before 31 January 2000, to be aware of the insufficiency in the assessment — was satisfied. The Commissioners had decided against the Revenue and Mr Justice Andrew Park reached the same conclusion, albeit with different reasoning, and dismissed the appeal.

Court of Appeal

In this article, we do not need to study Mr Justice Park's decision too closely because it was thrown out by the Court of Appeal. However, we must read carefully the decision of the Court of Appeal ( Langham v Veltema [2004] STC 544 ) and learn from it just how the courts will interpret the so-called second condition of section 29. It will come as a surprise to many, including some Inspectors who may now realise that assessments they thought they could not pursue could be pursued and which arguably can be revisited.

Put simply, the Court of Appeal found, by a unanimous decision, that when considering section 29(5) one interprets the wording thereof literally by focusing solely on the Inspector's knowledge of the facts as presented to him by the taxpayer in his self assessment return and the facts presented in supporting documentation, etc . (See section 29(6).) It is not possible for the taxpayer to argue that any competent officer of the Revenue examining the appeal would have referred the case to the district valuer for advice and that, as a consequence of the officer's failure, the valuation figure has become final. In short, the only way to get complete certainty in a case involving a valuation is to ensure that the matter is referred to the appropriate valuation office of the Revenue (and, of course, ensuring all material information is made available too).

Most clients want certainty on this type of issue and the self assessment system does not provide such certainty in this area.

Personally, I have no problem with Mr Veltema having to pay tax on his true taxable income for the year and I understand why the case was pursued by the Inland Revenue. However, the 'holy grail' of self assessment is the certainty that taxpayers long for as regards their taxation affairs, as is provided by the limited enquiry window in many situations. Generally, self assessment works well, but following this judgment the law now needs to be changed. I know from my own contributions to the Inland Revenue's Capital Gains Tax Simplification Committee that it is far easier to call for the law to be amended, than to suggest the precise nature of that amendment. However, in the hope of starting a debate about the need for a change to the law, may I suggest that consideration be given to:

(a) extending the enquiry window by a further 12 months, but only doing so in connection with any matter involving valuations (where the valuation issue affects either income tax on earnings or tax on capital gains); and

(b) further revising the law so that after this extended period has expired the Revenue (having been made aware in good time that a valuation is a factor influencing the return) will no longer be able to disturb the self-assessed figure having had ample opportunity to do so.

Meantime, the only alternative that occurs to me is to add a note in the white space asking the Inspector to open an enquiry on the matter to put the question of the valuation beyond doubt. Indeed, why not amend the law to allow the taxpayer to 'self start' an aspect enquiry by ticking a box on the self-assessment return and indicating which aspect of the return must be enquired into! Yes it's different, but would it not be fairer too? Whilst on the topic of fairness, rumour has it that the Inland Revenue's guidance to Inspectors has been updated to, in effect, highlight the flexibility that Inspectors have following Veltema . If this is true, this would not seem to be in the spirit of working together!

Conclusion

I have no particular problem with the outcome of the case. But, whatever the Revenue may say, it got the right result, but in the wrong way. Even if the initial valuation had been set down in writing (and the basis thereof had been clearly stated) and it had been referred to in a white space on the return, how could the Inspector have known that the figure was too low? The court has held that the Inspector could not reasonably be expected to know that the value adopted was too low and this logic seems sound. The test in section 29(5) was therefore satisfied.

It is now clear that the question to be asked when considering subsection (5) is whether the officer responsible for the taxpayer's affairs could have been reasonably expected, on the basis of the information available to him before 31 January 2000, to have realised that the self-assessment return showed insufficient tax payable. The question is not whether a reasonable Inspector would have got his act together quicker, as clearly could and should have happened in Veltema . Neither is it relevant that the Revenue's own manuals tell the Inspector to seek valuation advice in the circumstances of the case under consideration.

Even where no one is at fault, gross errors which are not plain for the Inspector to see must be capable of correction. The only alternative might be to allow the Revenue to take legal proceedings against the valuer to recover the tax lost by the Crown as a result of his value being too low!

However, my concerns in this area, which I first expressed nearly ten years ago, are now plain for all to see. Having been assured that problems would not arise in practice, Mr Veltema's case proves this not to be so. There has to be a better way of the self-assessment system coping with the statutory fiction that is fiscal valuation. It has to be said that the decision of Mr Justice Andrew Park, though comprehensively overturned, does nevertheless make very interesting reading. It seemed at the time to be a practical solution to a real problem and gave the honest taxpayer the degree of protection we had been encouraged to believe existed, with the Crown left to bear the cost. Alas, this was not to be. It is a shame that the appeal is not going to proceed to the House of Lords; their Lordships might have thrown further light on the proper interpretation with a watchful eye on the self-assessment régime generally.

Self assessment has been a great success, but it is now time to face up to this problem area. If a taxpayer makes the disclosure required of him by law and the Inspector sits on his hands for whatever reason, why should the uncertainty rest on the taxpayer's shoulders for such a long period of time? Let's get this sorted, even if we have to settle for giving the taxpayer the ability to self start an aspect enquiry into a valuation issue included in a self assessment return. It could work, but please don't tell anyone I suggested it!

Finally, the question to be answered is what happens if the Revenue officials stand their ground and do nothing to rebuild the level of certainty to that promised by their colleagues during the consultation process? Could it be that the members of the professional bodies who took part in the consultation process were all duped? My view is that the Parliamentary draftsman produced legislation intended to go some way towards giving the Olin decision ( [1982] STC 800 ) a statutory basis under the self-assessment régime, but never went as far as the Revenue said he was going. Certainly, the Revenue introduced the, so-called, CGT 34 procedure, but my view of this has always been that this did no more than paper over the cracks in the legislation introducing self assessment.

Arguably, the only certainty which exists at present is that certainty is hard to come by. It has been suggested that the professional bodies involved in the consultation process should dig out from their records the minutes of the various meetings with the Revenue, minutes often sent to the Revenue as a record of the meeting which took place. For what it is worth, my view is that we should look forward. The legislation was defective from the start and needs to be changed to give statutory effect to Mr Justice Park's decision. Mr Justice Park's decision was wrong, but it had the hallmark of reason. It remains to be seen whether the Revenue's responses also have the hallmark of reason ... or of a revenue-raising initiative.

Kevin Slevin CTA (Fellow), ATT TEP is a partner in Bristol-based chartered accountants Solomon Hare LLP and specialises in providing taxation consultancy services to professional firms. (Tel: 0117 933 3147. E-mail: Kevin_Slevin@solomonhare.co.uk .) An audio visual presentation written by Kevin Slevin and entitled 'Discover more about discovery assessments' will be available on CD from taxawareness@aol.com in October 2004.

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