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IT ALL STARTED with Readers' Query T15,108 'Painter's stock' (see Taxation, 20 November 1997 at page 202). The taxpayers' names and personal details have been changed but everything else is exactly as it happened. Apart from illustrating the importance of reading Readers' Forum and providing a reminder of two very important sections of statute for executors, there is a simple moral to this story: do not be bulldozed.
I live next door to one of my partners, Steve Golby, who suffers from the additional misfortune of being a Burnley supporter. One day, chatting over the fence, he asked if I had seen the replies to readers queries in that week's Taxation, specifically the one about valuing stock on death. As it happened, I had written one of the two published replies. Steve said he had a client in a very similar position.
Antiquarian books
Mr Bookend had run a bookshop in partnership with his wife until she died in January 1990, and then alone until his death in July 1995. They had specialised in antiquarian books, a lifelong passion, and had a substantial number of books in their home in addition to those in the shop. The number and value of the books was so substantial in fact that when the executors put them up for sale (at Christie's), the local paper ran an article under the headline 'Aladdin's cave in Eastbourne Bookshop'. BBC Southeast then ran the story, as did the bookselling press. Copies of the articles and the television broadcast were collected and collated by the Inland Revenue (yes, it really does go to these lengths) and ended up with Special Compliance Office.
The solicitor dealing with the estate had included the private collection of books at their realised value in the inheritance tax account. The Special Compliance Office Inspector wanted to treat all of the books owned by Mr Bookend at the date of his death as trading stock and at selling price. Not only that, he wanted to reopen the 12 years before the year of assessment of death on the grounds that stock had been seriously and negligently understated each year. He calculated the income tax, interest and penalties at £500,000, but pointed out that there would be inheritance tax relief on the amount of the settlement. A Revenue accountant had recomputed the previous 12 years profit and loss accounts based upon higher stock values (and a disregard for the principles of double entry bookkeeping).
The point from the query was that the stock's market value would be liable to inheritance tax, albeit fully covered by business property relief. It should, however, be included in the final Schedule D accounts at the lower of cost and net realisable value, not at market value thanks to section 102, Taxes Act 1988 which says:
'Where ... a trade ... is treated as having been permanently discontinued ... it shall be so treated for the purposes of sections 100 and 101; but those sections shall not apply in a case where a trade ... carried on by a single individual is discontinued by reason of his death.'
The exciting bit
As the discussion across the fence developed, our wives drifted away, despairing of us ever holding a conversation that did not involve work. This was a shame, because they missed the exciting bit. The Inspector could not go back 12 years because of section 40(2), Taxes Management Act 1970.
'I think,' said Steve, 'that you had better look at the file'.
Section 40(2) says:
'For the purpose of making good to the Crown any loss of tax attributable to the fraudulent or negligent conduct of a person who has died, an assessment on his personal representatives to tax for any year of assessment ending not earlier than six years before his death may be made at any time before the end of the third year next following the year of assessment in which he died.'
Ibid, subsection (1) makes clear that this applies to assessments under sections 34, 35 and 36, viz. extended time limit assessments. The Revenue Investigation Handbook refers to this 'line in the sand' at paragraph 4151. The situation in the case of a partnership was considered in Harrison v Willis 43 TC 61, and is set out in the Investigation Handbook at paragraph 4236:
'If no member of the partnership is alive when the assessment is made, the time limits in section 40(1) or 40(2), Taxes Management Act 1970 apply, and the assessment should be made within three years of the end of the year of assessment in which the last surviving partner died.'
The file contained the exchange of correspondence between Special Compliance Office and the solicitor, together with interview notes. The Inspector had been adamant that a bookseller could never distinguish between a personal collection and trading stock and that everything had therefore to be treated as stock. Because of the alleged neglect or fraud, each of the last 12 years accounts would, he said, have to be adjusted to show the 'correct' opening and closing stock.
I have a lot of time for Special Compliance Office. They do a difficult job and I too want tax evaders to be dealt with effectively and rigorously. Perhaps because of the nature of their work, however, many Special Compliance Office Inspectors tend to be better negotiators than technicians. I certainly felt that this Inspector was in the former category. The first task was to make him state his case clearly and unequivocally. I wrote, asking if our list of documents (letters and interview notes) was complete and for confirmation that he wanted the executors to agree to a market value for closing stock of £1,000,000 and cost of £330,000. He confirmed the completeness of my file and, crucially, the figures in writing.
The meeting
So, on a fine spring morning in 1998, Steve and I set off for the Big City. Even though I had virtually memorised the file, spent hours rehearsing the arguments, read and reread the legislation and the Revenue Investigations Manual, I have rarely felt so apprehensive. I do not take meetings with Special Compliance Office lightly. Part way through the journey, I even rang my old friend John Newth to see if he agreed my understanding of section 40(2), which he did.
The greeting at Special Compliance Office was very affable and the coffee arrived with some pretty decent biscuits. I asked if the Inspector would mind if I kicked off and he shrugged acquiescence. I rehearsed the agreed facts and then took a deep breath.
'Are we able to deal exclusively with you or do you have to go back to Capital Taxes Office before agreeing?'
'I can agree an overall deal.'
'Were any extended time limit assessments issued before Mr Bookend died?'
'No, only normal assessments.'
'OK. So let's talk about the stock, which will be included in the final accounts at a cost of ...'
'... market value.'
'No, cost, section 102, Taxes Act 1988 says ...'.
'It was actually sold at auction for £1,000,000, there is no question that is the value for the accounts. You cannot argue with facts.'
'I do not dispute the facts or the sale value, but the value in the final accounts is fixed by section 102.'
'I will look at it, but you should have raised this before you came all the way up here. We could have done a deal today and settled it all.'
'Actually we could not have done that, because you cannot go back 12 years either, six is the limit.'
'That I have looked at and my boss will back me. We can link to the last year of the partnership six years before Mr Bookend's death and bring in the six previous years.'
'Sorry, but even your own Investigations Handbook says otherwise. The case of ...'.
The biscuits had disappeared by this point and, like the room, the coffee seemed to have gone cold. We left.
We said nothing until we had been on the road for several minutes.
'How do you think that went?', Steve asked.
'On reflection, I think I should have used more anti-perspirant,' I replied.
Terminological inexactitudes
Next day I received a fax from the Inspector. It was an extract from Whitehouse Revenue Law. I telephoned and said, 'Great, so now you can agree'.
'Of course not,' he replied. 'It proves my point.'
I re-read the faxed pages and began to wonder which one of us could not read. To be sure of my ground, I took counsel's opinion via the Tax Faculty scheme and faxed it to him. The response was that the barrister could not read either. I then asked the Inspector to put the point to the Revenue solicitor and, as I had shown him counsel's opinion, to let me see the response. He accepted this as a reasonable request.
A couple of weeks later I received a letter to say that the Inspector had been along to Business Profits Division and that both he and the Inspector there felt that the Revenue's position was justified. I reminded him that this was not what he had agreed to do and asked him again, formally, to put the question to the Revenue solicitor. He replied by return to say that he had now 'passed all [his] papers to the Revenue solicitor with a request for urgent action'.
Fresh look
The next contact was from another Inspector at Special Compliance Office to say that his colleague had left the Revenue, and could he come to see us. He had an unenviable task. It turned out that not only had the papers not been sent to the Inland Revenue solicitor, but that the Inspector at Business Profits Division had confirmed my interpretation of both section 102, Taxes Act 1988 and section 40(2), Taxes Management Act 1970. I was asked to renegotiate the cost of stock. I said no: we had agreed the value proposed by the Inspector, and he only wanted to change it now because it no longer suited him. The Revenue would have been perfectly content to collect tax on a seriously incorrect misreading of statute, and it now had to accept the consequences. I was asked to inform the executors that they could make voluntary restitution of the tax (see Investigation Handbook at paragraph 4121) if they wished. I cannot record their reply, as I know that many readers of this magazine have sensitive dispositions.
The income tax, interest and penalties reduced from £500,000 to £172,000 and the inheritance tax on the assets reallocated from personal chattels to business stock from £400,000 to nil.
If there is a single lesson to be drawn from this story, it is this: do not be tempted by offers to do a deal if you know you are right. Statute and case law form the bedrock of tax work, even for Special Compliance Office.
Bulldozers?
So how does the reference to bulldozers in the title fit in? The original Special Compliance Office Inspector had endeavoured to put the solicitor's mind at rest by offering 'a rough and ready approach', with an assurance that Special Compliance Office Inspectors were 'not like bulldozers'. Often, I accept, they have to be, but in this case it was singularly inappropriate and spectacularly unsuccessful. The executors were very happy indeed with the result.
Paul Aplin FCA, ATII is a tax partner with A C Mole & Sons, Taunton, and Steve Golby is the firm's managing partner based at Bridgwater.
