Lessons for HMRC and advisers on case handling

Key points

• Did HMRC allow itself enough time to prepare for the hearing?
• Was the department’s approach influenced by the fact that they were dealing with a ‘litigant in person’?
• HMRC appeared not to understand the nature of the taxpayer’s business.
• One of the tribunal’s main objectives is to ensure that justice is done.
• Those appearing before a court have a duty to act with independence.
• Why was the decision in the case of Kirk & Randall Ltd v  Dunn not raised by HMRC?
• Did the department ignore its own guidance on entrepreneurs’ relief?

In my recent article on J and N Potter (TC7348) (Taxation, 21 November 2019, page 18), I said that the appeal against HMRC’s rejection of the taxpayers’ claims to capital gains tax entrepreneurs’ relief was interesting for two reasons. And just to recap, these were that, first, the tribunal found that the taxpayer’s company should continue to be regarded as a trading company for some years after its final sales invoice was issued and, second, the tribunal’s exploration of the term ‘substantial extent’ in TCGA 1992, s 165A(3).

That said, there was, in fact, a third reason for my interest in Mr Potter’s fight against the might of the Revenue: how matters proceeded. Putting aside the technical issues examined in the tribunal hearing, I now pose the question: ‘Should HMRC be comfortable with the events as portrayed in the published decision?’

Where to begin?

As a mere commentator on matters, I accept that I am at an obvious disadvantage given that I was not present at the First-tier Tribunal hearing. Not having been involved in the case in any way I, as for other Taxation readers, can draw conclusions based only on the published decision. However, I am comfortable in doing so because the published decision must be viewed as coming from a reliable source of information – Judge McKeever – on which it is reasonable to base one’s conclusions. This article reflects my assumption that the published decision fully reflects all material facts about the conduct of the case.

Let’s start by focusing on what I understand is often referred to these days by the Treasury as the taxpayer’s ‘compliance pathway’; the journey the taxpayer takes in situations where an HMRC enquiry results in a technical dispute.

The Potters’ pathway

In my previous article, I stated that Mr Potter made a good fist of presenting his arguments during the hearing. This was an understatement; my impression is that he did this brilliantly. Indeed, I wish I had been there as a spectator. On the other hand, HMRC did not do so well.

Regardless of the result, the only sensible conclusion to be reached on studying the published decision is that Mr Vallis, who presented HMRC’s case to the tribunal, had not been allowed the time he needed to prepare for the hearing. It will be clear from the following how I have arrived at this conclusion, but my criticism is not directed at his contribution to proceedings but at the management structure of HMRC which resulted in the presentation to be found so wanting. The real question is, bearing in mind the thorny issue of staff performance targets, whether Mr Vallis let down HMRC or did HMRC’s system of management let him down? I suspect it is the latter.

There are several reasons why I am not happy about how matters appear to have proceeded. In essence, my concerns emanate from the fact that HMRC’s representative was not contesting matters against a barrister or an experienced tax professional. Mr Potter represented himself and his wife and was therefore to be viewed as a litigant in person (LiP). Bearing this in mind, one expects specific standards from HMRC’s representative – whether or not they are a barrister – and the tribunal judge. The objective is to ensure that justice is done and it has to be said that Judge McKeever’s conduct in this regard was exemplary. She went out of her way to deal with the situation in a manner that can be said to be of great credit to the tribunal’s reputation.

Inadequate preparation?

Although I said above that I wished to avoid the technical issues (addressed in my previous article) there is one technical aspect worth repeating. The Potter family company was involved in a specialist area of the financial world – the London Metal Exchange (LME). Mr Potter operated as an ‘introducing broker’ and ‘dealer’ on the exchange where trades in base metals, such as copper, took place. Mr Potter found people among his contacts who wished to speculate in metals and introduced them to banks willing to finance large LME transactions. Believe it or not, HMRC’s statement of case to the tribunal (an important document to which many hours are devoted) asserted: ‘The company sold insurance.’ So, there we have it. The purpose of the hearing before the tribunal was to establish whether the family company was a trading company yet, as Judge McKeever observed in her decision: ‘HMRC did not have a good understanding of the nature of the taxpayers’ business.’ This seems astonishing. Did not Mr Potter have the right to expect that HMRC’s presenting officer would have a good grasp of this important fact?

All the indications are that Mr Potter had made the position quite clear to HMRC long before the case was listed for a hearing. Particular reference to some of the past correspondence between the parties was made during the hearing and the judge commented to the effect that the nature of some of the questions asked by HMRC in the correspondence (presented in evidence), suggested a lack of understanding. The full explanations provided by Mr Potter had fallen on deaf ears, so to speak.

Such misunderstandings are unfortunate but they are not unusual and, if the only point of concern was that the caseworker (as opposed to the presenting officer) was found to have been floundering in their attempts to understand the situation properly, I would not be writing this article. My first serious concern is that there appears to have been inadequate preparation by HMRC for the hearing. Is it not self-evident to officials handling a dispute regarding the status of a company’s activities that they must have a firm grasp of the type of activities carried on? Might it be that the departmental team thought they understood the entrepreneurs’ relief provisions, but did not? I shall return to this later in this article.

The path to justice

My next concern may lead readers to suspect that I am naïve. I refer again to Mr Potter being a LiP and ask whether, if HMRC is represented by a barrister, such litigants can expect to enjoy a better ‘pathway’ to justice than when HMRC is represented by one of its own team of presenting officers?

My point is this: I understand that it is accepted in legal circles that if one party to a hearing is represented by a barrister or other authorised person and the other party is a LiP, an overriding duty to the court falls on the authorised person. For example, (in relation to situations involving a LiP) part of the Law Society’s guidance to its members states: ‘A lawyer’s paramount duty is to the court and to the administration of justice.’

While noting that authorised persons should act in the best interest of their client, the guidance goes on to state: ‘Persons who exercise before any court a right of audience, or conduct litigation in relation to proceedings in any court, by virtue of being an authorised person should comply with their duty to the court to act with independence in the interest of justice…’

Recognising the seeming conflict in the above statements, the society’s guidance confirms that the duty to the court and to the administration of justice may operate to the potential disadvantage of a lawyer’s client by, for example, requiring that the lawyer should not mislead the court or withhold from it documents and authorities even where they detract from their clients’ cases. I understand the Bar Standards Handbook contains similar guidance as to when a barrister’s duty to the court takes precedence, broadly speaking, over their core duty to the client.

What point am I making now?

While nothing in the protocols alluded to above requires a solicitor or barrister to aid the LiP and argue the case on their behalf, there is a clear expectation that justice must be seen to be done despite the LiP’s lack of experience or training. So my question is this: if Mr Vallis had been a barrister, would he not, having drawn the judge’s attention to the high court decision in Marriott v Lane [1996] STC 704, been expected to say something along the lines of: ‘I would also like to draw the attention of the court to the case of Kirk & Randall Ltd v Dunn [1924] 8 TC 663 which, at first sight, addresses a similar point and from which it will be seen that the judge observed: “Because in the middle of a great career a company, or still more an individual professional man, might have a year when he was holding himself out for business, or the company was holding itself out for business, but nothing came, yet that would not effect a break in the life of the company for income tax purposes.”’

He might have gone on to add: ‘This judgment might be thought to assist Mr Potter in his arguments, but I believe the situation facing Mr and Mrs Potter can be distinguished from that of Kirk & Randall Ltd for the following reasons…’

The issue in my eyes is that Mr Vallis was silent on this point. Had Mr Potter been represented by a competent professional there can be little doubt that Kirk & Randall Ltd v Dunn would have been discussed and presented (along with other relevant decisions) in support of the claim – despite the distinctions.

Why was Kirk & Randall Ltd v Dunn not raised, if only to be dismissed by Mr Vallis as not relevant? Surely HMRC would not argue that by allowing someone who is neither a qualified lawyer nor barrister to represent the department the LiP can only rely on the judge to ensure the hearing is fair and properly analyses the law in the light of relevant authorities? Unless I am mistaken, it appears to have been left to Judge McKeever to balance the scales of justice. Did this come about because of HMRC’s policy, the pragmatism of officials or both?

Another grumble?

If the published decision in the Potter case is anything to go by, the level of advance consideration given by HMRC officials suggests a mind-set along the lines of: ‘It’s obvious the taxpayer is going to lose.’

When, in my previous article, I suggested HMRC might have been expecting a quick win, I drew attention to the absence of any real analysis of the relevant law: TCGA 1992, s 165A(3) and (4). It is perhaps worth repeating (with my emphasis) the key aspects of these subsections:

‘(3) “Trading company” means a company carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities.

‘(4) For the purposes of subsection (3) above “trading activities” means activities carried on by the company:

a) in the course of, or for the purposes of, a trade being carried on by it;

b) for the purposes of a trade that it is preparing to carry on;

c) with a view to its acquiring or starting to carry on a trade; …’

Judge McKeever analysed the relevant statute carefully and commented: ‘As ever, I must start from the legislation. Section 165A(3) focuses on “activities”. The company’s activities must not “include to a substantial extent activities other than trading activities”. In other words I need to consider what the company actually does.’

Later, she states: ‘The focus is on what the company is actually doing; its activities. In addition, those activities must be done for the purposes either of a trade that is actively being carried on or that the company is preparing to carry on.’ Clear and concise.

What I have been unable to work out is why Judge McKeever’s approach was a surprise to HMRC. The judge’s approach reflects exactly the department’s own interpretation of the legislation since its introduction in 2008. Was advice taken from the department’s own capital gains tax specialists? Worse still, did no one read any of the material in Taxation? Neither of the above seems likely but, from the arguments advanced, it seems that the case was not submitted to a policy or technical specialist for advice.

The upshot is that it was left to Judge McKeever to sort the wood from the trees which brings me back to my question of whether the case would have been handled in the same way if the department was not preparing to encounter a LiP?

I hope I am wrong in contemplating that HMRC might have been influenced by the type of litigant. And to demonstrate that this article is not an ‘HMRC bashing’ exercise I would like to draw readers’ attention to the judgment in a more recent tribunal decision on entrepreneurs’ relief, Reneaux and Reneaux-Smith (TC7441). There is no need to go into detail other than to highlight paragraphs 24 and 25 of the judgment. Once again, HMRC was represented by Mr Vallis. However, on this occasion, when the taxpayers were represented by a tax practitioner, the judges went as far as to record: ‘Mr Vallis helpfully summarised the questions for the tribunal arising from s 169I and s 169S.’ They went on to say: ‘We agree that these are the questions which should be asked and we will address these questions in order.’

To be commended in this manner is no mean feat. To be frank, the different approach adopted in the two cases makes me wonder whether there is more than one Mr Vallis handling entrepreneurs’ relief appeals within HMRC.

Just a bad day at the office?

Returning to the Potter case, Mr Vallis went on to argue that, even if it was found that there were some trading activities in the relevant period, as a consequence of the decision made by the directors in November 2009 (not long after the impact of the financial chaos in 2008 and 2009 became clear for all to see), to invest £600,000 (almost 75% of the company’s then cash reserves) into two investment bonds, the activities of the company then became ‘substantially’ investment activities.

Mr Vallis acknowledged that there was no statutory definition of ‘substantial’ but, given the amount invested in the bonds and the fact that the company’s only income was derived from them, he asserted that it was difficult to say that the investment of the cash funds in the two bonds could be considered anything other than a substantial non-trading activity. In his opinion, that was all there was to it and, seemingly, there was no need for further analysis.

Fortunately for the Potters, Judge McKeever considered matters more carefully. She began by alluding to the fact that ‘Mr Vallis did not refer to HMRC’s own guidance on when a company will be regarded as having substantial non-trading activities.’ Almost as if enlightening him on the matter, Judge McKeever states in her published decision ‘[HMRC’s] guidance is to be found at CG53116 in the Capital Gains Manual and states as follows…’ The key paragraphs referred to by Judge McKeever are as follows.

‘The phrase “substantial extent” is used in various parts of the TCGA 1992 to provide some flexibility in interpreting a provision without opening the door to widespread abuse. In this context “substantial” means more than 20%.

‘A company, group or subgroup whose non-trading activities amount to more than 20% of its total activities (excluding intra-group or intra-subgroup activities) does not meet the trading requirement. Some or all of the following are among the indicators that might be taken into account in reviewing a particular company, group or subgroup’s status.

• The level of turnover received from non-trading activities (CG53116a).
• Whether the value of non-trading assets was substantial in relation to the value of all assets (CG53116b).
• The expenditure incurred or time spent by officers and employees on non-trading activities (CG53116c).
• The company’s history (CG53116d).

‘Balance of indicators

‘These indicators should not be regarded as individual definitive tests to which a 20% “limit” applies. They are factors, or indicators, that may be useful in establishing whether there is substantial overall non-trading activity. It may be that some indicators point in one direction and others the opposite way. You should weigh up the relevance of each in the context of the individual case and judge the matter “in the round” (see approach of the Special Commissioner in the inheritance tax case of Farmer and another (exors of Farmer dec’d) v CIR SpC 216).’

It is clear from the above that, in HMRC’s opinion, there is much to be addressed in any given situation but Mr Vallis seemed to turn away from his department’s guidance.

Judge McKeever points out in her judgment that HMRC’s guidance is just that; it is not legislation – a subject covered by Robert Maas in ‘Dispensing the correct treatment’ (Taxation, 16 January 2020).

The question of investments

Let’s be clear, Mr Vallis was right to raise the question of the investments held by the Potters’ company. Admittedly, my only knowledge of the Potters’ case is derived from the written judgment but I do question how the issues raised in paragraph CG53116 of the department’s own Capital Gains Manual were not even alluded to when he presented his argument to the tribunal. Was he unaware of its contents or did he choose to ignore this guidance recognising that, by having to take a view based upon the ‘balance of indicators’, his position would be weakened? Was Mr Vallis simply having a ‘bad day at the office’, so to speak, or was he too focused on winning the case?

The importance of the approach outlined in CG53116 can be seen from Judge McKeever’s comments. She noted that although Farmer was an inheritance tax case (where the focus is on ‘business’ rather than ‘activities’ – so it was not looking at quite the same test), the approach set out in CG53116 was nevertheless helpful to her. She concluded:

‘When one stands back and looks at the activities of the company as a whole and asks “what is this company actually doing?” the answer is that the activities of the company are entirely trading activities directed at reviving the company’s trade and putting it in a position to take advantage of the gradual improvement in global financial conditions. Having carefully considered all the evidence and circumstances I find that the activities of the company did not, to a substantial extent, include activities other than trading activities.’

In short, HMRC’s argument that there existed a substantial investment activity was totally rejected.

Why am I banging on about HMRC’s approach given the taxpayers’ appeals were successful? In short, I feel the outcome in this case was brought about by a combination of Mr Potter’s considerable ability to present the facts of the situation and the judge’s resolve to focus on the legislation and its interpretation.

Earlier, I asked whether Mr Vallis understood the relevant entrepreneurs’ relief provisions as well as he thought. On reflection, it seems pretty clear – especially taking on board the conduct of the Reneaux appeal – that he knows the provisions as well as I do. Perhaps pressure of work resulted in an unfortunate approach being adopted in the Potter case.

I wonder whether HMRC’s officials are comfortable with the events as portrayed in Judge McKeever’s published decision? I hope not and that the conduct of the case will be quietly reviewed within the department.

And finally...

After all is said and done, the Potters’ appeals were successful. May I suggest that readers find the time (the self-assessment deadline of 31 January having now passed) to study the case of Bashir Ahmed Jafari (TC7465) at tinyurl.com/sf82o63. The judge was disappointed with HMRC’s pleadings and went on to say: ‘It is one thing for HMRC to take a principled stance that certain decisions of the courts and tribunals contain errors of law and to argue accordingly (but frankly) in affected cases. But it is quite another thing to gloss over decisions which HMRC knows but dislikes and to proceed as if they do not exist. Doing so obscures the true position and risks the tribunal coming to a legally insupportable conclusion.’

Judge Austen added: ‘HMRC did not act with the necessary candour. In fact, regrettably, I would say that HMRC failed to meet its obligation to “help the tribunal to further the overriding objective” of dealing with cases fairly and justly under rule 2(4)(a) of the rules’ (the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009).

Am I wrong to care about HMRC’s conduct of appeals? Has it become all about winning rather than demanding the right amount of tax? Should the outcome of an appeal depend on which HMRC officer presents its case? As not only a longstanding chartered tax adviser but also a former employee of the Inland Revenue, I very much hope not.

Comment from HMRC

An HMRC spokesperson said:

'We are disappointed that Mr Slevin’s article, “A bad day at the office,” appears to HMRC to question our conduct at a tribunal hearing, and the actions of an HMRC Officer. Mr Slevin acknowledges that he was not present at the hearing.

‘We consider that the article does not fairly describe the proceedings before the Tribunal, including suggestions that HMRC had not prepared for the proceedings properly, and that HMRC’s approach was influenced by the fact that the case involved a litigant in person.

‘We are unable to comment in detail about the case, as readers will know that our duty of confidentiality prevents this. Nevertheless, we wish to make clear that HMRC prepared properly and carefully for this case, as we aim to do in all litigation matters.

‘We are always mindful of the challenges faced by litigants in person and take our role in supporting them through the litigation process seriously, helping them to understand the process and what actions they are required to take.

‘It is not uncommon in litigation that new evidence and facts may emerge late in the process (or during a hearing), which if known earlier, may have altered HMRC’s analysis of the issues in dispute. ‘We are therefore surprised at the inferences that Mr Slevin feels able to draw from the tribunal judgment.’

Issue: 4730 / Categories: Comment & Analysis