'Staleness' in UK tax discovery assessment

The recent case of Clive Beagles v HMRC considers whether a 'discovery' by HM Revenue & Customs (HMRC) that insufficient tax had been paid can go 'stale' if a discovery assessment is not issued within a certain period of time after the discovery is made, invalidating the assessment.

Discovery assessments

When a taxpayer files their self assessment tax return, there is a standard 'window' within which HMRC can open an enquiry, which is typically twelve months following submission of the tax return. Once those twelve months have passed, if an underpayment of tax is identified by HMRC in relation to that return, they have the ability to raise an assessment for the tax only if the conditions of 'discovery' have been met and the affected tax year falls within the extended time limits that discovery provides. The loss of tax must have been brought about carelessly or deliberately and "the officer could not have been reasonably expected, on the basis of the information available to him before that time, to be aware" of the tax loss. The legislation does not, however, set out how long after becoming aware of the tax loss the officer must make an assessment.

If the discovery conditions are met, HMRC is able to assess a tax year at any time up to six years after the end of the year of assessment to which it relates if there has been careless behaviour on the part of the taxpayer and 20 years in the case of deliberate behaviour.

So, the development in the case law around staleness in discovery is significant. It could be the difference between HMRC assessing underpaid tax involving tax years within a 20 year window versus not being able to assess anything

Cases on staleness

Since 2008, the courts have been exploring whether there is a concept of 'staleness' when dealing with discovery assessments. In Corbally-Stourton v HMRC, the First-tier Tribunal (FTT) acknowledged that a discovery could go stale by defining that a discovery is something which "newly arises". Subsequent cases have affirmed this interpretation with the Upper Tribunal (UT) decision in Charlton v HMRC stating that a discovery assessment must be issued whilst it retains its "essential newness". The decision in Pattullo v HMRC echoed this sentiment but chose the turn of phrase "fresh" to describe the state of a discovery when it should be acted upon. The concept of "staleness" provides for each case to be decided on its facts as to when the particular piece of information which alerted HMRC to the tax loss becomes stale.

In February 2018, the UT in HMRC v Tooth said it agreed with the UT in Charlton that "on making a discovery, HMRC must act expeditiously in issuing an assessment" and that an assessment must be issued whilst the discovery is "new".

The latest case to consider the issue is Clive Beagles v HMRC. Clive Beagles entered into a tax avoidance arrangement promoted by KPMG to create a tax loss which was reported in his 2001/02 tax return and HMRC did not open an enquiry into this return by the normal enquiry window deadline of 31 January 2004. HMRC had opened enquiries into the returns of all the other taxpayers who had entered into the KPMG scheme for the 2001/02 period within the enquiry window. By 30 June 2004 HMRC became aware that it had missed the time limit to enquire into Beagles's return. As they were merely investigating the scheme and had not yet 'discovered'  a loss of tax in respect of the arrangement, an HMRC officer decided not to raise a discovery assessment at this time.

However, in August 2005, HMRC notified KMPG that it had received advice from counsel that the arrangement was not effective and that it intended to challenge it in a test case in the tribunal. The letter said there was a possibility of a discovery assessment being issued to Beagles, if the scheme was found not to work.

In August 2007, the Special Commissioners decided that the KPMG scheme did not work in the case of Astall v HMRC [2008] STC (SCD) 142, a decision which was subsequently upheld by the Court of Appeal.

HMRC did not issue a discovery assessment to Beagles until January 2008. As at January 2008, tax year 2001/02 was within the time limits of discovery but Beagles appealed against the assessment on the grounds that the discovery had become stale. The FTT found for HMRC, but Beagles was successful in the Upper Tribunal.

Can a discovery go stale?

The FTT dismissed HMRC's arguments that it was not possible for a discovery to become stale on the basis that it was bound by the decision of the Upper Tribunal in Patullo. 

A decision of the Upper Tribunal is not binding on a later Upper Tribunal but will be followed unless the later tribunal is convinced that the earlier one is wrong. In the Beagles case the judges decided to follow the Patullo decision as they were not convinced it was wrong, but they did comment that the issue needed to be considered by a higher court. They did not seem to be entirely convinced that staleness was a valid concept, commenting that they could see both sides of the argument. They recognised that it seems wrong not to require HMRC to assess promptly once a discovery has been made, but on the other hand they accepted that the legislation does not expressly state that an assessment must be made within a specific period of a discovery being made.

When was the discovery made?

The FTT had decided that the HMRC officer did not make the discovery until the Special Commissioners' decision in the Astall case in August 2007.

However, the UT decided that the discovery was made by August 2005 at the very latest, when HMRC wrote to KPMG, as by that time the HMRC officer was of the view that the scheme did not work and Beagles's return was therefore incorrect. The Astall decision could have constituted a discovery but in this case the discovery had already been made at the time of the advice from counsel and an HMRC officer could not make the same discovery twice for the same reason.

The UT said that in Beagles's case that the lengthy delay of nearly two and a half years before the assessment was issued was material and meant that the discovery had lost its quality of newness by the time the assessment was issued and so the assessment was invalid.

Where does the case leave us?

It seems as if the question of whether the staleness of a discovery can invalidate an assessment is likely to be considered at some stage in the higher courts. In the meantime, the current position is that we now have two cases where the UT has expressly decided that the concept exists, and a raft of other cases where judges have expressed the view that discoveries can become stale.

There appears to be no hard and fast rule as to what time needs to elapse before a discovery becomes stale. This will depend upon the circumstances. In Charlton a delay of a few months to wait for an appeal in another case to be decided did not cause a discovery to lose its "essential newness". In Patullo despite an observation that a discovery would only lose its newness "in the most exceptional of circumstances" due to inaction on the part of HMRC, Lord Glennie said that a delay of 18 months would render an assessment stale "on any view". In Tooth the UT said a five year delay would make a discovery stale.  

In Beagles the judges felt a wait of two and a half years after the discovery to make the assessment was too long. The judges pointed out that there was no ongoing litigation in August 2005 at the time of the discovery as the Astall case had not yet begun and so the HMRC officer could not have known whether there would be any relevant litigation or whether it would be determined before the six year assessment time limit expired.  

In cases where HMRC has taken a long period of time to issue a discovery assessment, the decision underlines the importance of trying to establish when it could be argued that HMRC has discovered an under assessment and of raising staleness arguments in appropriate cases. With HMRC's backlog of work in avoidance cases, there will always be taxpayers who slip through the net and where assessments are not raised in a timely fashion. As a successful staleness argument can effectively invalidate an assessment meaning that the tax cannot be recovered, the stakes are high for both HMRC and the taxpayer.

Josie Hills and Steven Porter are tax experts at Pinsent Masons, the law firm behind Out-Law.com.

This update is based on an article which was published in Tax Journal on 25 January 2019.