HMRC disputes own calculations

HMRC has won a £3.1m case at a First Tier Tribunal (FTT) where part of the argument centred on whether or not the tax authority could challenge calculations derived from third party software developed to meet its own technical specifications, which may have implications for Making Tax Digital implementations

The case related to two closure notices, both dated 13 February 2015, one for the tax year 2006/07 and the other for the tax year 2007/08. They concerned a taxpayer who had used a scheme involving insurance policies to produce a deduction which was then offset against other gains. [Andrew Scott and the Commissioners for Her Majesty’s Revenue and Customs [2017] UKFTT 385 TC05851].

The closure notices showed income of £44.16m in respect of the tax year 2006/07 and chargeable gains of £8.84m; and in respect of the tax year 2007/08, income of £7.98m and chargeable gains of £14.71m.

Part of the argument related to an appeal against HMRC’s decision that the rate of capital gains tax (CGT) applicable to gains accruing in each of those tax years was 40%, rather than 20% as the taxpayer contended, on the basis of the taxation regime which prevailed at the time.

The other element in dispute turned on the manner in which the tax was calculated and assessed.  The returns for the relevant tax years were submitted incorporating calculations of the tax due made using software based on HMRC’s specifications. Those calculations showed tax payable on capital gains at the lower rate.

Following enquiries under section 9A of the Taxes Management Act 1970 (TMA), HMRC issued closure notices charging tax on those gains at the higher rate. Scott argued HMRC was responsible for the way in which his tax liability was calculated in the relevant years and it was not open to HMRC to ‘enquire’ into a calculation which HMRC had itself performed.

The FTT heard evidence that HMRC accepted that third party software developed to its specifications could still throw up potential errors because it was not possible to test it against all potential fact patterns.

HMRC dealt with problems in two ways – one category was ‘specials’ where a ‘work-around’ can be used to enter the figures in a particular way using the software in order to produce the correct result; the second category was ‘exceptions’, which are cases where it is known that the software will not produce the correct result, but there is no known work-around using the software. In these cases, the taxpayer has to file a paper return.

Scott’s was one of only 13 cases identified in the 2007/08 tax year in which the tax calculator for the relevant CGT rules produced what HMRC believed to be an incorrect result. The total tax at stake in the other 12 cases was £23,000, whereas in Scott’s case it was £3.1m.

The FTT disagreed with Scott’s argument that HMRC could not enquire into what were, effectively, its own calculations.

The judge said: ‘The wording of section 9A(4)(a) is clear. HMRC is entitled to enquire into “anything contained in the return”. That wording is broad and would naturally extend to the calculation of tax payable that is contained in the return.’

On that basis HMRC was entitled under section 9A TMA to enquire into the calculations of tax due for the tax years in question and so the amendments made by the closure notices were valid.

In his commentary on the outcome, Andrew Hubbard, consultant with RSM, said the FTT case underscored widespread concerns about the operation of HMRC’s flagship Making Tax Digital programme, which will require quarterly online tax updates.

‘We know, because HMRC has said this many times, that it will not be issuing its own software and that all users will have to rely on third party software. We also know that HMRC will be specifying how that software should operate - so similar problems may occur again.

‘In the end I have to reluctantly agree with the tribunal: the law is the law and problems in software design can’t be allowed to override it.

‘But this sort of thing does leave a bad taste in the mouth. If people are forced to use third party software designed to HMRC’s specification then surely HMRC must have some responsibility for that software.

‘I’d like to think that this was an exceptional case because of the amounts involved, and that in future, any small glitches in favour of the taxpayer are allowed to stand. But somehow I doubt I,’ Hubbard said.

In a statement, HMRC said: ‘We welcome the tribunal’s decision. HMRC works hard to secure all taxes that are due, including defending challenges in courts and tribunals. This decision revolved around a set of exceptional circumstances, and has no significant implications for Making Tax Digital’.

Andrew Scott and the Commissioners for Her Majesty’s Revenue and Customs [2017] UKFTT 385 TC05851 is here.

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Given the fiasco over the 2016/17 self-assessment returns where there will be rather more than 13 cases - in the thousands I imagine - where tax calculated in accordance with HMRC specs is wrong, their conclusion that 'This decision...has no significant implications for Making Tax Digital' is ludicrous. If the legislation is so complex that even HMRC can't calculate it correctly then the taxpayers - who have nowhere near HMRC's resources and specialist knowledge - are in an untenable situation. Did they charge penalties in this case for careless or deliberate mistakes because the taxpayer used HMRC's calculations?

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