Smith v Commissioners for HMRC

A recent tax and insurance case, reviewed by Heather Viljoen

An appeal against a discovery assessment to capital gains tax relating to a second-hand insurance policy (SHIP) scheme was the root of this case.

HMRC became aware of a capital loss avoidance scheme using SHIPs around 2001. In July 2002, an internal memo was issued to HMRC staff describing the scheme and noting its intention to challenge it. This was followed up by a paper setting out how this may be done.

HMRC noted that the scheme typically operated through the taxpayer buying a second-hand non-qualifying life assurance policy then redeeming it a few days later, often for less than the purchase price. A capital loss equal to the amount paid for the policy was then claimed by the taxpayer on the basis that all the disposal proceeds had been taken into account in calculating the chargeable event gain liable to income tax.

The only figure in the capital loss calculation was, therefore, the price paid for the policy. The losses were typically set against capital gains in the same year.

The scheme in which the taxpayer participated was designed to create a tax deductible capital loss of £532,695.

The taxpayer's accountants filed his tax return for tax year 2000-2001 in January 2002. The return included white space disclosures describing the acquisition and redemption of the bond, cross-referring between income pages and capital gains tax pages, citing applicable sections of the relevant legislation, showing the calculation of nil income and a £532,695 capital loss on redemption, and giving a short description of how those results were obtained.

The HMRC officer reviewing the taxpayer's return discussed it with HMRC's technical group and subsequently received - during sick leave - written guidance on dealing with scheme cases such as the taxpayer's. No action was taken on the file in his absence and, by the time he returned, the enquiry window had closed.

In November 2006, HMRC raised a discovery assessment against the taxpayer under section 29 of the Taxes Management Act 1970 in the amount of £159,808.40. The taxpayer appealed.

Change of mind

The tribunal agreed with HMRC's argument that the threshold to establish a discovery within section 29 was low: HMRC could raise a discovery assessment (subject to the section conditions) if it discovered that insufficient tax had been assessed or excessive relief given. This included where the discovery was merely because of a "change of mind". HMRC did, therefore, make a "discovery" within the meaning of section 29.

However, under the section, HMRC can only assess a taxpayer if one of two conditions is met. In this case, the applicable condition was that the HMRC officer could not have been reasonably expected to know about the unassessed gains, on the basis of the information available to him before the enquiry window closed. Information would be considered to be made available to the officer if it was within the list set out in section 29(6) and (7) of the Act. This list was exhaustive.

Here, only the taxpayer's 2000-2001 tax return was relevant. And, although the information in the taxpayer's return was sufficient to warrant a hypothetical officer opening an enquiry, this was not the relevant test.

It was unreasonable to expect the actual officer to be aware of an insufficiency of tax at the time the enquiry window closed given the complexity of the scheme law, HMRC was still then considering whether the scheme worked, and the Court of Appeal's decision in Drummond v HMRC [2009], which determined the ineffectiveness of the scheme, was many years away. The discovery assessment was, therefore, valid and the appeal dismissed.

See Smith v Commissioners for HMRC [2013] UKFTT 368 (TC)

Heather Viljoen is a solicitor at Michelmores

She writes regular case updates for Private Client Adviser

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