Ames: No EIS relief without income tax claim but Tribunal grants judicial review of HMRC's decision

In Ames v HMRC [2018] UKUT 190, the Upper Tribunal (UT) has held that capital gains tax (CGT) relief under the Enterprise Investment Scheme (EIS) is not available on the disposal of shares where no income tax relief was claimed on their acquisition. However, in refusing to allow a late claim for EIS income tax relief, HMRC had misapplied the relevant guidance, fettered its discretion, and failed to consider material facts. The UT therefore granted judicial review of HMRC's decision.

Background

In January 2005, Mr Robert Ames (the taxpayer) invested £50,000 in shares in a company. It was accepted that these shares were eligible for EIS relief. As the taxpayer's taxable income for 2004/05 was only £42, he did not claim EIS income tax relief.

In June 2011, the taxpayer sold his shares for £333,200 and in October 2012, he submitted his self-assessment tax return for 2011/12. He did not include in his return any gain in relation to the shares because he understood that the gain was exempt from CGT under EIS. This understanding was influenced by telephone conversations with an HMRC tax adviser in April and May 2011, during which the taxpayer had been informed that despite not having made an EIS income tax relief claim he would be fully exempt from CGT.

HMRC considered that the taxpayer was only entitled to exemption from CGT if he had obtained EIS income tax relief on the acquisition of the shares and, as he had not, he was liable to pay £72,000 in CGT in relation to the gain. 

HMRC also refused the taxpayer's late claim for EIS income tax relief.

The taxpayer appealed to the First-tier Tribunal (FTT). 

FTT decision

The taxpayer's appeal was dismissed.

The FTT held that the CGT exemption under the EIS required there to have been a grant of EIS income tax relief. In relation to the late claim for relief, the FTT considered that it lacked jurisdiction to allow the taxpayer to make a late claim, but suggested that he ask HMRC to reconsider its refusal. The taxpayer did make such a request to HMRC, maintaining that he had had a reasonable excuse, but HMRC once again refused his claim.

The taxpayer appealed to the UT.

UT decision

The taxpayer maintained before the UT that, under section 150A(2), Taxation of Chargeable Gains Act 1992, it was not necessary for a person to be granted EIS income tax relief in order to be entitled to the CGT exemption and/or that the tribunal should apply a rectifying construction to ensure that the gain was exempt from CGT if EIS income tax relief was available on the acquisition of the shares, even if not actually claimed.

At the relevant time, section 150A(2) had provided that where "an amount of EIS relief is attributable to the shares ... the gain shall not be a chargeable gain". The meaning of "attributable" was made clear in section 150A(11) and section 289B, Income and Corporation Taxes Act 1988. Section 150A(11) provided that section 289B applied for the purposes of determining whether EIS relief was attributable to any shares. Section 289B(2) provided that "relief attributable to any shares" had to be read as a reference to "any reduction made in the individual's liability to income tax which was attributed to those shares". That interpretative provision applied directly to section 150A(2). 

In the view of the UT, it was clear that at the time the CGT exemption was claimed, a claim for EIS income tax relief had to have been made and given effect to.

In relation to the argument that the UT should adopt a 'rectifying construction' to the relevant legislation, the UT said that before applying a rectifying construction a court had to be sure: 

(a) of the intended purpose of the statute under consideration; 

(b) that by inadvertence Parliament had failed to give effect to that purpose; and

(c) of the substance of the provision Parliament would have made had the error been noticed.

In the instant case, the UT could not be sure that the intended purpose of section 150A(2) was to allow CGT exemption on the disposal of shares where no EIS income tax relief had been obtained. It was not obvious that no policy justification could justify linking the two types of tax relief and that such a link was a mistake, even if it had anomalous results for subscribers of EIS shares who had no income tax liability. It was also not clear to the UT what provision Parliament would have made, had it intended to extend the benefit of CGT exemption to those who had no relevant income tax liability. Accordingly, the UT concluded that it was not entitled to apply a rectifying construction and the tax appeal was dismissed.

Judicial review

In refusing the late claim, HMRC had applied its guidance from 'Guidance Note SACM10040'. The final point of that guidance stated that there might be "exceptional cases ... not covered by guidance concerning the ... claim ... where it might still be unreasonable for HMRC to refuse a late claim". The UT determined that HMRC had not applied that important final point. The fact that a broader consideration of the merits had not been carried out was demonstrated by HMRC's contention that "the concept of reasonable excuse does not come into consideration in accepting late claims". Although reasonable excuse was not a criterion in itself, it was a relevant factor when considering other circumstances that justified late admission. In the view of the UT, it could not be inferred that HMRC had had the residual discretion in mind but decided not to exercise it. 

Further, there was evidence that an HMRC officer had thought that full relief would be available and had informed the taxpayer accordingly during a telephone call. This demonstrated that even HMRC's own technical expert had misunderstood the guidance as it applied to the taxpayer's circumstances and that he had been given misleading information by the HMRC officer concerned. The UT concluded that HMRC had wrongly fettered its discretion and there had been no consideration of whether it was an exceptional case despite the unusual circumstances. 

The UT was influenced by the fact that claiming relief would have been a pure formality and would not have resulted in income tax relief being obtained by the taxpayer. It had been perfectly reasonable for the taxpayer to believe that, given his very small income, he did not have to make a claim for relief. There was no guidance dealing specifically with those circumstances. The taxpayer had been expected to waive his personal allowance, which was entirely counter-intuitive and was not dealt with in any guidance. The decision-making process was flawed, in that HMRC had misapplied its guidance, fettering the exercise of its discretion and had failed to consider material facts. The question of whether to allow the late claim was remitted by the UT back to HMRC.

Comment

This decision is important in that it demonstrates that, in the context of a judicial review challenge, the UT (in this case the judicial review claim was heard by the UT, as opposed to the High Court) is able to quash a decision made by HMRC when the decision in question was not reached in a proper and fair way. In this case, HMRC had not followed its own guidance and its decision was therefore unlawful. The UT found that HMRC's decision-making process was flawed as it had fettered the exercise of its discretion and had failed to consider material facts.
Although HMRC's guidance is not law or legally binding, where HMRC officers act contrary to such guidance, their decisions are susceptible to successful challenge by way of judicial review. 

A copy of the decision may be viewed here.