Judicial Review in the Tax Sphere: Does the Court of Appeal's decision in Murphy offer taxpayers a glimmer of hope?

In overturning the High Court's (HC) refusal of the taxpayers' judicial review claim, the Court of Appeal (CoA) in Murphy v HMRC [2023] EWCA civ 497, confirmed that HMRC had breached their legitimate expectation as to the application of an Extra-Statutory Concession (ESC). While Murphy is unlikely to be the harbinger of a wholesale rebalancing of the judicial review scales in the taxpayer's favour, it is a welcome step in the right direction.

This blog is based on an article by Adam Craggs and Liam McKay that appeared in Tax Journal issue 1622 (9 June 2023).

Extra Statutory Concession B18

In Murphy, the courts considered the proper approach to the construction of ESC B18 (first issued in 1978), which sought to address certain anomalies that arose under Finance Act 1973 (FA 1973), in respect of payments out of discretionary trusts. The underlying statutory provisions were re-enacted without any substantive change in the Income and Corporation Taxes Act 1988 (ICTA 1988), and subsequently replaced by sections 492 to 498, Income Tax Act 2007. 

ESC B18 extended the "look-through" relief contained in section 18 FA 1973 (later section 809, ICTA 1988) to non-resident beneficiaries of a non-resident trust with UK source income, enabling them to claim credit for UK income tax paid by the trustees (Concession One). Credit could only be obtained in respect of taxed overseas income that arose to the trustees not earlier than six years before the end of the year of assessment in which the payment was made to the beneficiary. ESC B18 provided a “similar concession” in relation to payments from a non-resident discretionary trust, subject to the trustees submitting the requisite returns and paying the additional rate tax on UK source income.  

Further iterations of ESC B18 were issued in 1994 and 1999. ESC B18 (1994) extended relief to UK resident beneficiaries of non-resident trusts. ESC B18 (1999) largely replicated ESC B18 (1994). It retained Concession One, and contained two further concessions under the heading "Non-resident trusts": one applying where “a non-resident beneficiary receives … a payment out of income of the trustees in respect of which, had it been received directly, it would have been chargeable to UK tax” (Concession Two) and the other allowing a “UK beneficiary of a non-resident trust” to “claim appropriate credit for tax actually paid by the trustees on the income out of which the payment [to the beneficiary] is made” (Concession Three). 

The key issue in Murphy was whether Concession Three was subject to the six-year limitation period.

Background

The claimants were the beneficiaries of a retirement trust (the Trust). The trustees were resident for UK tax purposes in Guernsey and the claimants were resident in the UK. The trustees received UK source income in the form of interest, on which they were liable to (and did) pay UK income tax. The net amounts generated further income as overseas bank interest.

The claimants sought confirmation from HMRC that ESC B18 applied to allow tax credit on distributions from the Trust with no six-year limitation. HMRC advised that a six-year limitation applied. 

The claimants requested that HMRC reconsider its decision but, before HMRC replied, the Trust deed was varied and the Trust assets were distributed to the claimants. The distributions constituted income in the hands of the claimants for tax purposes. Each claimant paid UK income tax on the distributions, but made claims for tax credit, under ESC B18, in respect of the UK income tax paid by the Trust in all past tax years on the income out of which the distributions were made. 

HMRC allowed the claim for credit for income tax paid by the trustees on UK source income arising to the trustees for the previous six years and repaid the income tax paid. However, HMRC rejected the claims for credit in respect of the income tax paid by the trustees on UK source income arising in tax years before that period. 

The claimants brought a judicial review claim challenging HMRC's decision, arguing that Concession Three granted relief without a six-year limitation, such that HMRC was wrong to reject their claims. The claimants also argued that ESC B18 had to be interpreted so as not to infringe the EU law rights of taxpayers, and that HMRC's interpretation would constitute unjustified discrimination contrary to Articles 49 (freedom of establishment) and/or 63 (free movement of capital) of the Treaty on the Functioning of the European Union.

HC judgment

The HC determined that ESC B18 was susceptible to two competing interpretations and, to decide between them, it was necessary to go beyond the language of ESC B18 and consider the statutory scheme and previous iterations of ESC B18. The HC considered that to be the context against which the ordinarily sophisticated taxpayer would read ESC B18. 

The HC held that while Concession Three may have extended the credit mechanism in section 17, FA 1973, (later section 687, ICTA 1988), which was not subject to the six-year limitation, rather than the look-through relief in section 18, FA 1973, it did not follow that the extension was unrestricted. Rather, taken in conjunction with the fact that the draftsman regarded Concession Three as a second limb of Concession Two, it would be anomalous if Concession Three provided relief to a greater extent than either section 18, FA 1973, Concession One, or Concession Two. The HC considered that conclusion was supported by the fact that Concession Three granted relief that must be claimed, and it was understandable that HMRC would wish to limit the number of years of records it had to check when deciding whether to grant such relief. In the view of the HC, the claimants' case was not advanced by resort to principles of EU law. Accordingly, the claim was dismissed.

CA judgment

The CoA approached the interpretation of ESC B18 in a rather more orthodox fashion than the HC, focussing primarily on the text of the concession itself. In that regard, the CoA determined that, read naturally, the text of ESC B18 strongly supported the claimants' case. In particular, it concluded that on a natural reading it was clear that the conditions specified in Concession One, including the six-year limitation, were applicable also to Concession Two. That was because both Concessions supplemented section 809, ICTA 1988, such that it was to be expected that both Concessions were restricted in the same way as section 809.

However, the CoA considered the position was different for Concession Three, for five reasons. Firstly, because of the way in which ESC B18 was laid and the fact that Concession Three was located in a separate paragraph to Concession Two. Secondly, if the conditions set out in respect of Concession One were intended to apply to Concession Three, there would have been no need to spell out the conditions contained in the text of Concession Three. Thirdly, while the conditions listed in Concession Three largely replicated those provided for in Concession One, the draftsman did not consider it appropriate to repeat the requirement for a payment to be “out of income which arose to the trustees not earlier than six years before the end of the year of assessment in which the payment was made”. In the view of the CoA, the obvious inference was that Concession Three was not intended to be subject to that limitation. Fourthly, the absence of any paragraph break in key parts of the text provided additional reasons for thinking that the conditions in Concession Three were stated comprehensively. Fifthly, it was highly significant that Concession Three specifically invoked section 687, ICTA 1988, which differed from section 809, ICTA 1988, in its omission of the limitation. 

Further, and unlike the HC, the CoA did not consider that issues of practicality for HMRC would lead an “ordinarily sophisticated taxpayer” to infer there was a six-year limitation if ESC B18 did not otherwise so indicate. That was especially the case given the stringency of the conditions specified in Concession Three. 

The CoA was also of the view that EU law was of significance. In particular, the CoA determined the hypothetical “ordinarily sophisticated taxpayer” could be expected to appreciate that, read in the way advanced by HMRC, ESC B18 could favour UK trusts over non-resident ones and therefore potentially run counter to EU law principles. The CoA considered that would tend to confirm that, contrary to HMRC’s case, Concession Three was not subject to a six-year limitation.

The CoA expressed some doubt as to whether it was right to have regard to previous versions of ESC B18 because an “ordinarily sophisticated taxpayer” would not expect to have to research earlier versions in order to understand ESC B18 (1999), especially when ESC B18 (1978) and ESC B18 (1994), were not readily available. An “ordinarily sophisticated taxpayer” should not be assumed to have looked at, or even to have had access to, old books where earlier versions of ESC B18 may have been located, and neither of the earlier versions was readily accessible on the internet. In any event, if it was appropriate to consider the earlier versions, the CoA held that, on balance, the prior history tended to support the claimants' case. 

Finally, and although obiter, the CoA agreed with the HC that no account should be taken of materials that the “ordinarily sophisticated taxpayer” could not have been expected to be aware of. As such, if the “ordinarily sophisticated taxpayer” would have had no means of knowing of an HMRC practice in relation to an ESC, it was appropriate to disregard it. Conversely, the CoA considered there may be cases in which the “ordinarily sophisticated taxpayer” would have been alerted to a settled practice of HMRC through, for example, HMRC manuals, published guidance or commentaries in practitioner texts, and such materials may be relevant when determining whether a taxpayer had a legitimate expectation in those cases. 

The CoA therefore concluded that Concession Three was not subject to a six-year income limit and allowed the appeal.

Comment

In the tax sphere, increasing demands on public finances, coupled with a seemingly ever-worsening economic climate, have brought HMRC's revenue gathering function and HMRC's wide array of powers to help it satisfy the government's desire to increase the tax yield, into sharp focus. HMRC's exercise of its powers has, in some cases, been more ambitious than Parliament intended, with the result that, in recent times, there has been no shortage of judicial review claims against HMRC. However, the perception is that it has become more difficult in recent years to successfully challenge a decision of HMRC by way of judicial review. 

It is against that backdrop that the CoA's decision in Murphy was made and why many tax practitioners will welcome the decision. That is not to suggest that Murphy represents a seismic shift in the taxpayer's judicial review fortunes, it does not. It is nonetheless a small step in the right direction, for a number of important reasons. 

Firstly, on the substantive point, the decision confirms that there is no time limit in respect of Concession Three of ESC B18. That is of course a significant outcome for UK-resident beneficiaries of non-UK resident trusts. Secondly, the CoA's guidance on the characteristics to be attributed to the "ordinarily sophisticated taxpayer" provides helpful clarification on the test to be applied in claims for breach of legitimate expectation. Thirdly, the CoA's guidance is supplemented by its preference for a more orthodox approach to the courts' task of construing the statements on which a legitimate expectation may be founded, which arguably limits HMRC's ability to expand the type of knowledge to be ascribed to the "ordinarily sophisticated taxpayer" in any given case. The CoA's comments, albeit obiter, on the irrelevance of materials such as HMRC manuals, guidance and commentaries that the "ordinarily sophisticated taxpayer" could not have been expected to be aware of, are especially helpful in that regard. Finally, the CoA's confirmation that EU law can be of relevance when construing the statement in dispute will strengthen taxpayers' claims for breach of legitimate expectation where the interpretation favoured by HMRC can be shown to be inconsistent with EU law. All of these will be welcomed by taxpayers.

The judgment can be viewed here.