Knibbs – HMRC's challenge to carry-back loss relief claims was correct

In Knibbs and ors v HMRC and R (oao Astley and ors) v HMRC [2019] EWCA Civ 1719, the Court of Appeal has held that Schedule 1B, Taxes Management Act 1970 (TMA), can apply to a claim for carry-back loss relief.

Background

The claimants had made claims to carry back losses arising from tax avoidance arrangements which they had participated in, either directly or through partnerships, mainly involving investments in films. It had been held (in other proceedings) that those arrangements failed to generate losses. 

The central issue was whether the only way in which HMRC could enquire into the carry-back claims to 'Year 1' was by means of a notice of enquiry given under paragraph 5(1)(a), Schedule 1A, TMA, or was it also open to HMRC to enquire into the claims under section 9A, TMA, as part of an actual or deemed enquiry into the taxpayers' self-assessment returns for 'Year 2' (i.e. the year of assessment in which the claimed losses arose). As no enquiries had been opened by HMRC under Schedule 1A before the time limit expired, it was necessary to determine whether the carry-back claims fell within the exclusive ambit of Schedule 1A.

Following the decision in R (on the application of De Silva) v HMRC [2017] UKSC 74, HMRC's position was that it was entitled to enquire into the carry-back claims either under section 9A (into the claimants' self-assessment tax returns for Year 2), or under section 12AC, TMA (into the partnership returns). The claimants accepted that following De Silva the appeals of those claimants whose Year 2 was 2006/07 or earlier, being before the Income Tax Act 2007 (ITA) came into effect, would fail. 

The claimants applied for declarations from the High Court (under CPR, Part 7) that their claims had become final and HMRC was obliged to give effect to them, as no HMRC enquiries had been made within the relatively short time limits for enquiries under Schedule 1A, TMA. 

The High Court struck out the claims on the basis that (a) bringing the claims in the High Court was an "abuse of process"; and (b) that where a carry-back loss relief claim has mistakenly been given effect to, HMRC may seek repayment through an adjustment to the taxpayer's tax return for the year in which the losses arose.

The claimants appealed the High Court order striking out their claims to the Court of Appeal. There was also before the Court of Appeal an application for permission to appeal against a High Court order refusing permission to proceed with an application for judicial review. Both cases raised essentially the same substantive issues of law and the six applicants in the judicial review proceedings were claimants in the Part 7 proceedings.

Court of Appeal judgment

The Court of Appeal, upholding the decision of the High Court, rejected the applications for declarations, for the following reasons:

1.  the applications constituted an abuse of process; and

2. HMRC was entitled to enquire into the claims under sections 9A and 12AC, TMA.

Abuse of process

The Court held that the correct procedure for the individual partners to challenge the amendments made to their returns was by way of judicial review rather than seeking declarations from the High Court. The Court gave four principle reasons for this:

1. There were no private law rights involved in the instant claim. 

2. The time limits (in CPR 54) were a strong factor in favour of judicial review being the correct procedure. 

3. The challenges affected a large number of people and raised no issues of fact that might be unsuitable for determination in judicial review proceedings. 

4. The requirement for permission to pursue a judicial review did not make it an unsuitable procedure in the circumstances of the case, any more than in the many other tax and non-tax cases to which it applies.  

The High Court was therefore correct to conclude that, irrespective of the merits of the substantive issues arising, the Part 7 proceedings should be struck out as an abuse of process.

Enquiry into the claims 

In the view of the Court, the highly prescriptive scheme for calculation of income tax liability in Part 2, Chapter 3, ITA, did not have to be construed so as to exclude from its ambit the operation of paragraph 2(6), Schedule 1B, TMA, in circumstances where a carry-back claim for trade loss relief had been made. In the opinion of the Court, it was clear that Parliament intended paragraph 2(6) to continue to apply to such claims, and that effect should therefore be given to them in the context of the Chapter 3 calculations of tax liability. 

The Court explained that first, the list of reliefs deductible at step 2 in section 24(1), ITA, included trade loss relief against general income under section 64, ITA. As section 64 was contained in Part 4, Chapter 2, ITA, the relief was expressly made subject to paragraph 2, Schedule 1B, TMA, (by virtue of section 60(2), ITA). Section 60(2) provided the necessary link between trade loss relief under ITA and Schedule 1B, and showed that Parliament must have intended paragraph 2 to have full force and effect for the purposes of Part 4, Chapter 2, loss relief where the claim required the relief, or part of it, to be given in Year 1. In other words, the provisions of paragraph 2 would apply for the purposes of any claim to trade loss relief under ITA which was not confined to a "sideways" claim for relief in Year 2 alone.

The Court went on to say that it would be wrong to construe sections 23 and 24, ITA, in "hermetic isolation" from the rest of the Act, when section 24 required you to look at section 64, which was expressly made subject to paragraph 2, Schedule 1B, where the claim to trade loss relief had a carry-back element. Accordingly, calculation of the taxpayer's income liability for Year 2 under section 23 had to, where appropriate,  take account of, and give effect to, the provisions of paragraph 2, Schedule 1B. 

The Court emphasised that the taxpayer had to give full information about the claim in their Year 2 return, because it might impact on the amount of tax for which they were liable in that year; and HMRC could then open an actual or deemed enquiry into the Year 2 return under section 9A. Once the necessary link to Schedule 1B had been identified within ITA, there was no basis for distinguishing post-2007 claims from pre-2007 claims.

Comment

The Court of Appeal has confirmed in this case that tax returns for years in which losses arose that were the subject of carry-back claims, can be the subject of actual or deemed enquires by HMRC under sections 9A or 12AC, TMA, even though the losses arose in tax years after 2006/07.

The Court also confirmed that tax returns for years in which losses arose that were the subject of carry-back claims can be the subject of actual or deemed enquiries by HMRC, under sections 9A or (in the case of partnership losses) 12AC, TMA (sections 9A and 12AC), and that those returns can be amended to recoup sums wrongly paid to the taxpayers, even though the losses arose in tax years after 2006/07.

The Court has also made it clear that seeking declarations, in relation to tax issues, from the High Court where either a statutory right of appeal exists and/or the taxpayer has a right to seek judicial review of HMRC's decision, will amount to an "abuse of process". 

The judgment can be viewed here.