The power of HM Revenue and Customs (HMRC) to make discovery assessments is a powerful one. It broadly enables HMRC to (among other things) assess additional tax resulting from tax return errors, if certain conditions are satisfied.
The discovery assessment legislation is a contentious area. The provisions are relatively brief and widely drawn, resulting in a considerable body of case law before the courts and tribunals over the years. This article deals with the discovery assessment legislation as it applies to individuals (ie for income tax and capital gains tax purposes) in TMA 1970, s 29. However, the discovery rules for companies (in FA 1998, Sch 18, paras 41-45) are broadly similar.
HMRC will generally seek to use its discovery powers if (for example) the statutory time limit for enquiring into the taxpayer’s return has expired (ie normally twelve months after the date of filing, or longer if the return was submitted late), or after HMRC has completed an enquiry into the return. However, certain requirements must be satisfied for a discovery assessment to be valid.
An HMRC officer must broadly ‘discover’ in respect of the taxpayer for a particular tax year that income or gains have not been assessed; or that a tax assessment has become insufficient; or that excessive relief has been given (s 29(1)). This discovery requirement is subject to certain taxpayer safeguards (in s 29(2), (3)), including where the taxpayer has submitted a return which was made under the ‘practice generally prevailing’ when it was made.
If the taxpayer has filed a tax return for the relevant tax year, HMRC cannot generally raise a discovery assessment unless one of two conditions is satisfied. The first condition is that the loss of tax was brought about carelessly or deliberately (s 29(4)). This condition was recently considered in Bubb v Revenue and Customs  UKFTT 216 (TC) (see below).
The distinction between a ‘careless’ or ‘deliberate’ loss of tax can be an important one. The ordinary time limit for HMRC to make income tax or capital gains tax assessments of four years after the end of the relevant tax year is extended to six years if the loss of tax was brought about carelessly, or 20 years if brought about deliberately (TMA 1970, s 36). HMRC often refers to these discovery assessments as ‘extended time limit’ assessments.
The second, alternative condition is broadly that when HMRC’s tax return enquiry window closed, or when an enquiry into the taxpayer’s return was completed, the HMRC officer could not have been reasonably expected, from the information made available to him before that time, to be aware of the relevant loss of tax (s 29(5)).
The ‘careless’ condition
In an appeal hearing regarding an extended limit discovery assessment made because of an alleged careless (or deliberate) loss of tax (ie on the basis that the condition in s 29(4) is satisfied), HMRC guidance accepts that it must demonstrate that the alleged behaviour supports the assessment (see HMRC’s Enquiry manual at EM3348). In other words, the tax assessed must be attributable to careless (or deliberate) behaviour.
In Bubb v Revenue and Customs, the taxpayer’s self-assessment returns for 2009/10 and 2010/11 contained the following errors:
(1) The taxpayer mistakenly omitted his state pension from both returns (nb HMRC’s system picked up this error for the 2010/11 return and corrected it, but did not do so for 2009/10).
(2) The taxpayer’s return for 2009/10 significantly understated the total amount of his occupational pensions (he had included the correct amounts for pensions and tax deducted in the additional information or ‘white space’ section of the return, but this information was not picked up by HMRC’s system when processing the return).
(3) His tax return for 2010/11 understated employment earnings and overstated tax deducted.
HMRC issued discovery assessments for both tax years. The taxpayer appealed. He pointed out that there had been difficulties in putting information together for the returns. For example, having sold his house in England, many of his records were in storage in England or packed up in France, and he also had no form P60 in respect of his employment earnings for 2010/11. Furthermore, the taxpayer contended that he had experienced difficulties submitting his tax returns online from France, resulting in around eight failed attempts. He also stated that the online system had randomly deleted some figures and changed others.
The First-tier Tribunal was satisfied that the discovery requirements of s 29(1) were met, and noted that s 29(4) required the taxpayer’s careless behaviour to have brought about the under-assessments. The tribunal found that the taxpayer was careless in not including his state pension in either the 2009/10 or 2010/11 tax returns. The taxpayer simply overlooked the income on the basis that it was paid into his wife’s account, which was clearly careless.
However, the tribunal concluded that the discrepancies for 2009/10 had no rational explanation other than a software or system-related submission error. The extent to which the errors in the tax return for 2010/11 return were due to system problems was less clear. The tribunal stated that the error in respect of employment income might be attributable either to a system error, or to the taxpayer using his last payslip rather than form P60. However, the tribunal did not think that this was careless in the circumstances. With regard to pension income for 2010/11, the tribunal thought it more likely than not that there was a system error.
The discovery assessments were made to make good under-assessments resulting from the errors in (2) and (3) above. The tribunal noted that the burden of proof was on HMRC to establish carelessness (Hankinson v HMRC  EWCA Civ 1566, citing HMRC v Household Estate Agents Ltd  EWHC 1684 (Ch)).
However, the tribunal did not consider HMRC had established that those errors were caused by careless behaviour by the taxpayer (by contrast, there was careless behavior in omitting the state pension income). HMRC was not permitted to raise assessments to recover a loss of tax that HMRC had not established was attributable to careless behavior. Accordingly, the taxpayer’s appeal against the discovery assessments was allowed, as they were not validly made under s 29.
HMRC in the above case made discovery assessments in respect of the ‘wrong’ errors, i.e. the only careless errors made by the taxpayer were in respect of his omitted state pension income, which were not the subject of the discovery assessments. The tribunal also noted that throughout correspondence between HMRC and the taxpayer, including the independent review process that HMRC undertook in respect of the discovery assessments, significant errors were made by HMRC in relation to determining whether the taxpayer had been careless, and also in their explanations to him.
The moral of the above case is to check carefully that discovery assessments have been validly made. The tribunal in Bubb provided a useful reminder that HMRC has no general power to raise assessments under s 29, and that in the case of the condition in s 29(4) HMRC’s power is limited to making good a loss of tax brought about by careless (or deliberate) behaviour.
Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP is a consultant to professional firms with Mark McLaughlin Associates Ltd (www.markmclaughlin.co.uk). Mark is the General Editor of the Bloomsbury Professional Core Tax Annuals as well as a contributor to many other Bloomsbury professional titles. He is also Managing Editor of TaxationWeb (www.taxationweb.co.uk). He can also be contacted via Twitter https://twitter.com/charteredtax and LinkedIn http://www.linkedin.com/pub/mark-mclaughlin/11/811/12.