Taxpayers held liable for failure to recognise the commercial reality of transactions


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Taxpayers held liable for failure to recognise the commercial reality of transactions

A recent case where two taxpayers were held negligent for submitting incorrect tax returns because they failed to determine the commercial reality of transactions they entered into highlights the importance of seeking tax advice.


The recent case of Litman & Newall v HMRC [2014] UKFTT 089 (TC) illustrates that investors should understand any planning they undertake and should question whether the proposed planning is likely to result in challenges by HMRC- especially in the current environment that is hostile to aggressive tax avoidance.

The facts were broadly as follows. The taxpayers participated in a capital redemption policy scheme under which they claimed a capital loss of £400,000 each in their tax returns. Under the scheme they each took out a loan of £400,000 which was used to buy the policies and was later repaid. The loans facilitated a capital loss which they could offset against capital gains. They were both advised on the entries they should make in their returns, including the Disclosure of Tax Avoidance Scheme (DOTAS) number for the relevant scheme.

In 2009 the England & Wales Court of Appeal ruled that the scheme was ineffective. As a result the couple were forced to pay the tax and interest due. In addition HMRC also charged the couple penalties for submitting ‘negligently delivered incorrect returns’.

The couple decided to appeal against this decision and argued that they had insufficient experience in tax law and had relied on professional advice. The appeal was dismissed on the basis of a decision made in the case of Hanson v HMRC [2012] UKFTT 314 (TC) where it was stated that a taxpayer cannot leave everything to their professional adviser. The tribunal found, that because the scheme involved a loan, the taxpayers were negligent for not having enquired into whether it had been advanced or repaid. Further by including a DOTAS number on their return they ought to have been aware that HMRC may enquire into their returns and this in itself would not relieve them from the responsibility of questioning the commercial basis of the transactions.

This case serves as a reminder that taxpayers may not be able to absolve themselves of all responsibility for their actions in relation to the consequences of tax planning arrangements. More importantly investors should seek appropriate tax advice to ensure they fully understand how certain planning arrangements work, that they appreciate any risks prior to deciding whether or not to proceed… and the recourse available to them if the arrangements fail.