On 2 July 2021, the Supreme Court delivered its judgment in R (on the application of Haworth) v HMRC [2021] UKSC 25, finding unanimously in favour of the taxpayer and upholding the Court of Appeal’s decision to quash the follower notice issued to him.
What it Means for Taxpayers
The Supreme Court held that HMRC can only issue a follower notice where they consider that there is “no scope for a reasonable person to disagree” that an earlier judicial decision would deny the taxpayer the advantage claimed. This test is both (i) more precise and (ii) imposes a higher threshold than the Court of Appeal’s formulation that required HMRC to only have “a substantial degree of confidence in the outcome”. This reformulation of the test is apt considering the severe consequences which such measures can have for taxpayers.
The Court’s decision is likely to be of primary relevance to cases with less uniform fact patterns or where the issues involved are fact sensitive. Tax avoidance schemes which are mass marketed are likely to be harder to distinguish from those addressed in earlier decisions and thus remain more susceptible to follower notices. Nevertheless, taxpayers may still be able to point to differences in the legal arguments raised, so a thorough assessment of such arguments would be sensible.
The Court also confirmed that follower notices are not automatically invalidated by defects. Taxpayers should therefore be wary of ignoring such notices simply because they consider them to be non-compliant, particularly on formal or technical grounds.
The Follower Notice Regime
The follower notice regime is contained in Part 4 of the Finance Act 2014 (“FA 2014”). It applies where HMRC contend that an advantage claimed by a taxpayer depends on a particular interpretation of a taxing statute which a court has already decided is wrong.
Where HMRC issue a follower notice, the taxpayer has two options: they can either (i) accept HMRC’s interpretation, concede the advantage and pay tax on that basis, or (ii) refuse to do so and maintain the claim. If they do the latter and HMRC are ultimately proven to be correct, the taxpayer may be liable not only for the tax owed but also an additional and substantial penalty calculated by reference to the value of the claimed advantage.
Furthermore, the existence of a follower notice forms one of the bases on which HMRC can issue an accelerated payment notice, which requires the taxpayer to pay the disputed tax to HMRC on account, in advance of the substantive issues being determined.
Background to the Case
The taxpayer sought to make use of what is commonly referred to as a ‘round the world’ scheme to avoid the payment of UK capital gains tax on the disposal of shares by a trust of which he was the settlor. It aimed to do this by taking advantage of provisions in the Taxation of Chargeable Gains Act 1992 and the UK/Mauritius double tax convention to ensure that Mauritius (which did not charge capital gains tax) had the sole taxing rights.
HMRC issued the taxpayer with a follower notice on the basis that the scheme was materially the same as the one which had been held to be ineffective by the Court of Appeal in the prior case of Smallwood v HMRC [2010] EWCA Civ 778 (“Smallwood”).
The taxpayer’s challenge by judicial review was initially rejected by the High Court but upheld by the Court of Appeal, which quashed the follower notice. The case then came to the Supreme Court to finally resolve the issue.
The UK Supreme Court’s Judgment
The main issue
Before HMRC can issue a follower notice, they must be of the opinion that “the principles laid down, or reasoning given, in the [earlier] ruling would, if applied to the chosen [tax] arrangements, deny the asserted advantage or part of that advantage” (emphasis added) (sections 204(4) and 205(3)(b) FA 2014).
The main issue before the UKSC concerned the degree of certainty that this test requires from HMRC as to the application of the prior ruling. The UKSC held that it is not sufficient for HMRC to opine that the earlier ruling is likely to deny the taxpayer’s advantage; instead, they must consider that there is “no scope for a reasonable person to disagree” that it would. Since this threshold was not met, the follower notice was quashed.
The Court’s decision was based, in part, on the fact that the follower notice regime restricts taxpayers’ constitutional rights to have their case determined by a court by imposing the risk of a significant financial penalty. As such, the provisions had to be interpreted narrowly to reduce the interference with those rights to the minimum extent necessary, whilst still being consistent with the aim that Parliament wanted to achieve by enacting the regime, namely to reduce the resources needed to deal with unmeritorious claims. It was therefore appropriate to give full weight to Parliament’s use of the word “would” in the legislation.
Having set out the relevant test, the Court identified four factors that it said would be relevant to whether HMRC can reasonably form the opinion that the earlier ruling would deny the claimed tax advantage. These were: (i) how fact sensitive the application of the previous decision is (i.e. whether a small difference in the taxpayer’s facts as compared with those of the earlier decision would prevent it from applying); (ii) HMRC’s view of the truthfulness (or otherwise) of the taxpayer’s evidence; (iii) whether the taxpayer raised any legal arguments not considered in the earlier decision; and (iv) the precedential value of the earlier decision (e.g. whether the taxpayer was legally represented and the reasoning in the decision was clear).
The remaining issues
The Court also determined three other issues, holding that:
- HMRC had overstated the Court of Appeal’s conclusion in Smallwood and therefore misdirected themselves as to its relevance to this case;
- Factual findings do form part of the “principles laid down” or “reasoning given” in a prior decision for the purpose of section 205(3)(b) FA 2014; and
- Whilst the follower notice was defective as it did not contain all of the information required by section 206 FA 2014, it remained valid as the legislation does not provide that any defect in the notice will render it invalid and the defects in this case did not do so.
The full text of the Supreme Court’s judgment is available here.