Could HMRC successfully tax income when its source could not be identified?

 In Tax

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Tax: discovery – Ashraf v HMRC [2018] UKFTT 97

Case Summary from LawSkills | Private Client specialist trainersMr Ashraf submitted a number of self-assessment returns, disclosing income from three different sources. HMRC opened an investigation and eventually raised further assessments after identifying a shortfall in the income Mr Ashraf had declared. He appealed the assessments and ensuing penalties.

The facts

Mr Ashraf made tax returns for the years 2005-6 to 2011-12. The income was of three different kinds: income from employments, profits from UK land and property, and dividends from UK companies.

On 21 February 2013 HMRC opened an investigation into Mr Ashraf’s tax affairs. Mr Ashraf declined to make admissions, but agreed to cooperate. He answered the standard questions denying any errors or inaccuracies in his returns and those of his businesses. The investigation had been opened because of a report from a VAT compliance officer dealing with Zonehead Ltd, a company controlled by Mr Ashraf.

In March 2015 HMRC sent a schedule of calculations of Mr Ashraf’s personal income and expenditure over a period beginning in 2005, showing a shortfall of approximately £258,000 in his declared income, without taking into account personal expenditure such as food and clothing. Correspondence on the shortfall ensued, and in October 2015 HMRC’s current position, as communicated to Mr Ashraf, was that the shortfall was approximately £276,709.

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HMRC made assessments under s.29 Taxes Management Act 1970 (TMA), which were appealed by Mr Ashraf.

In May 2016 penalty determinations and assessments were made and notified for the same tax years as the s.29 assessments, and in June 2016 a penalty explanation letter was sent to Mr Ashraf. These penalties were also appealed. A reviewing officer upheld HMRC’s decisions to assess penalties, though considered further mitigation of the penalties justified.

Mr Ashraf appealed to the Tax Tribunal.

The Tribunal asked for clarification regarding the description of the income in the further assessments raised by HMRC. HMRC responded that they had not been able to identify an income source, so had allocated it to trading income. HMRC further submitted that as there was not a clearly identifiable source it was reasonable to describe this as ‘other income’, and the miscellaneous income charging provisions in the Income Tax (Trading and Other Income) Act 2005 (ITTOIA) were appropriate to use.

Mr Ashraf had sought to explain that the deficits arose from non-taxable sources, some of which had been accepted in the review, but most not.

The law

S.687 ITTOIA states:

“Charge to tax on income not otherwise charged

(1)     Income tax is charged under this Chapter on income from any source that is not charged to income tax under or as a result of any other provision of this Act or any other Act…”

The decision

The tribunal first considered what income was assessed, quoting from Tiley’s Revenue Law:

“…If an income receipt does not fall within any part or Schedule, it is not taxable; there is no need to seek a general definition of income” and “…the courts have held that every piece of income must have a source…

The Tribunal held that it was clear s.687 ITTOIA did not apply to the deficit in Mr Ashraf’s figures. The Tribunal again referred to Tiley, who noted that s.687 was the successor of Case VI Schedule D income (as it used to be). A receipt must have a source to be within Case VI, and a typical source for Case VI income was a contract for services rendered — the Tribunal noted a sum or receipt could not be its own source. HMRC relied solely on s.687 when they realised they needed to show a taxable source, but applying the features identified by Tiley, it was clear that s.687 did not apply to Mr Ashraf’s deficit.

The further assessments, so far as they sought to charge income under s.687 ITTOIA, could not stand and should be cancelled. As a result, the penalties charged fell away and must be cancelled.

The Tribunal did however comment that:

“We wish to make it clear that this decision does not by any means represent a clean bill of health for the appellant and his companies.”

Mr Ashraf’s accountant had been prepared, in an effort to settle the case, to acknowledge a deficit of £70,000, although the appellant was ‘wholly unable’ to say from what source the deficit arose. The Tribunal noted they would have found there were substantial inconsistencies and difficulties with timing and credibility of many of the explanations given. Nevertheless, this was insufficient in the absence of a source of the income.

Practice points

  1. At first sight this case might have seemed a long shot for the client, but detailed analysis of how the tax legislation worked helped him to win the appeal, even where the merits were perhaps not on his side.
  2. Practitioners will want to ensure that technical arguments that may benefit their client are carefully considered in preparing an appeal.

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