We act for a number of clients who have made trading losses and claims have been made to carry these losses back to earlier tax years. HMRC is currently enquiring into the trading losses. The clients are self-employed and currently the tax relief is shown as a credit on the statement of account. Following the decision in Cotter v HMRC, do our clients now need to pay the tax?
The decision in Cotter [2013] UKSC 69 emphasises the issue with UK common law which is that the courts can only decide the cases that are brought before them. The facts in that case were relatively unique, in that the taxpayer sought to amend the tax return for the earlier tax year but did not elect to calculate the tax. The question before the court was whether the claim was included in the return. This should have been a simple question, but the High Court and the Court of Appeal came to opposing decisions. In the Supreme Court, Lord Hodge decided the claim was not included in the return, as the taxpayer had not elected to calculate the tax and HMRC was entitled to ignore the claim. So far, the matter seems clear. However, Lord Hodge went further and indicated the position would have been different if the taxpayer had entered the claim in the return and elected to calculate the tax.
Lord Hodge seemed to put great emphasis on the taxpayer requesting the tax calculation pages and electing to calculate the tax. In many cases, however, the return will be completed using a computer program which automatically calculates the tax. It is also more common for such claims to be included in the tax return for the year in which the loss was incurred (year 2) and carried back to an earlier year (year 1). These issues were not addressed in the decision because they did not need to be.
Claims made by amending the earlier year tax return (year 1)
If your clients made the claims by amending the tax return in year 1, then they fall within the facts of Cotter. It is clear that if your client did not elect to calculate the tax, then the claim was not included in the return. HMRC is therefore not required to give effect to the claim and an enquiry should be made under TMA 1970 Sch 1A.
However, at para 27, Lord Hodge indicated the answer could have been different if the taxpayer had calculated the tax. In these circumstances, the claim would have been included in the return and TMA 1970 s 9A would be applicable. HMRC would therefore need to enquire into the claim and your clients would be entitled to retain the credit until the matter was determined by a closure notice.
Claims made in the tax return for the year in which the loss was incurred (year 2)
If the claim was made in the tax return for year 2 and the taxpayer did not include the claim in the tax calculation or did not elect to calculate the tax, it would seem that, based upon the decision in Cotter, this will be a claim not included in the return. As such, HMRC is not required to give effect to the claim and the enquiry should be made under Sch 1A.
However, following Cotter, it may be possible to argue that the entry of the claim in the return and its inclusion in the self-assessment calculation mean that the claim is included in the return and s 9A applies. Until further clarification is obtained from the courts, it is probably sensible to take the view most beneficial to the client in respect of whether the claim was or was not included in the return.
Claims made separately
Where the client made a claim completely separate from the tax return (a standalone claim), the claim will not have been included in the tax return and the enquiry should be under Sch 1A.
Giving effect to the claim
The above should cover most situations applicable to your clients. Where s 9A applies, there should be no requirement to pay the tax until the enquiry is concluded. However, where Sch 1A applies, the issue arises as to whether HMRC has given effect to the claim. Where the credit has been given in the statement of account and has not been disputed by HMRC, it is reasonable to argue that effect has been given to the claim. Any tax would then be payable at the conclusion of the enquiry.
Interest
The cash flow benefit of receiving the tax credit may be a material consideration for your clients. However, it should also be remembered that if the claims are found to be partly or wholly invalid, interest will be due.
Legal basis for enquiry
You should also consider the basis on which HMRC has opened any enquiry. There are two clear and distinct paths under s 9A and Sch 1A. You should ensure that HMRC is using the correct path.
Conclusion
Unfortunately, Cotter has only clarified the situation in respect of very particular facts. In other circumstances, you will need to look at how a particular claim was made and determine if s 9A or Sch 1A applies. In the latter case, you then need to determine whether effect has been given to the claim. Once these questions have been answered, together with the client you will need to weigh up the cash flow benefit of retaining the credit against the interest which could eventually be payable.
