HMRC v Cotter (2011) - Carry-back of relief for losses in employment

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29 June 2011

The High Court recently heard a test case regarding the correct procedure for claiming employment loss relief which is available to be carried back against income and gains of previous tax years.  The Court held that such a claim must be made in respect of the year in which the loss arises, and may not be included in a taxpayer's return for an earlier year of assessment.

Background

The case concerned a scheme designed to generate an employment loss which could be offset against a taxpayer's income and capital gains for the tax years 2007-08 and 2008-09.  Mr Cotter was one of approximately 60 individuals who used the scheme.  In January 2009, his accountants amended his 2007-08 return to include a provisional loss relief claim, which purported to reduce his tax liability from £211,927 to nil.  In submitting the claim, his accountants acknowledged that it might be at variance with HMRC's interpretation of tax law, and stated that they assumed HMRC would open an enquiry into the merits of the claim.

HMRC subsequently notified Mr Cotter of its intention to make such an enquiry, but also demanded payment of the full sum of £211,927, on the basis that the claim could not be made by way of amendment to the 2007-08 return, because the relevant loss did not arise in that year of assessment.  According to HMRC, Mr Cotter was obliged to pay the full amount of assessed tax up-front, and he would then be entitled to repayment of the tax with interest if and when his claim for loss relief was established in accordance with the statutory procedure.

Mr Cotter argued that he was entitled to include the claim in his 2007-08 return, and that it should therefore be taken into account in calculating the net tax due.  HMRC brought proceedings in the County Court to recover the unpaid tax, and the matter was then transferred to the High Court to determine the question of whether claiming loss relief by way of amendment to a previous year's tax return was a permissible approach.

Judgment

The High Court held that as Mr Cotter's claim for loss relief related to the 2008-09 year of assessment, he was not permitted to include it in his return for 2007-08.  It followed that Mr Cotter could not rely on his claim for employment loss relief as a defence to HMRC's claim for the assessed tax.

The relevant legislation is contained in paragraph 2 of Schedule 1B to the Taxes Management Act 1970.  This provides that where a claim for relief involves two or more tax years, the claim "shall relate to the later year" and "[e]ffect shall be given to the claim in relation to the later year".  According to the analysis adopted by the Judge in this case, the effect of these provisions is that such a claim may not be included in the return for the earlier year, because under the statute it relates to the later year.

Analysis

The dispute between HMRC and the taxpayer in this case arose in the context of a commercially-marketed tax avoidance scheme, and the decision of the High Court may be viewed as supporting HMRC's anti-avoidance strategy, by removing the cash-flow benefits which may otherwise be gained through deferring the payment of tax while a claim for loss relief is tested through the Tribunal system.

However, the potential significance of the decision may be considerably wider than the specific circumstances of the scheme used by Mr Cotter.  For example, the statutory interpretation favoured by the Court could also be applied to early trade losses relief and terminal trade loss relief under sections 72 and 89 respectively of the Income Tax Act 2007, and to claims in respect of losses on earnouts under section 279A of the Taxation of Chargeable Gains Act 1992.  The requirement of up-front payment may be an onerous one in many cases, especially when viewed in the light of the potentially severe penalties for late payment of tax which came into force on 6 April 2011.  

We understand that the taxpayer is currently in the process of bringing an appeal against the High Court's decision in this case.

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