The decision of the First Tier Tax Tribunal in the case of Silvester v HM Revenue and Customs published this month considered the tax position where a farmer makes habitual trading losses, as well as revisiting the question of when HMRC can make a discovery assessment.
The Five Year Rule
Most farmers are aware of the so called 5 year rule, also sometimes referred to as the hobby farming rules, which prevents the sideways relief of losses (before capital allowance claims) sustained over a continuous 5 year period.
Whilst there was no dispute that Mr Silvester, through his partnership, had suffered the requisite 5 years of losses he put forward an argument that he met the less well known sub-test in the legislation which permits relief to continue after 5 years where there is a “reasonable expectation of a profit”.
That sub-test, found in s.68 Income Taxes Act 2007, requires (to paraphrase) that a competent person:
- Carrying on the activities in the current year would reasonably expect future profits, but
- Carrying on the activities at the start of the loss making period could not reasonably have expected a profit until after the end of the current tax year
It was a valiant effort by the taxpayer to sidestep the intended effect of the 5 year rule but the Tribunal ultimately sided with HMRC and upheld the Revenue’s assessments to tax. From a neutral standpoint, it was probably the right decision, and there was probably a collective sigh of relief from HMRC who would no doubt have been worrying itself about the raft of loss relief claims they might have received had the Tribunal found in the taxpayer’s favour.
The other interesting facet of the case was that one of the years in question was out of time for HMRC to launch an enquiry and could only be amended by the use by HMRC of what is termed a discovery assessment.
In the simplest possible terms, taxpayers’ returns may be looked into by HMRC for only a period of 1 year following their submission, but may be amended in cases where HMRC ‘discover’ an error between 2 and 20 years following submission, depending on the perceived behaviour of the taxpayer in making that error.
A discovery, to quote from the tribunal decision, required that “an officer of HMRC could not have been reasonably expected to be aware, on the basis of the information made available to him or her before that time, that the partnership’s farming activities had made losses in each of the previous five tax years.”
The taxpayer contended that HMRC were well aware of the loss position of the partnership in each of the preceding five years, having been in receipt of partnership tax returns and corresponding accounts for each of those years and having also been in receipt of the returns of the partners which incorporated the corresponding loss relief claims.
However the Tribunal also found in HMRC’s favour on this point, concluding that only an explicit entry on the return in question highlighting that a five year period of losses had occurred would have been sufficient to have made HMRC aware of the facts of the case.
This seems to be just the latest in a long string of tax findings in favour of HMRC in respect of time limits and discovery assessments, the result of which seems to be that the statutory one year time limit protection given to taxpayers in respect of their self assessments has been eroded almost to the point of uselessness.
If you would like to further discuss the affect this ruling could have for you or your business, please feel free to talk to us on 0845 606 9632 or contact us via our webform.