Litman & Anor v Revenue & Customs

Factual and Procedural Background

This appeal concerns penalties imposed on two taxpayers for negligence in their 2004/5 capital gains tax returns arising from the disposal of shares in a UK company and UK land and buildings. The taxpayers participated in a capital redemption policy scheme marketed by a group based in the Isle of Man, claiming capital losses to offset gains realized. They relied on professional tax advice from two firms and included a DOTAS number in their returns as required by tax avoidance disclosure rules.

The scheme involved the creation of life settlement trusts, acquisition of capital redemption policies funded by interest-free loans from a related company, and subsequent surrender of the policies. HM Revenue and Customs (HMRC) opened enquiries into the taxpayers' returns and subsequently issued penalty determinations for negligent delivery of incorrect returns under section 95(1)(a) of the Taxes Management Act 1970. The taxpayers appealed the penalties, which were heard together by the First-tier Tribunal.

Legal Issues Presented

1. Whether the taxpayers were negligent in failing to understand the commercial reality of the acquisition and disposal of the capital redemption policies and the financing arrangements underlying the scheme.
2. Whether reliance on professional advice and the inclusion of the DOTAS number in the tax returns negated negligence.
3. The appropriate level of penalty to be applied, considering the taxpayers’ cooperation and disclosure.

Arguments of the Parties

Appellants' Arguments

• The taxpayers fully disclosed all relevant information on their returns based on professional advice from two reputable firms and included the required DOTAS number.
• They exercised reasonable diligence consistent with a taxpayer entering a packaged tax avoidance scheme, relying on advisers for technical and commercial matters.
• Reliance on professional advice should protect them from negligence penalties, as established in precedent cases.
• They cooperated fully with HMRC during enquiries and paid the tax due before the final decision in a related case.

Respondents' Arguments

• HMRC did not argue that entering a tax planning transaction is negligent per se, but that the taxpayers were negligent in failing to investigate the commercial reality of the transactions, including the existence and repayment of the loans funding the acquisition.
• The scheme documents were flawed and could not be authenticated; the taxpayers should have been aware of this and not relied solely on them.
• Taxpayers, as business people, had a duty of care to ensure the accuracy of their returns and should have understood the commercial implications.
• Failure to establish the commercial reality constituted failure to take reasonable care, thus amounting to negligence.

Table of Precedents Cited

Court's Reasoning and Analysis

The Tribunal acknowledged that taxpayers entering packaged tax avoidance schemes are entitled to rely on professional advisers for technical and legal matters, and that ignorance of complex legal details does not necessarily constitute negligence. The court applied the Anderson test, considering what a reasonable taxpayer exercising reasonable diligence would have done in this context.

However, the court distinguished between technical legal reliance and basic commercial reality. It found that the taxpayers failed to make any reasonable enquiry into the commercial substance of the transactions, particularly the existence and repayment of a significant £400,000 loan necessary to acquire the capital redemption policies. The lack of documentary or banking evidence to support the loan and the retrospective nature of repayment confirmations raised serious doubts about the genuineness of the transactions.

The Tribunal concluded that even a sophisticated taxpayer should have conducted basic due diligence to confirm that the commercial elements of the scheme were genuine and not a sham. Reliance solely on limited advice and documents provided by professional advisers was insufficient. The taxpayers’ failure to satisfy themselves on these commercial matters amounted to negligence in completing their tax returns.

Regarding the DOTAS disclosure, the court found that including the DOTAS number did not relieve the taxpayers of their obligation to ensure the commercial reality of the transactions. While the taxpayers cooperated fully during HMRC enquiries and paid the tax due promptly, these factors did not negate negligence but were relevant only to mitigation of penalties.

Holding and Implications

The Tribunal DISMISSED the taxpayers’ appeal against the negligence penalties but exercised its discretion under section 100B of the Taxes Management Act 1970 to mitigate the penalties.

The penalties were reduced to 10% of the tax due for each taxpayer, reflecting increased allowance for disclosure and cooperation compared to HMRC's original penalty calculation. The decision confirms that taxpayers entering packaged tax avoidance schemes cannot rely solely on professional advice without basic commercial scrutiny, particularly regarding significant financing arrangements underlying such schemes.

No new legal precedent was established beyond the application of existing principles concerning negligence, reliance on professional advice, and taxpayer obligations in the context of complex tax avoidance schemes.