An unwelcome Notice - the full story

The Follower Notice regime has often been described as draconian. Whatever your view, it is undeniably a powerful tool in HMRC’s armoury, one which should (in theory) be handled with the utmost care. But what happens if you put this tool in the hands of an inexperienced inspector? We explore the recent ruling in Haworth v HMRC [2021] UKSC 25, where the Supreme Court found HMRC had issued a follower notice unlawfully.

This has been a long-running case that is systemically important in establishing taxpayer protection. It demonstrates that HMRC’s interpretation and operation of the legislation were not correct and brings into question the validity of many other notices which HMRC may have issued.

What is a Follower Notice?

A Follower Notice is issued by HMRC to taxpayers who took part in avoidance schemes that have been determined by previous court rulings to be ineffective. These Notices were designed to accelerate the resolution of open enquiries by forcing taxpayers to accept the ruling made in other cases and pay any tax and NICs due.

Follower Notices are no different from any other powerful tool at HMRC’s disposal, as there are certain conditions that HMRC must satisfy before issuing such Notices. These conditions are as follows:

• Condition A - A tax enquiry must be in progress into a return or claim made by the taxpayer in relation to a relevant tax, or the taxpayer must have made an appeal in relation to a relevant tax that has not been determined, abandoned, or otherwise disposed of
• Condition B – The taxpayer made the return, claim or appeal on the basis that a particular tax advantage arises from the tax arrangement.
• Condition C – HMRC is of the opinion that there is a judicial ruling which is relevant to the chosen arrangements.
• Condition D – No previous Follower Notice has been given to the same person (and not withdrawn) by reference to the same tax advantage, tax arrangement, judicial ruling and tax period.
• Follower Notices need to be issued in a particular time frame. A Follower Notice will be out of time if it is served any later than either of the following: 12 months from the date of the judicial ruling becoming final or 12 months from the day that HMRC received the taxpayer’s return, claim or appeal. 

Can you appeal a Follower Notice?

Once a Follower Notice has been issued there are three options. A taxpayer can either:

• Do nothing.  If a taxpayer chooses to do nothing then HMRC will impose penalties based on a percentage (10%-50%) of the denied advantage
• Comply with the notice.  If a taxpayer complies with the notice, he/she will have 90 days in which to take the corrective action requested by the notice
• Challenge the notice.  It is important to note that this is not an appeal as there is no right to appeal a Follower notice. However, representations can be made to HMRC to challenge the validity of the Follower Notice on the basis that one of the conditions A to D listed above have not been met. 

Key facts

Mr Haworth had established a trust to hold shares. The trustees were originally residents in Jersey and later in Mauritius. The change to Mauritius resident trustees was made in 2000 as Mr Haworth was considering disposal of his shares at this point. The intention was that this change in trustees would avoid any capital gains tax on the disposal of the shares. The premise of the scheme revolved around the argument that gains would be exempt from the charge to UK tax by virtue of the UK/Mauritius double tax treaty. If the tie-breaker provision under the treaty determined that the place of effective management (“POEM”) of the trust was in Mauritius and not the UK, the gain would be exempt from UK CGT.

Mr Haworth disclosed that he had entered arrangements where he avoided any capital gains tax arising from the disposal of shares in his tax return for 2000/2001. HMRC subsequently opened an enquiry into Mr Haworth’s tax return and issued a Follower Notice contending that the Court of Appeal had already decided in Smallwood v Revenue and Customs Comrs [2010] EWCA Civ 778; [2010] STC 2045 (“Smallwood”) that the provisions Mr Haworth relied on did not relieve him of a UK CGT liability.

Mr Haworth brought judicial review proceedings to challenge the Follower Notice and although Mr Haworth’s challenge was initially dismissed at the first instance, it was subsequently allowed by the Court of Appeal and Supreme Court, on the basis that the conditions required for the giving of a Follower Notice had not been satisfied.

HMRC and Mr Haworth had common ground with regards to Conditions A, B, and D. it was Condition C which proved to be the point of contention. The Supreme Court considered four issues in arriving at its decision.

Issue 1 – Did HMRC form the opinion required by Condition C?

This issue was the most discussed, with significant commentary on this in the judgment of the Supreme Court. HMRC was of the opinion that it was “likely” that Smallwood was a relevant ruling covering Mr Haworth’s case and so it was more than likely that it results in the asserted tax advantage being denied. The Supreme Court stated that,

 “The issue here is whether, HMRC having reasonably formed the opinion that it is likely that the application of Smallwood would deny Mr Haworth his asserted tax advantage, that is enough to establish that Condition C is satisfied.”

Emphasis was placed on the word “Would” and the question asked as to,

 “how certain must it be, in HMRC’s opinion, that Smallwood provides the answer in Mr Haworth’s case before it can be said that HMRC’s opinion is that Smallwood would deny Mr Haworth the advantage he asserts?”

It goes without saying that HMRC was not pleased with the above and suggested that the Court of Appeal had placed “a non-statutory, additional threshold or gloss on the wording of section 204(4) by holding that HMRC must have a high degree of confidence or certainty before it can form the opinion that the relevant ruling would deny the tax advantage.”

While discussing this issue, the Court considered the judgment in R (UNISON) v Lord Chancellor (Equality and Human Rights Commission intervening) (Nos 1 and 2) [2017] UKSC 51; [2020] AC 869, where it was clear that it is important to take into account the severe consequences for the taxpayer of the giving of a notice. The Supreme Court then concluded that,

“the use of the word “would” in the provision requires that HMRC must form the opinion that there is no scope for a reasonable person to disagree that the earlier ruling denies the taxpayer the advantage. Only then can they be said to have formed the opinion that the relevant ruling “would” deny the advantage. An opinion merely that is likely to do so is not sufficient” [emphasis added].

The Supreme Court stated that whether HMRC can reasonably form the opinion that an earlier ruling is relevant to the taxpayer’s asserted advantage will depend on a number of factors. These factors include the sensitivities of the fact patterns of each case, the truthfulness of the taxpayer’s evidence, differing legal arguments (as demonstrated in  R (Locke) v Revenue and Customs Comrs [2019] EWCA Civ 1909; [2020] 1 All ER 459; [2019] STC 2543.) and the nature of the earlier ruling.

Taking all of the above into account, Mr Stone (HMRC representative) accepted that the evidence presented by HMRC did not support the conclusion that HMRC’s opinion was anything more than that it was likely that the ruling in Smallwood if applied, would deny Mr Haworth his tax advantage. Thus, the Supreme Court dismissed HMRC’s appeal on this ground.

Issue 2 – Did HMRC misdirect themselves in their analysis of Smallwood?

This issue revolved around HMRC’s understanding of the legislation and the decision in Smallwood. Evidence provided demonstrated that HMRC was working on the premise that any case that shared a set amount of pointers with Smallwood inevitably meant that its POEM would be the UK and not Mauritius. However, the Supreme Court agreed with the following statement from the Court of Appeal,

“no definitive rule can be given and all relevant facts and circumstances must be examined to determine the place of effective management”

Accordingly, the Supreme Court held that HMRC Had misdirected in this respect.

Issue 3 – Whether the “reasoning given” in the ruling covers factual findings

Counsel for Mr Haworth argued that factual findings in a judgment do not form part of the principles laid down or reasoning given in a ruling for the purposes of Condition C. This contention was rejected by the Judge, the Court of Appeal and also the Supreme Court And so Mr Haworth’s submission on this point was dismissed. 

Issue 4 – The validity of the follower notice

Mr Haworth contended that HMRC had not given an explanation as to why Smallwood determined its case which is required by section 206. The Follower Notice should have identified the key facts on which HMRC relied in forming their opinion that Smallwood would defeat Mr Haworth’s appeal. The Supreme Court agreed that the Follower Notice was deficient. The key quote on this point is as follows:

“I would not want to encourage HMRC to send voluminous notices to taxpayers. But some more explanation as to why the corresponding reasoning applied to his arrangements should have been set out. This is required even though there may have been discussions between HMRC and Mr Haworth’s advisers prior to the giving of the notice. The notice need not be lengthy, but it should have contained a description of the features of Mr Haworth’s arrangements that in HMRC’s opinion meant that Smallwood would deny him the tax advantage asserted.”

However, it is important to note that although the Court agreed that the Notice was defective, there is no mechanism within section 206 that allows for such defects to invalidate the Notice. As a result, Mr Haworth’s contention was rejected.

That said, the Court decided that overall, there was enough evidence to dismiss HMRC’s appeal. 

Where now?

The decision is a great win for maintaining the rule of law. It provides a layer of protection to taxpayers. As mentioned at the start, Follower Notices are a great tool for HMRC but, to paraphrase the Spiderman author Stan Lee, great power needs to be wielded responsibly. This tax case has established that Follower Notices were never intended to be used by everyone. They are to be used by skilled investigators after much thought and consideration. Going forward the fact pattern of each case needs to be scrutinised and, only when HMRC is confident that the potential case is materially the same as a litigation case and the taxpayers' appeal would fail, should Follower Notices be issued.

The decision could have ramifications for taxpayers who have received Follower Notices in the past. There are no doubt taxpayers and advisers will be in discussions to review the validity of such Notices.   

Currently there is no mechanism to approach HMRC if you feel that you may have been affected by this judgment, other than through judicial review. However, HMRC confirmed they will contact any taxpayers who they believe may have been affected by the judgement as soon as possible.

Get in touch

If you have been served a Follower Notice and would like a no obligations free initial discussion, get in touch with a member of the Tax Investigations team on +44(0)121 232 9519, +44(0)20 7063 4639, or +44(0)161 238 9235.