The U.K. Supreme Court released its decision on July 2, 2021 in what is a landmark case in the tax world—R (on the application of Haworth) (Respondent) v Commissioners for Her Majesty’s Revenue and Customs (Appellant)  UKSC 25. The judges unanimously concluded on an application for judicial review by Mr Haworth and found that HM Revenue and Customs (HMRC) had unlawfully issued a follower notice and consequently an accelerated payment notice to Mr Haworth.
Follower notices were introduced in the Finance Act 2014 and gave HMRC further powers to tackle historic tax avoidance. At the time, the introduction of the legislation was very controversial because once issued, the taxpayer had no statutory right of appeal and the notice required the taxpayer to close HMRC’s inquiry into the tax avoidance that the taxpayer had participated in—paying the tax saved plus interest—or risk a 50% penalty.
Effectively the taxpayer had the option to “throw in the towel” or risk an extremely onerous financial penalty if, at the eventual outcome of the inquiry into the tax avoidance, it was found to be unsuccessful.
At the time the accountancy and legal profession expressed grave concerns that the proposed legislation could in practice deny clients access to justice because of the penalty risk, and also that the decision whether to issue a follower notice rested solely with HMRC and the inability to appeal the notice meant that HMRC would be acting as judge and jury in the decision-making process.
In response HMRC committed to put in place “strict internal governance and safeguards so that follower notices can only be issued following approval at senior level within the organization, and will be scrutinized by staff other than those who have been working on the detail of the case.”
The only legal remedy open to a taxpayer on receipt of a follower notice is judicial review—which is expensive and, being litigation, carries uncertainty.
The essential criterion for HMRC to issue a follower notice is that there needs to be a previous judicial ruling, which if the principles or reasoning of that judicial ruling were applied to the tax avoidance the taxpayer had participated in, would (author’s emphasis) deny the benefit of that tax avoidance.
Mr Haworth listed his successful software business on the U.K. Stock Exchange in the summer of 2000, at the height of the technology bubble when company valuations were irrationally high (albeit the bubble burst shortly afterwards). He held shares personally but also through a long-standing family trust.
Because of the unfairness of the application of the taper relief rules (the predecessor to entrepreneurs’ relief), on advice from leading tax counsel the trust was migrated to Mauritius and the U.K. in the same tax year with the objective of taking advantage of the U.K.–Mauritius double tax treaty. This tax planning was colloquially called “Round the World” and was implemented by approximately 50 taxpayers.
HMRC issued a follower notice to Mr Haworth citing the case of Smallwood v HMRC [EWCA/Civ/2010/778] as the relevant judicial ruling and its justification for issuing the notice.
Through the judicial review process, documents were obtained from HMRC which established that the internal submissions to HMRC’s governance panel said that it was “likely” the ruling in the Smallwood case would deny the tax advantage sought by Mr Haworth. Lady Rose giving the leading judgment of the Supreme Court agreed with Mr Haworth’s Counsel that the statutory test of “would” is a higher threshold than HMRC had adopted of “likely.”
HMRC’s appeal against the decision of the Court of Appeal was rejected on this ground.
HMRC also lost its appeal on the second ground—which is that it misdirected itself on what Hughes LJ said in the Smallwood case.
Hughes LJ identified seven key factual “pointers” from the Smallwood case. HMRC argued that these “pointers” inevitably led to the conclusion that the management of the Haworth trust was in the U.K. rather than Mauritius (along with the other clients that HMRC issued follower notices to) and proceeded to use this as another reason to issue a follower notice to Mr Haworth.
Lady Rose rejected HMRC’s view, saying “That does overstate the conclusion of the Court in Smallwood. Hughes LJ did not decide that it was an inevitable consequence of a scheme which shared the Smallwood pointers that its POEM would be the UK and not Mauritius.”
Another important point arose in the Haworth case. The documents obtained from HMRC demonstrate it could not unequivocally show that all the documents presented by Mr Haworth’s advisers to HMRC in support of his case were fully reviewed before the submission to the internal governance panel which decided to issue the follower notice.
Impact of Decision
It is understood that HMRC issued follower notices to a number of other taxpayers who implemented the Round the World tax planning, and did so adopting the same internal governance process it followed with Mr Haworth. Based on the Supreme Court’s conclusions, it is highly likely those follower notices were also unlawfully issued. The author is aware that most of those other taxpayers in receipt of a follower notice decided—many very reluctantly—to bring HMRC’s inquiry to a conclusion at that point in time and pay the tax HMRC concluded was due, rather than risk a 50% penalty.
Some of those taxpayers may want to consider revisiting their position. If their fact pattern supports the original tax planning was robust but they closed the inquiry on receipt of the follower notice, the Haworth decision may give them the ability to have their inquiry re-opened.
The wider context of the Haworth decision is whether HMRC applied the wrong threshold test for the many other follower notices it has issued in respect of other tax planning arrangements, i.e. it applied the “likely,” not “would,” test. The precise number of follower notices HMRC has issued is not known to the author but it is likely to be in the thousands. If the incorrect threshold has been applied, many if not all of those follower notices were also unlawfully issued.
Since the Supreme Court released its decision HMRC has made the following announcement:
“On 2 July, the Supreme Court handed down its judgment in the case R (on the application of Haworth) vs Commissioners for Her Majesty’s Revenue & Customs. The case related to a Follower Notice (FN) issued to Mr Haworth, and the Accelerated Payment Notice (APN) which accompanied it. HMRC may issue FNs to users of avoidance schemes which, in the opinion of HMRC, have been shown to fail in another person’s litigation. APNs can be issued with FNs and require the recipient to pay the disputed tax to HMRC pending resolution of the dispute.
“This was the first challenge to the FN legislation to be considered by the Supreme Court. HMRC lost the case on all grounds.
“The Court provided a useful clarification of the test HMRC must apply when deciding whether to issue Follower Notices. HMRC are considering the judgment carefully and the extent to which any customers who have received FNs might be affected. There is no need for customers to contact us about this case, we will contact any customers we think will be affected by the judgment as soon as possible.”
It remains to be seen how HMRC reacts to, and whether and if so to what extent it agrees with, the analysis of the Haworth decision—not just that of the author, but other commentators from within the accountancy and legal professions.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Jon Claypole is a Partner in tax dispute resolution at BDO.
The author can be contacted at: firstname.lastname@example.org